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Need for safe harbour provisions
July, 12th 2007
Safe harbour rules provide the circumstances in which the tax authorities would automatically accept transfer prices.

The apex courts reasoning in the Morgan Stanley case is that back-office operations do not constitute PE (permanent establishment), but for the service angle with regard to deputationists.PE refers to a fixed place of business through which the business of the enterprise is wholly or partly carried on, as Section 92F of the Income-Tax Act, 1961 defines. The term PE has been defined on the lines of the definition found in tax treati es entered into by India with other countries, states in a page about Transfer pricing law in India. Transfer pricing, as Wikipedia educates, is the pricing of goods and services within a multi-divisional organisation, particularly cross-border transactions.

Transactions between a foreign enterprise and its PE, for example between the head office abroad and a branch in India, are subject to transfer-pricing regulations, says the taxmans site. Any income arising from an international transaction or an outgoing such as expenses or interest from the international transaction between associated enterprises should be computed having regard to the arms length price, which is the price that would be charged in the transaction if it had been entered into by unrelated parties in similar conditions, elaborates the site. Of late, OECD (Organisation for Economic Cooperation and Development) and some other tax jurisdictions are taking a position that an arms length payment cannot extinguish attribution of income to PE in all cases and in all circumstances, says Mr Samir Gandhi, Partner, Deloitte Haskins & Sells, Mumbai, in an e-mail to Business Line about the apex court decision.< /p>

While one will need to study the fineprint there is a need to appreciate the interplay between attribution of income to PE and application of transfer pricing principles. It is relevant to note that as the economic activity of an enterprise gets more complex, the tax exposure from PE perspective is minimised, but from the transfer pricing perspective increases.

Taxation of outsourcing units including the determination of arms length price has become contentious in the recent past in India, he observes. This critically depends on functions performed, assets deployed and risks assumed, explains Mr Gandhi. It is imperative to appreciate the economics of the outsourced services for resolving the intricate tax issues peculiar to outsourcing.

While outsourcing represents a great opportunity for India, it is necessary that tax issues and concerns are addressed promptly to facilitate the smooth flow of business, he says. One can consider removing uncertainties in the positions and approaches and introduce safe harbour provisions (as in Australia and Mexico) for ensuring certainty and avoiding controversies and litigation. It will be of assistance if the CBDT (Central Board of Direct Taxes) also issues administrative rulings on certain aspects and nuances, adds Mr Gandhi.

Safe harbour rules provide the circumstances in which the tax authorities would automatically accept transfer prices. The rules could, for example, require taxpayers to establish transfer prices or results as per a specific information-reporting and record-maintenance provision with regard to controlled transactions.

D. M.

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