With a view to reduce prolonged transfer pricing disputes, the much-awaited Safe Harbour Rules (SHR) were notified by the Central Board of Direct Taxes (CBDT) in September 2013. SHR provide for the parameters based on which the transfer prices declared by an eligible assessee in respect of an eligible international transaction would be accepted by the income-tax authorities. Accordingly, the acceptable rates (return on operating costs) for the captive service providers from the information technology (IT) sector, the manufacturers and exporters of auto components, and the rates for prescribed intra-group loans and corporate guarantees have been prescribed.
The Assessment Year (AY) 2013-14 was the first year to be covered under the SHR, but the financial accounts of many taxpayers were closed when the final SHR were notified. Further, a very small two-month window was available for the taxpayers to decide whether to opt for the SHR or not, given the due date of November 30, 2013, for the filing of their income-tax return. Given this, and certain other reasons as mentioned subsequently, it appears that not many eligible taxpayers opted for the SHR in the first year.
A challenge faced by captive software services providers was the categorisation of such services into software development services, knowledge process outsourcing services and contract research and development services wholly or partly relating to software development”, with prescribed safe harbour operating margins from 20% to 30% of the operating costs, depending upon the category of services. These margins were perceived to be on the higher side with a potential for double taxation for the Group, given their likely unacceptability in the jurisdiction of the payer of these services, coupled with the unavailability of Mutual Agreement Procedure under the Double Taxation Avoidance Agreements if one were to opt for the SHR. Moreover, in certain situations, given the manner in which the categories were defined, there was ambiguity on the category within which a captive software services provider will fall if the SHR were to be adopted. There was also a requirement that such service providers should be providing services with “insignificant risk”. While the rules did elaborate that this would inter alia mean that the overseas principal is performing most of the economically significant functions, including managing and controlling of all the significant risks, there were apprehensions amongst some of the captive software services providers, as to whether they