Rule 86 — Definitions for safe harbour rules for international transactions.
The rule defines the expressions used in itself and in rules 87 to 93, which carry the safe harbour scheme for international transactions.
Clause (a) defines "accountant". It means an accountant referred to in section 515(3)(b) who, if practising individually or acting as a valuer, has professional experience of not less than ten years and annual receipts from the profession in the year preceding the year of cost certification exceeding fifty lakh rupees; or, if a member or partner in an entity rendering accountancy or valuation services, where that entity's annual receipt in the preceding year exceeds three crore rupees. It also includes a person recognised for undertaking cost certification by the government of the country where the associated enterprise is registered or incorporated, or any of its agencies, who meets those conditions and, where he is a member or partner in such an entity, where the entity or its affiliates have presence in more than two countries.
Clauses (b), (r), (h) and (j) draw the boundaries of the service categories: "contract research and development services wholly or partly relating to software development" is a list of eight research and experimental development activities; "software development services" is a list of seven routine development and support activities, but excludes research and development services whether or not in the nature of contract research and development services; "information technology enabled services" is a list of fifteen business process outsourcing services provided mainly with the assistance or use of information technology, again excluding research and development services; and "knowledge process outsourcing services" is a list of seven such services requiring application of knowledge and advanced analytical and technical skills, with the same exclusion.
Clauses (c) and (l) split auto components into "core auto components" — engine and engine parts, transmission and steering parts, suspension and braking parts, and lithium-ion batteries for use in electric or hybrid electric vehicles — and "non-core auto components", meaning everything else. Clause (d) defines "corporate guarantee" as an explicit corporate guarantee extended by a company to its wholly owned subsidiary being a non-resident in respect of any short-term or long-term borrowing, excluding a letter of comfort, an implicit corporate guarantee, a performance guarantee or any guarantee of similar nature. Clauses (e) and (f) define "data centre" and "data centre services". Clause (g) defines "generic pharmaceutical drug". Clause (i) defines "intra-group loan" as a loan advanced to a non-resident associated enterprise, excluding one advanced by a financial company, bank, financial institution or enterprise engaged in lending or borrowing in the normal course of business, and excluding a credit line or other loan facility with no fixed term for repayment.
Clause (k) defines "low value-adding intra-group services" by six positive tests — support services, not part of the core business, not shareholder or duplicate services, no unique and valuable intangibles used or created, no assumption or control of significant risk, and no reliable external comparable services — followed by ten excluded categories. Clause (m) defines a "no tax or low tax country or territory" as one in which the maximum rate of income-tax is less than 15%.
Clauses (n), (o) and (p) build the profit measure: "operating expense" is the costs incurred in the tax year in relation to the international transaction during normal operations, including Employee Stock Option Plan or similar stock-based compensation provided by associated enterprises to the assessee's employees, reimbursements at cost, amounts recovered at cost, and depreciation and amortisation, but excluding interest expense, provision for unascertained liabilities, pre-operating expenses, foreign currency fluctuation loss, extraordinary expenses, loss on transfer of assets or investments other than those whose depreciation is included, income-tax expense and other expenses not relating to normal operations; "operating revenue" is the corresponding revenue measure with seven exclusions; and "operating profit margin" in relation to operating expense is the ratio of operating profit, being operating revenue in excess of operating expense, to operating expense, expressed as a percentage. Clause (q) defines "relevant tax year" as the tax year for which the option for safe harbour is validly exercised.
The safe harbour scheme accepts a declared transfer price without examination if the transaction falls in a listed category and the margin clears a listed figure. That works only if the category and the margin are defined tightly enough that neither side can argue about them afterwards. This rule does that work for rules 87 to 93: it fixes who may certify costs, what each service category covers and — as importantly — what it excludes, and exactly which items go into operating expense and operating revenue before the margin is computed.
| What | Figure | The condition on it | Where |
|---|---|---|---|
| Professional experience required of an individually practising accountant or valuer | Not less than ten years | Where he is pursuing the profession of accountancy individually or is a valuer | Clause (a)(i)(A)(I) |
| Annual receipts required of such an accountant | Exceeding fifty lakh rupees | From the exercise of the profession in the year preceding the year in which cost certification is undertaken | Clause (a)(i)(A)(II) |
| Annual receipt required of the entity where the accountant is a member or partner | Exceeding three crore rupees | Receipt of the entity engaged in rendering accountancy or valuation services in the year preceding the year in which cost certification is undertaken | Clause (a)(i)(B) |
| Presence required of a foreign-recognised certifier's entity | More than two countries | Where the person included by clause (a)(ii) is a member or partner in an entity rendering accountancy or valuation services; the entity or its affiliates must have that presence | Clause (a)(ii)(B) |
| Maximum rate of income-tax that makes a country or territory a "no tax or low tax country or territory" | Less than 15% | The maximum rate of income-tax in that country or territory | Clause (m) |
| Operating profit margin in relation to operating expense | Operating profit as a percentage of operating expense | Operating profit is operating revenue in excess of operating expense, both as defined in clauses (n) and (o) | Clause (p) |
The exclusions carry as much weight as the definitions. Software development services, information technology enabled services and knowledge process outsourcing services each exclude research and development services whether or not in the nature of contract research and development services, so a provider doing genuine research cannot route it through a lower-margin category. "Corporate guarantee" is confined to an explicit guarantee to a wholly owned non-resident subsidiary, which puts a letter of comfort, an implicit guarantee or a performance guarantee outside the scheme altogether, and "intra-group loan" excludes both lending by financial businesses and any facility without a fixed term for repayment. The operating expense and operating revenue definitions decide the margin before any safe harbour figure is applied: interest, foreign currency fluctuation, extraordinary items and income-tax fall out of both sides, while stock-based compensation provided by associated enterprises to the assessee's employees is expressly brought into the cost base. The 15% figure in clause (m) is a definitional test of a country's maximum rate of income-tax, not a rate applied to anyone.
An Indian company provides back office operations and payroll processing to its foreign parent and also runs a team writing new algorithms for the parent's product. The first two activities are information technology enabled services under clause (h), but the algorithm work falls in clause (b) as contract research and development services relating to software development and is excluded from clause (h) in terms. If cost certification is needed, the accountant engaged must satisfy clause (a) — for a sole practitioner, ten years of professional experience and receipts above fifty lakh rupees in the preceding year.
A taxpayer rarely meets this rule alone; it is read whenever the option for safe harbour is exercised under rules 87 to 93, in classifying the transaction and in computing the operating profit margin shown in the transfer pricing documentation.
"no tax or low tax country or territory" means a country or territory in which the maximum rate of income-tax is less than 15%
"corporate guarantee" means explicit corporate guarantee extended by a company to its wholly owned subsidiary being a non-resident in respect of any short-term or long-term borrowing, but does not include letter of comfort, implicit corporate guarantee, performance guarantee or any other guarantee of similar nature
"operating profit margin" in relation to operating expense means the ratio of operating profit, being the operating revenue in excess of operating expense, to the operating expense expressed in terms of percentage