It is redeeming that the finance ministry has finally come out with draft rules that software MNCs can follow in pricing their services while doing business with their parent or subsidiaries overseas. The simpler method, or safe harbour, to compute transfer prices will prevent arbitrary tax demands, lower disputes and not taint India’s appeal as a software and R&D hub. MNCs complain of aggressive transfer pricing audits. Companies that opt for safe harbour will be spared from audits as taxmen will accept transfer prices declared by them. So, a wider coverage of six sectors, including IT, ITeS, contract R&D centres and pharma, makes sense.
The rules propose a mark-up on costs for each sector. For the IT sector, the mark-up — operating profit margin in relation to the operating expense — is 20% or more for an international transaction up to . 100 crore. However, a threshold of . 100 crore is not a good idea. It will limit the takers for safe harbour. India exported software worth $76 billion in 2012-13, of which a quarter was from captives. The need is to have simple rules to foster the creation of an R&D ecosystem in the country. Also, a higher mark-up for knowledge process outsourcing companies could fuel classification disputes and is, therefore, avoidable. The mark-ups can be reworked to soften the tax blow on MNCs.
Companies doing business with their arms or parent in tax havens will not qualify for safe harbour. This is sensible, given that MNCs can use transfer pricing to shift profits out of India to tax havens. Many countries already have safe harbour, but the rules need to be tailored to meet specific economic needs. India needs to attract more foreign investment to revive the economy. The government should quickly firm up safe harbour rules to improve investor confidence.
