Government frames ‘safe harbour’ rules for MNCs, move to end rising transfer pricing disputes

NEW DELHI: The government on Wednesday announced draft rules under which income-tax authorities will not question the pricing of related party transactions, hoping to end the rising dispute and litigation with multinationals companies over their dealings with Indian subsidiaries.

Finance minister P Chidambaram had promised these ‘safe harbour’ rules in the budget to address transfer pricing disputes. "These rules will provider certainty...The idea is to ensure there is less litigation," Revenue secretary Sumit Bose told reporters announcing rules.

The draft rules are based on the recommendations of the N Rangachary committee set up by Prime Minister Manmohan Singh and will be applicable for two assessment years beginning 2013-14 for sectors including IT, ITeS, contract research and development in pharmaceutical, financial transactions such as outbound loans and corporate guarantees and auto ancillaries.
Transfer pricing refers to what related entities charge to each other in a cross-border transfer of goods, intangibles like brand or services. Though these transactions are supposed to be priced on an arms-length principal -- what it would cost if the purchase was from a non-related party -- but how such arms length price is determined is often a source of dispute.

According to Grant Thornton, India is the third litigious country in respect of transfer pricing, a situation these rules should address by providing clarity and certainty. India made adjustment of about Rs70,000 crore under transfer pricing.

MNCs such as Shell and Vodafone were slapped notices worth thousands of crores for allegedly undervaluing the sale of shares in cross-border transactions as tax authorities increased heat under transfer pricing. The safe harbour rules are expected to provide conditions under which tax authorities will not question these transactions and in line with Chidambaram’s promise of a stable tax regime.

For example, if the safe harbour rules stipulate that the margin in a particular industry is 20%, and if the transfer price declared by a company in the industry is not less than this margin then the tax authorities would accept the return without questions.

The rules will cover transactions up to Rs100 crore and specify the acceptable margins for different industries. The final set of rules will be issued after August 26 by which stakeholders can give their feedback.

Tax experts welcomed the rules and expected them to reduce litigation, but felt that final rules can be better.

“In order to positively impact dispute resolution, the margins or safe harbours proposed in the draft may need to be recalibrated to a more acceptable zone,” said Vijay Iyer, Partner & National Leader - Transfer Pricing, EY. Investors from no-tax or low-tax jurisdictions notified under the income tax will not be eligible to under these rules and will apply only in cases where taxpayer exercises his option to be governed by such rules.

A taxpayer invoking safe harbour rules will not be able to invoke mutual assessment procedure under tax treaties. Tax administrations in most developed nations such as Australia, New Zealand and Canada have incorporated safe harbour rules in tax laws to provide clarity on tax liability of MNCs operating in their countries.