Amendment in Safe Harbour Rules under Income Tax Act

“Safe Harbour” means circumstances under which Income-tax authorities shall accept the transfer price declared by the assessee himself. Thus, ‘safe harbour rules’ specifies the various circumstances under which transfer price declared by the Assessee with respect to International transactions shall be accepted by Income tax authorities. Safe Harbour rule is given under Rule TD of Income Tax Rules, 1961.

Rule 10TD specifies various transactions wherein Tranfer price declared by the Assessee shall be accepted under specified circumstance. Such as, as per S. No. 1 of Rule 10TD, International transaction of software development services, The operating profit margin declared by the assessee from the international transaction in relation to operating expense incurred is –

Not less than 20% where the aggregate value of such transactions entered into during the previous year does not exceed a sum of 500 crore rupees; or
Not less than 22%, where the aggregate value of such transactions entered into during the previous year exceeds a sum of 500 crore rupees.

Central Board of Direct Taxes (CBDT) has made amendment in Safe Harbour rules with respect to Operating Expenses, Operating Revenue and Scope of Inter-group scope vide Notification No. 104/2023-Income Tax dated 19 December 2023. Summary of latest amendment and corresponding analysis is given below:

1. Definition of Operating Expense

As per Rule 10TA(j) of Income tax Rules, “operating expense” means the costs incurred by the assessee in relation to the international transaction during the course of its normal operations including depreciation and amortisation expenses relating to the assets used by the assessee.
However, there are certaining expenses which are not included under operating expenses such as Interest expense, Provision for unascertained liabilities etc.
As per Rule 10TA(j)(vi), “Loss on transfer of asset or Investment” is not included under operating expenses.
However, Such clause has been substituted with “loss on transfer of assets or investments other than assets, on which depreciation is included in the operating expense” vide notification No. 104/2023-Income tax with effect from 19th December, 2023.
Therefore, assets on which depreciation is included in operating expense, loss on transfer of such asset shall be included in operating expense. Whereas, Loss on transfer of other assets, i.e., on which depreciation is not included in operating expenses, shall not be included under operating expense.

2. Definition of Operating Revenue

Definition of operating revenue, as given under Rule 10TA(k) of Income Tax Rules, has been amended on the same lines as operating expenses.
Therefore, revenue from transfer of asset, depreciation on which has been included in operating expenses, shall be included in operating revenues. However, income on transfer of other assets, i.e., asset on which depreciation is not included under other expenses, and investment shall not be included under operating revenue.

3. Definition of Intra-Group Loans

Existing Provisions:

Presently, as per Rule 10TA(f) of Income Tax Rules, “Intra-Group Loan” means Loans advanced to Wholly owned subsidiary, where the loan:

Is sourced in Indian Rupees;
is not advanced by a financial company including a bank or a financial institution or an enterprise engaged in lending or borrowing of funds; and
does not include credit line or any other loan facility which has no fixed term for repayment

Therefore, intra-group loans only covered loans extended to Wholly Owned Subsidary in Indian Rupees. Definition of intra-group loan under rule 10TA of the Rules covered only loans sourced in Indian Rupees, although the Safe Harbour interest rates prescribed under rule 10TD of the Rules covered intra-group loans denominated in both Indian Rupees and foreign currency.

Amended Provisions:

However, the definition of Intra-Group Loan has been amended with effect from 19th December, 2023. As per amended definition, Intra-Group loans means loans advances to Associate Enterprises being a non-resident. Requirement of Loan to be denominated in Indian currency has also been removed.

Therefore, loans given to associate enterprises, other than wholly owned subsidiaries, are also included under Intra-group loans. Further, to align the provisions of Rules 10TA with Rule 10DA, loans given in both Indian Rupee and other currency are included under Intra-Group Loan.

4. Interest Rate on Intra-Group Loans under Safe Harbour Rules

a. Loans Denominated in Indian Rupees:

Existing provisions

Interest rate of Intra-group Loans shall be decided as per credit Rating of the Associate Enterprises. E.g. The interest rate declared in relation to the eligible international transaction is not less than the one-year marginal cost of funds lending rate of State Bank of India as on 1st April of the relevant previous year plus 175 basis points, where the associated enterprise has CRISIL credit rating between AAA to A or its equivalent.

Therefore, presently, interest rate is determined as per Credit rating assigned to Associate Enterprise by the CRISIL.

Amended Provision

However, as per amended rules, interest rate shall be determined as per Credit Rating assigned to the Associate Enterprises by Security and Exchange Board of Indian (SEBI) and Reserve Bank of India accredited credit Agency. Further, where:
- associated enterprise has only one credit rating, then such rating shall be taken as its credit rating; and
- where the associated enterprise has more than one rating, then the least of such ratings shall be taken as its credit rating

b. Loans denominated in Foreign Currency:

Existing Provisions

As per Rule 10TD, with respect to Intra-group Loan denominated in Foreign Currency, interest rate declared in relation to the eligible international transaction is not less than the six month London Inter-Bank Offer Rate (LIBOR) of the relevant foreign currency as on 30th September of the relevant previous year plus 150 basis points, where the associated enterprise has CRISIL credit rating between AAA to A or its equivalent. Different basic points are to be added as per Credit rating of Associate Enteroses.

Presently, Interest rate is determined as per LIBOR of the relevant foreign currency and credit rating of the Associate enterprise given by CRISIL.

Amended Provisions

As per amended provisions, Interest rate shall be determined as per reference rate of the relevant currency and Credit rating assigned to the Associate enterprises by the Security Exchange Board of Indian and Reserve Bank of India accredited Credit Rating agency. Further, Separate categorisation, where the loan advanced to the Associate enterprises including loans to all Associate Enterprises exceeds and does not exceed a sum equivalent to INR2.5bn, with a markup ranging from 150 basis points to 600 basis points.

Reference rate means rate determined by difference agency for every currency, Such as:

for US dollar, 6-month Term Secured Overnight Financing rate (SOFR), currently administered by Chicago Mercantile Exchange (CME), as increased by 45 basis points;
for Euro, 6-month Euro Inter Bank Offered Rate (EURIBOR), currently administered by European Money Markets Institute; etc.

With the cessation of LIBOR, the notification of alternative reference rates (e.g. SOFR, EURIBOR, SONIA, TORF, BBSW and SORA) was a necessary amendment. Moreover, only a CRISIL-assigned credit rating of the AE was earlier recognised for the purpose of Safe Harbour. Post the amendment, credit ratings assigned by any SEBI registered and RBI-accredited credit rating agency will be recognised for the purpose of the Safe Harbour.

5. Conclusion

The rationalization of the Safe Harbour Rules is certainly a welcome amendment for the taxpayer community in India. It was essential to bring loans granted to Associate enterprises, other than wholly owned subsidiaries, under the umbrella of Harbour Rules. Also, considering Credit rating assigned by Credit Rating Agencies, other than CRISIL, also makes harbor rules more flexible.