IT rules 4 years late, just for 2 years and very restricted
Given that the Income Tax Act had first talked about bringing in ‘safe harbour’ rules in April 2009 and it took more than three years to constitute the N Rangachary committee to formulate them, the norms notified on Wednesday were long overdue—after a discussion period of a couple of weeks, the norms will be finalised. Once done, this will make life much simpler for overseas assesses who run development and/or other centres in India since, subject to the ‘safe harbour’ floor rates, the taxman will simply accept the company’s financial statements as true. So, if a foreign firm has a local KPO which declares a profit of 30%, this will be accepted at face value—in the case of software development services, the minimum acceptable profit margin prescribed in the draft norms is 20%. Anything below this, and the taxman is within his rights to scrutinise the returns carefully.
That’s the theory, the reality depends on how the taxman chooses to write the rules that govern safe harbour. Even the draft rules, for instance, apply to firms that have global transactions that are under R100 crore in the case of software development, IT-enabled services and KPO—no such limit is prescribed in the case of contract R&D, manufacture and export of “core auto components” and “non-core auto components”. Why there should be a limit for software development/ITeS/KPO is not clear, and does this apply to each transaction or to the full year’s transactions? In the current form, the draft norms leave out around half the industry from the application of safe harbour rules, in which case it is not clear how the norms will help. And distinctions such as core and non-core auto components, each of which has different safe harbour profit margins specified, will only add to discretion on the taxman’s part.
Nor is it clear why the rules, four years in the making, should be applicable for two years only. Nobody sets up businesses in a country with just a two-year horizon. What is even more worrying is that there is no remedy even suggested for the rash of transfer pricing cases already initiated by the taxman—had the Rangachary norms been applied retrospectively, several cases of transfer pricing adjustment over the past few years, where the taxman used the now-discredited profit-split method, would not even have arisen. Indeed, while the new norms are applicable for the assessment years FY14 and FY15, the rash of transfer pricing orders issued—these rose from R44,000 crore in FY12 to R70,000 crore in FY13—are only up to those for assessment year FY10. In other words, assessees still run the risk of getting more outlandish transfer pricing orders for another four years, after which the new safe harbour norms will come into operation. Hopefully these issues, including whether the profit norms are too high, will be addressed in the consultation phase.