Transfer pricing: Advance pricing pact vs safe harbour provision

Transfer pricing (TP) provisions are aimed at ensuring that transactions entered into between related parties are carried out on arm’s length basis. Globally, TP has helped governments to address concerns of base erosion and profit shifting and also in keeping a check on possible tax leakages in cross border intra-group transactions.

India introduced TP regulations in 2001. With the passage of time, various disputes arose between the taxpayer and the Indian tax authorities. These disputes ranged from simple issues such as the selection of most appropriate TP methodology and comparability analysis to much more complex matters such as computation of notional income on overdue trade receivables, arm’s length nature of financial arrangements such as loans and guarantees, rights in intangibles, etc. To avoid litigation, Advance Pricing Agreement (APA) regime was introduced in 2012, followed by Safe Harbour Rules in 2013.

APA provides an opportunity to taxpayers to negotiate and finalise the arm’s length price (ALP) of its intra-group transactions or the manner for computing such ALP, with the Indian tax authorities for a fixed period. On the other hand, safe harbour provisions prescribe minimum return/price (such as a minimum return of 17/18% on total operating costs for a captive software developer) for a specified list of intra-group transactions, which, if followed by the taxpayer, would be accepted by the Indian tax authorities.

APA and safe harbour provisions

The initial version of the safe harbour scheme did not find much favour with the taxpayers, primarily on account of unduly high margins/prices being prescribed, such as operating profit margin in the range of 20-22% for IT/ ITeS transactions. This led the government to bring out revised rules in 2017 to make it more appealing.

The revised rules, in addition to bringing down the prescribed margins, also included ‘inbound low-value adding intra-group services’ (which primarily covers support services having limited risk and which are neither in the nature of core business activities, nor involve use of or result in creation of unique and valuable intangibles) as one of the covered intra-group transactions.

However, only transactions up to `10 crore can be covered under the safe harbour regime for low-value adding services and a maximum of 5% mark-up could be charged on such services.

Further, pricing for high-end KPO services was linked to the percentage of employee cost in the revised rules.

The revised rules have still received a cold response, primarily due to limited applicability to the notified intra-group transactions and higher margins, as compared to the margins agreed under an APA in the past.

The APA programme, on the other hand, has gained considerable traction as evidenced by the successful conclusion of 271 APAs, including 31 bilateral APAs till 31 March 2019. The concluded APAs span across diverse industries such as IT, telecommunication, pharma, oil, gas and minerals, automobile, banking & finance, etc. Furthermore, they cover varied intra-group transactions such as the provision of IT/ITeS/ KPO, investment advisory services, import and export of goods, financial transactions, intangible related transactions such as royalty payments, the incurrence of advertising, marketing & promotion expenses, etc.

The Indian government has time and again highlighted its intent to develop a non-adversarial tax regime through the progress of its APA programme.

It is also attempting to win over taxpayer confidence by ensuring quick resolution of such APA requests. FY 2018-19 was the first year when the APA signed from FY 2013-14 onwards became due for renewal. Indian government was even successful in concluding a renewal request within a short span of few months in October 2018. This clearly shows the willingness of the Indian government to provide a quick resolution to taxpayers.

In conclusion

The safe harbour provisions are due for renewal in FY 2019-20. It is expected that the government may continue with its agenda of developing an investor-friendly tax regime and come out with an improved version of the current safe harbour regime to make it more appealing. APA has gained acceptance as an effective tool to achieve certainty on the transfer pricing front. The government is also adopting a pragmatic approach while concluding APAs even in case of complex transactions such as financial arrangements and intangible related transactions, thereby creating positive sentiment amongst the investor community.

The choice between APA and safe harbour provisions needs to be made by the taxpayer after evaluating multiple factors such as nature and complexity of the transactions involved, value of transactions, future business plans, TP litigation history, need of attaining certainty on TP positions in both jurisdictions, etc. Thus, companies having their presence in India should objectively decide between APA and safe harbour provisions, based on its requirement.

1. When should one file for an APA or safe harbour request??

A safe harbour application can be filed by the taxpayer either in one go for all the years for which such option is proposed to be applied (provided such years are covered by the scheme) or for each such year separately. However, such request needs to be filed before the due date of filing return of income in India (for the first year/year for which such safe harbour is opted).

On the other hand, an APA request needs to be filed before the start of the first FY proposed to be covered under the APA (in respect of an ongoing transaction) or before entering into the transaction (in respect of a proposed transaction). Furthermore, the roll-back request also needs to be filed along with the main APA application/ request

2. Can the taxpayer withdraw its application after opting for an APA or safe harbour?

An APA request can be withdrawn at any time before the terms of the APA are finalized, by furnishing a withdrawal request in the prescribed format. However, in the event of withdrawal, the statutory fee paid by the taxpayer is not refunded.

On the other hand, if the safe harbour is opted in one go for multiple FYs, then the taxpayer can opt out of the scheme in respect of subsequent year(s) (except the initial FY) by furnishing a declaration to this effect to the tax officer.

Vikas Vasal is national leader tax, Grant Thornton India LLP.

Rajeev Jain and Varun Gupta contributed to this article.