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CBDT panel finds hole in transfer pricing tax rate
January, 25th 2010

The Central Board of Direct Taxes (CBDT) is in a fix over the application of one safe harbour rate to all sectors. A committee, formed last month to frame safe harbour rules as announced in the 2009-10 Budget to minimise transfer pricing disputes, has estimated that there is a huge difference in the margins of companies which would come under the ambit of safe harbour.

The rules will apply to all sectors, such as information technology (IT), business process outsourcing, IT-enabled services (ITeS), auto, garments, wrist watches and liquor, that involve international transactions between two related companies. We are discussing what should be the ideal safe harbour rate. The problem is that in the IT sector alone, margins vary between 5 per cent and 75 per cent and they change every six months, a CBDT member told Business Standard.

Transfer pricing refers to cases where a company outsources work to its own subsidiary and profits are thereby transferred from one entity to the other. Taxation of captive units has become a complex area for the revenue department, with the government often disagreeing on the profits declared by a foreign company for its Indian unit.

Demands for transfer pricing rose from Rs 3,500 crore in 2007-08 to Rs 10,000 crore in 2009-10. In a safe harbour regime, transfer prices declared by a taxpayer would be accepted by revenue authorities.

Experts, however, argue that a lower rate should not be a problem, as it evens out in the long run. The industry is of the view that the rate should be based on the average margins of the industry.

In a presentation made to the committee, headed by CBDT member Prakash Chandra, consultancy firm Deloitte proposed a safe harbour margin of cost plus 12 per cent for the IT or ITeS industry.

Margins do not fluctuate too much. Uncertainty around markups causes concerns among multinational companies, thus affecting foreign investment. All over the world, the rate is cost plus 5, 7 or 10 per cent, said Paul Riley, leader (Asia-Pacific) of global transfer pricing, Deloitte.

According to consultants, instead of a range (for example between 10 and 15 per cent) there should be one single rate for safe harbour, with the flexibility of a minor adjustment of 2.5 per cent on either side.

The government, however, wants to keep the rate higher to avoid any kind of revenue loss. It is also discussing whether the rate can be based on something else and not on margins.

A finance ministry official said the same rules and the rate would be applicable to all the sectors but the interpretation of the rules would be different to suit the needs of each sector. The government is trying to frame the rules before the next Finance Bill is introduced in 2010.

Safe harbour is a significant source of revenue in some advanced countries like the US and Australia. In India, however, it does not constitute a major part of the governments revenues, as the tax department picks up cases with international transactions worth Rs 15 crore and above in a year.

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