Internationally, safe harbour and Advance Pricing Arrangement (APA) are emerging as the two most efficient ways of reducing litigation in the area of transfer pricing, which is developing as the most important taxation subject among the chief executives and tax authorities.
The literal meaning of the term “safe harbour” is “safe haven or a place which provides security or safety”. In taxation, it means that the results of the taxpayers who fulfil the required conditions are accepted and they are exempt from detailed scrutiny. This provides certainty to taxpayers, particularly to those investing in a new tax jurisdiction. This concept is not new to India as the tax law has several such provisions that provide for computation of income on the presumptive basis. For example, 5% of the receipt has to be taken as profits or gains of a non-resident engaged in the operation of aircraft for transporting passenger or cargo from any place in India.
Obviously, for tax administrations, the safe harbour or presumptive basis of taxation is a simplified approach for the computation of income with a view to bring more prospective taxpayers in the tax net. It minimizes not only the compliance cost for taxpayers but also the administrative cost for tax administration.
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Though the safe harbour provisions provide a degree of simplicity for tax administrations and taxpayers, these suffer from a couple of drawbacks. First, it is difficult (but not impossible) to quantify the safe harbour. Second, if the other tax jurisdiction does not accept the approach, then there may be double taxation. Further, it may suffer from a fundamental problem in tax administration not agreeing to give up its discretion in determining the taxable income.
APA is the alternative approach, which is gradually gaining greater acceptability. The basic difference between the two is that while safe harbour is general in nature, APAs are taxpayer-specific.
An APA is as an arrangement between a tax authority and a taxpayer that determines, in advance of intra-group transactions, an appropriate transfer pricing methodology for a fixed period of time. An APA is unilateral if one tax jurisdiction is involved, and bilateral when two tax jurisdictions are involved. The latter provides the certainty of the arrangement being accepted by both the tax jurisdictions, thereby removing any chance of double taxation.
In spite of certain shortcomings, APAs are becoming popular due to the certainty these provides. Many countries, such as the US, the UK, Australia, China, South Korea and Singapore, have put APA mechanism in place. APAs can be successful only when the tax authorities show sufficient openness and willingness to reach a compromise solution, and taxpayers are willing to share necessary information with tax authorities. The obligation on tax authorities is that they must maintain secrecy and must not use information collected during the process against taxpayers if the process fails.
In India, either the jurisdiction of the Authority for Advance Ruling should be increased to cover the APA or the Competent Authority unit in the Central Board of Direct Taxes may be strengthened to deal with APAs. Alternatively, a separate unit with experts from the income-tax department and outside may be constituted to work on APAs. This unit may provide support to the Competent Authority. To make it workable, sufficient authority and protection may be granted by law to this unit. However, until the APA mechanism is put in place, the provisions of safe harbour can be incorporated in tax law to minimize litigation on transfer pricing.
S.P. Singh, Prashant Deshpande and Ankit Arora are with Deloitte India. Respond to this column at firstname.lastname@example.org