News Update

Safe Harbour Rules: a much-awaited antidote in an era of uncertainty

JULY 19, 2021

By Vikas Gupta & Sreemoyee Ghose

AT a time when India had emerged as a hub of controversial Transfer Pricing ("TP") disputes, often involving high stakes, amongst others, the Safe Harbour Rules were introduced in 2013 with the three-fold objective of reducing litigation for highly litigative international transactions (started with few international transactions with addition of few more in the recent years), providing certainty for both taxpayer and tax authorities, and directing the focus of tax authorities towards more complex TP transactions.

On the basis of various parameters, the Safe Harbour Rules was perceived to have been the game-changer for TP litigation in India as it is easier to comply with simplified procedures, a high degree of certainty within a reasonable time period, and have the flexibility to be suitably adopted in line with the constantly evolving Indian TP environment.

With the ongoing disruption to businesses owing to the Covid-19 pandemic, as we have moved to the Financial Year 2021-22, the Indian taxpayers continue to grapple with uncertainties on several TP issues, and have time to time requested the Indian tax authorities for providing clarity on the same.

Few governments around the world have initiated several relief measures on account of Covid-19, i.e.

- The Australian Tax Office has introduced a detailed Covid related TP guidance, clarifying a plethora of issues which taxpayers are presently struggling with to ensure TP related compliances, along with the impact of Covid-19 on existing APAs1 and way forward for ongoing APAs

- The Inland Revenue Authority of Singapore published detailed FAQs to address TP considerations of businesses impacted by the Covid-19 pandemic.

While the actions on the part of the Indian Government to address the plight of the taxpayers by extending the due dates for TP compliances from time to time are much appreciated, there has been no announcement on the specific guidance relating to COVID related uncertainties and impact on the Indian businesses.

In such a scenario, the Safe Harbour Rules, yet to be notified for the FY 2020-21 and 2021-22 (which can be categorized as the "Covid years") may prove to be the "Remdesivir" to provide the much-needed clarity and reduce uncertainty in such trying times for taxpayers. Some of the issues which can be addressed through the awaited Safe Harbour Rules are discussed below:

1. Reduction in the operating margins in the wake of the Covid pandemic:

A substantial portion of TP disputes in India are concentrated towards determination of Arm's Length Prices with regard to international transactions of providing software development (IT), IT enabled Services (ITeS) and other service transactions, which often arise due to a disconnect in the comparable used and also the use of appropriate filters while carrying out a search on third party databases. This has been one of the most prevalent issues, especially for captive cost-plus remuneration service provider and the objective of introducing the Safe Harbour regime was to address such situations, thereby helping to reduce TP litigations.

Recently, the first wave of Corona virus, which was a black swan event for the world economy, has been hard hitting on many businesses, and the second wave is continuing to cause severe disruptions to business. Also, it is anticipated that India is on the verge of facing the third wave as well soon.

Thus, the companies are constantly feeling the need to revisit the operating margins owing to the recurring imposition of lockdowns and business operations being hit.

Accordingly, considering the ongoing economic uncertainties revolving around different businesses, continuing with the higher prescribed margins as mentioned below may fail to attract several Indian taxpayers into the regime, thus defeating the very purpose of introducing it:

- 17-18% for provision of involving IT and ITeS;

- 18 to 24% for provision of KPO services;

- 24% for contract Research and Development services relating to software development or in relation to genetic pharmaceutical drugs; and

- 12 to 8.5% for manufacture and export of core or non-core auto components, as may be applicable.

Therefore, as business are heading towards the closure of the books of accounts for the year, it is imperative as well as crucial, that the Government considers reducing the previously notified prescribed margins for the years affected due to COVID-19, considering the economic realities surrounding various industries.

2. Clarity on treatment of various items in the cost base while calculating PLIs2:

Due to effects of COVID-19, there has been a drastic change in the manner in businesses are conducted. Businesses are scrambling to deal with a wide variety of problems, from slumping sales, stalling supply chains and the concept of working remotely due to stringent lockdown measures introduced by the Indian Government.

Accordingly, there has been a significant change in the cost structure especially relating to administrative related overheads. Typically for arriving at arm's length price/ margin for transfer pricing calculation purpose, revenue and expenses are classified into operating and non-operating categories and for this purpose, Indian taxpayers often rely on the existing guidance available in the existing Safe Harbour rules and principles are laid down in various judicial pronouncements over the years.

However, considering a fundamental shift in the ways the businesses are operating, such categorization of costs may be evaluated on a different basis, especially for the periods substantially affected due to Covid.

Considering the same, it is critical that the much-awaited Indian Safe Harbour rules provide guidance on the following type of cost categories, especially for the Financial year (FY) 2020-21 and 2021-22.

- Value added costs: Includes cost incurred which are contributing to the services rendered or products manufactured by the entity – which forms part of the cost base for the purpose of charging mark-up;

- Non-value added costs: Includes cost incurred due to long-term contractual obligations, but are currently not contributing to the services rendered or goods manufactured; and

- Extra-ordinary costs: Includes one-time extra-ordinary costs incurred as a part of COVID-19 related safety measures.

In light of the above, it can be anticipated that the Safe Harbour Rules will provide guidance on the manner of calculation of cost base considering the unforeseen costs incurred by taxpayers owing to the ongoing pandemic. We have listed below few of such examples:

- Certain cost which are continued to be incurred like leasehold related cost, maintenance for common area of offices, minimum charges paid to vendors for cafeteria charges etc., due to contractual obligations however not adding value to the business operations;

- Expense related to COVID-19 safety measures like for sanitizing the office premises, conducting vaccination drive, etc. which are in the nature of one-time cost;

- Provision for impairment of assets due to the effects of COVID- 19; and

- Costs related to restructuring of businesses like voluntary or involuntary shutting down of business segments or scaling back operations.

3. Clarity in relation to borrowing /guarantee :

With business operations being severely impacted owing to the ongoing lockdowns imposed from time to time, shortage of funds has become a fundamentally critical issue for several businesses. Globally, including India, major economic policy responses have been introduced by central banks and governments to try to attenuate the impact of the Covid-19 pandemic on the economy. This included lowering the interest rates and introducing quantitative easing measures.

In lieu of the same, the Government of India may consider lowering the Safe Harbour rates for guarantee transactions considering the substantial low interest rates prevailing globally due to the monetary stimulus measures introduced to curb the impact of Covid-19 on business globally.

4. Bringing in more international transactions into the ambit of Safe Harbour:

India is potentially becoming the most obvious choice with significant number of user base, technical expertise, and new incentives by the Government to attract investments from foreign players. As a result, there are an increased number of entities in India operating in various verticals which are constantly headed towards expanding business operations. Hence the Indian Government may take this opportunity to consider widening the scope of Indian Safe Harbour rules, by bringing amongst others, the below categories of international transactions:

- Market support services;

- Business support services;

- Business operating with Limited Risk Distributor (LRD) model; and

- Contract manufacturing and services in relation to toll manufacturing

5. Guidance on treatment of free of cost (FOC) transaction:

Indian taxpayer avail certain assets/ services free of charge, in the form of software/ software related services, management services, etc. which are provided by the foreign entity for the entire international group. Though not specifically clarified in the Act3 provisions, the ICAI4 Guidance Note released in August 2020 has made several references to disclose such items in the Form 3CEB. It is also relevant to note that the third edition of the UN5 TP Manual released in May 2021 refers to inclusion of such items within the cost base of the Indian entity during PLI calculation, in its newly inserted section on "Issues related to cost base under TNMM"6 within the India chapter.

Keeping in mind the same, the Indian Government may consider providing specific guidance on the treatment of such items under Safe Harbour regime as well.

6. Providing detailed guidelines on applicability of Safe Harbour rules to PEs 7:

Acknowledging the need to have concrete rules in place covering attribution of profits to PE in India, the CBDT8 formed a committee in 2019 which devised a draft guidance, considering both demand and supply side factors for profit attribution, thereby developing a formula based approach, assigning equal weights to sales, manpower and assets. Further, the Finance Act 2020 amended the provisions of section 92CB and 92CC of the Act to include profit attribution to PEs within the ambit of Safe Harbour Rules. While we await the draft guidance to attain finality, one may infer that this is one of the many steps taken by the Government towards easing the litigation burden on taxpayers and reducing the number of TP audits for relatively simpler issues that can be resolved through the Safe Harbour mechanism. Thus, one may expect the government to come up with specific mandates in terms of the transactions covered, margins, and other compliance requirements for PEs to avail Safe Harbour rules.

7. Exemption from carrying out economic/ benchmarking analysis:

Given that preparation of a TP study report is usually a complex, burdensome and time-consuming process, the Indian Government may consider providing certain relief to the taxpayers availing the Safe Harbour laws, like exempting the taxpayer from carrying out benchmarking analysis for the period for which Safe Harbour is availed.


The Indian Government has from time to time focused towards introducing several measures to promote transparency and ease of doing business. Some of them are the recent amendments like doing away with the requirement to file returns of income for foreign entities having income from royalty or technical services, increasing the monetary threshold for filing CbCR9 in India from INR 5500 crores to INR 6400 crores, and exempting foreign entities from filing Master File in Form 3CEAA where the designated Indian entity is already filing the same.

Till now, the response to Safe Harbour over the years has been lukewarm, with most of its targeted audience averse towards opting for it primarily due to a slightly higher rates prescribed as against rates agreed during the litigation route, APA and MAP proceedings. This is in spite of the fact that the Indian Safe Harbour Rules is well drafted with the objective of providing Indian taxpayer relief not only in quicker manner but hassle free in comparison to alternate dispute resolution routes [i.e. APA/ MAP10 or via CIT11 (Appeals), DRP12, ITAT13], involving lengthy procedure of negotiations and/or discussions over a prolonged period of time.

As businesses were recovering from the aftermaths of the first wave of the COVID-19 pandemic, the second wave has stalled the economic recovery and compelled businesses to take tough calls in such adverse circumstances. With the news of third wave, it is crucial that the Indian Government adopts Safe Harbour route to consider introducing Covid-19 related considerations in the arm's length framework.

In the present situation, as businesses are towards the closure for finalizing the year-end financial statements, a revised version of the Safe Harbour Rules would enable them to take benefits of the reduced mark-ups and provide much-needed clarity with regard to cost base calculations .

This would, in turn, also assist in making the scheme more widely accepted, with taxpayers being inclined towards adopting the hassle free route of the Safe Harbour rules for routine /relatively simpler international transactions and opting out for Alternate Dispute Resolution routes for the complex international transactions.

(Vikas Gupta is a Chartered Accountant, Company Secretary, LLB (General) and Sreemoyee Ghose is a Chartered Accountant. All the views in the article are strictly personal.)


1 Advance Pricing Agreement

2 Profit Level Indicator

3 The Income Tax Act, 1961

4 Institute of Chartered Accountants of India

5 United Nations

6 Transactional Net Margin Method

7 Permanent Establishment

8 Central Board of Direct Taxes

9 Country by Country Reporting

10 Mutual Agreement Procedure

11 Commissioner of Income-tax

12 Dispute Resolution Panel

13 Income Tax Appellate Tribunal

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