New Delhi, June 8, 2017

CBDT lowers operating profit margin norms for IT firms, KPOs

In a significant relief to multinational firms operating in India, the Centre has issued fresh safe harbour rules that are seen to provide them with more certainty and possibly reduce litigations.

The new rules notified by the Central Board of Direct Taxes (CBDT) allow for operating profit margins up to 24 per cent. These were earlier as high as 30 per cent for some sectors and led to a tepid response from taxpayers, many of whom chose to instead go for advance pricing agreements.

Introduced by the CBDT in 2009, safe harbour refers to the circumstances under which income-tax authorities will accept the transfer price declared by the assessee without any question or scrutiny.

“It has come into effect from April 1, 2017, or the assessment year 2017-18, and shall continue to remain in force for two immediately succeeding years thereafter, up to assessment year 2019-2020,” said the CBDT on Thursday.

The new safe harbour regime is available for transactions limited to Rs.200 crore and is applicable even for assessees in the current regime. For firms involved in software development services as well as those in IT enabled services (ITeS) such as BPOs, the operating margin is now pegged at 17-18 per cent, against the earlier 20-22 per cent.
3-tier structure

Similarly, for knowledge process outsourcing firms, or KPOs, the CBDT has introduced a three-tier structure — 18 per cent, 21 per cent and 24 per cent. The operating profit margin would depend on the employee cost-to-operating expense ratio.

Meanwhile, the operating margin for contract research and development services relating to software development as well as generic pharmaceutical drugs has been lowered to 24 per cent, from the earlier margin of 30 per cent and 29 per cent respectively.

In line with the OECD action plan on Base Erosion and Profit Shifting (BEPS), the CBDT has also introduced the provision of low value-adding intra-group services.

“This means services that are performed by one or more members of a multinational enterprise group on behalf of one or more other members of the same multinational enterprise group,” said the CBDT, adding that this could include support services or those which are not part of the core business.

To be certified by an eligible chartered accountant, the entire value of such services including a mark-up of up to 5 per cent should not exceed Rs.10 crore.

Move welcomed
Tax experts welcomed the new norms and called them a positive change from the first set of guidelines issued in 2013.

“The rules demonstrate the continued efforts of the government to reduce transfer pricing litigation,” said Amit Agarwal, Partner, Nangia & Co. He, however, noted that its scope is still quite restrictive, as many large software and ITeS firms have a turnover of over Rs.200 crore.

Kunj Vaidya, Leader Transfer Pricing, Price Waterhouse & Co LLP, said the new rules will provide a good option for small and mid-size companies.

“The key highlights include reduction of margins for service units, introduction of safe harbour rate for low-valued services and a well thought out scheme for KPOs,” he said.

[The Hindu Business Line]