News and developments
Extending the Reach of Indian Safe Harbour Provisions and Advance Pricing Agreement (Transfer Pricing) - A Critical Analysis
Expanding the scope of Safe Harbour and Advance Pricing Agreement (‘APA’) with respect to Profit Attribution
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Introduction of both Safe Harbour Rules and APA regime brought significant relief to non-resident taxpayers by providing certainty on transfer pricing of inter-company transactions. Acknowledging the need for similar certainty on profit attribution to non-residents, Budget 2020 proposed to extend Safe Harbour Rules and APA framework to profit attribution under Indian Tax Code[1].
A. Application of Safe Harbour Rules Section 92CB of Indian Tax Code defines the term Safe Harbour as ‘circumstances under which the income-tax authorities shall accept the transfer pricing declared by the assessee’. The Rule provides minimum operating profit margin that a taxpayer is expected to earn for certain categories of international transactions, which if maintained shall be accepted as arm’s length by Indian Tax Authorities. Current Scenario: The existing safe harbour provisions applied only for determination of arm’s length price for transactions between legal entities did not cover Permanent Establishment (‘PE’). Proposed Amendment- Safe Harbour Rules[2] have been expanded to cover profits attributable to PE[3];
- It is also clarified that amended provision would be applicable only from Assessment Year (‘AY’) 2020-21 and onwards.
- It is proposed to expand the scope of the Advance Pricing Agreement provisions to include determination of profit attributable[6] to a PE;
- It is also proposed that the benefit of rollback can be availed for PEs;
- The provision will apply to an APA entered into on or after April 1, 2020.
- Whether a PE exists?
- How to attribute profits to a PE (if a PE exists)?
Conclusion
In April 2019, the Government had released draft guidance on profit attribution to PE. The guidance considered both demand and supply side factors for profit attribution and offers a formula based approach for profit determination. Indian Government’s predilection towards the formulary approach is by now well-known especially after the release of ‘draft profit attribution rules’[9]. The alternative is authorized OECD approach based on Functional and Benchmarking Analysis. This approach is based on the ‘separate entity’ principle which hypothesizes PE as a distinct and separate entity amenable to a separate delineation of its functions, assets and risks. Once the functional and risk profiling for PE is complete, attribution of profits to PE proceeds in same manner as for separate legal entities. It would be interesting to see which approach Indian Government adopts while concluding APA’s on profit attribution. Recently, in the post Covid environment on May 20, 2020, Indian Government also released the Safe Harbour Rules applicable for Financial Year 2019-20. While the thresholds were released in the Covid environment, Government persisted with the same thresholds as for previous year without any downward revisions (mainly because Indian economy has been impacted by Covid post March 2020). However, these thresholds shall apply only for one year ie FY 2019-20. For financial year 2020-21, the safe harbour thresholds shall be specified next year by when it is expected to have greater clarity on economic impact of Covid on the performance of different sectors. Article has been authored by Ashutosh Mohan Rastogi (Founding Partner) and Dhruv Seth (Senior Associate) - Amicus – Advocates & Solicitors. Views Expressed are Personal.[1] Section 9(1)(i) of the Income Tax Act, 1961
[2] Section 92CB read with Rule 10TA to TF
[3] Under section 9(1)(i)
[4] Rule 10 of the Income Tax Rules, 1962
[5] Section 9(1)(i) of the Income Tax Act, 1961 (‘Act’)
[6] Ibid at Pt. 3
[7] Indian Tax Code provides non-residents with the facility of an advance ruling on questions governing non-resident taxation – an application to this effect must be made to the Indian Authority for Advance Ruling (Section 245) of the Indian Tax Code.
[8] DIT (International Taxation) v. Morgan Stanley & Co. Inc., (2007) 7 SCC 1; Commissioner Of Income Tax v. Hyundai Heavy Industries Co. Ltd AIR 2007 SC 2445 and Rolls Royce Singapore Pvt. Ltd. v. ACIT [TS-515-HC-2011(DEL)]
[9] Public Consultation on the proposal for amendment of Rules for Profit Attribution to Permanent Establishment dated 18th April 2019.