‘Safe harbour’ Tax Rules may be Haven for Smaller IT Firms

Smaller captive units in the information technology (IT) and IT enabled services (ITeS) space are likely to readily opt for the safe harbour route being introduced by the tax department.

This may not be the case for those engaged in the knowledge process outsourcing (KPO) space or contract R&D in information technology as the mark-up margins specified in these areas are on the higher side, say tax experts.

The safe harbour margins for IT, ITeS and KPO services diverge significantly from each other.

DRAFT RULES

The draft rules prescribe a margin of 20 per cent on the operating cost for IT and ITeS while the margin for KPO and contract R&D in IT is at 30 per cent on the operating cost.

Safe harbour provisions are being introduced to alleviate the uncertainty faced by captive units and at the same time ensure an acceptable level of taxable profit.

A safe harbour provides circumstances in which a taxpayer follows a simple set of rules/margins under which transfer prices are automatically accepted by the tax authorities.

“The Government has taken a right first step by bringing out the draft rules. Smaller companies in IT/ITeS will opt for it”, said Rahul Mitra, Leader-Transfer Pricing, PwC India.

For units in KPO, the Government can make safe harbour attractive and more acceptable if margins can be lowered (from 30 per cent), he added.

Ever since the transfer pricing regime was introduced in 2001, there had been innumerable disputes on the right arm’s length price for international transactions.

This had consumed resources of both the taxpayer and the tax department besides impacting the investors’ sentiment about the tax environment in India.

TRANSFER PRICING

The captives in particular were experiencing significant transfer pricing adjustments to their margins during audit in the last few years. This was seen to defeat one of the purpose of offshoring — cost arbitrage.

To minimise transfer pricing disputes, the Government has been taking various initiatives — the latest being introduction of draft safe harbour rules.

With the draft safe harbour rules now exposed for comments/feedback, the Central Board of Direct Taxes (CBDT) is getting slew of suggestions.

Professional services firm Deloitte has suggested to the CBDT that a single margin be adopted for the entire IT industry.

Given the macro-economic situations and similarity in profile of risk functions and assets across IT industry, it would be appropriate not to segment the services, Samir Gandhi, Tax Partner, Deloitte, Haskins & Sells, told Business line.

There should not be any classification of the industry into multiple segments as the political, social and macro-economic challenges of the industry have similar effect on different segments within the IT industry.

TURNOVER LIMIT

Deloitte has also made a case for increasing the turnover threshold provided in the draft rules to Rs 500 crore from proposed level of Rs 100 crore, Gandhi said.

“Either the threshold should be dropped completely or expand it substantially to say Rs 500 crore to cover sizeable number of taxpayers”, Deloitte has submitted.

Gandhi also said that an eligible taxpayer should be given an opportunity to file the prescribed form to avail safe harbour benefits within three months from the beginning of the financial year.

Business Line, New Delhi, 30-08-2014