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Government has notified Safe Harbour rules (SHR) to provides certainty to Indian associate enterprise of MNC group in its Transfer Pricing Assessment

The bigger question is that whether safe harbour will really provide certainty to MNC group as whole in connection with taxation in India

To bang upon the subject, I have considered the case of Software Development Services, as provided in safe Harbour rule

An enterprise engaged in Software Development services, can avail the benefits of SHR, if it is engaged in either of following activities relating to:

a. Business Application software and information system development using know methods and existing software tools

b. Support for existing systems

c. Converting or translating computer languages

d. Adding user functionality to application programmes.

e. Debugging of Systems

f. Adaptation of Existing Software

g. Preparation of User Documents

Further to avail, benefits under the SHR, for enterprise engaged in software development services, following FAR should be satisfied, as under:-


Foreign Principle

Indian Associated Enterprise


Critical functions – Conceptualisation and design of Product, providing strategic direction and framework and entire Supervision of Indian Associated Enterprise

Perform the work assigned under the supervision of Foreign Principle


Capital, funds and other significant assets including intangibles are provided by Foreign principle

No ownership right, legal or economic on any intangibles generated during the course of rendering services


Assume all economically significant Risk

Do not assume any significant risk.

Though by subjecting itself to SHR, Indian associate enterprise will be protected from uncertainty and high pitch transfer pricing adjustments

But there is other side of the story also.

Based on activities enumerated, aforesaid FAR analysis and other incidental factors, analysed hereinafter below, will the foreign principle be liable to taxation in India on account of presence of PERMANENT ESTABLISHMENT.

To elucidate the concept, Consider a case where Foreign Holding Company (H) is having wholly owned Subsidiary (S) in India and S is engaged in Software Development services and it has availed the SHR.

Further I have considered here UN model of DTAA, since Indian most of DTAA are based on this model only

The question for consideration is whether S will be considered as PE of H and if so, whether S reporting margins (20%/22% of operating expenses) as mandated in safe harbour rules, will be sufficient attribution of profit of H to PE under Article 7(2) or their needs further attribution of profits of H to PE.

Existence of Permanent Establishment -Analysed

1. In instant case, Existence of PE is to be evaluated from fixed PE (Article 5(1) ) and agency PE (Article 5(5)(a)) perspective.

2. Fixed PE- For Fixed PE, following test to be satisfied:-

a. Place of Business Test

b. Power of Disposition Test

c. Permanence Test

d. Business test

3. In circumstances of Instant case, Place of business test and Permanence test can be easily be satisfied, only remaining other tests need to be satisfied.

4. Power of Disposition Test

a. Test is satisfied when place of business of S is at the disposal of H or should be freely available to H for the purpose of business activities of H.

b. Since it is condition of SHR that employee of S has to work under the supervision of H and if it is a case where employees of H are freely using the S’s place of business for supervision of S employee for business purpose, power of disposition test can be deemed to be satisfied.

5. Business Test

a. Business test is satisfied when foreign enterprise is carrying core of peripheral activities in India, excluding the activities of auxiliary or preparatory in nature

b. Based on list of activities enumerated in ‘”Software Development Services”, possibility of satisfying the business test is established in following cases.


Business Test

Business Application software and information system development using know methods and existing software tools

Core Activity- Business Test satisfied

Support for existing systems

Auxiliary Activities – Business Test not satisfied

Converting or translating computer languages

Peripheral Activities – Business Test satisfied

Adding user functionality to application programmes.

Peripheral Activities – Business Test satisfied

Debugging of Systems

Peripheral Activities – Business Test satisfied

Adaptation of Existing Software

Peripheral Activities – Business Test satisfied

Preparation of User Documents

Auxiliary Activities – Business Test not satisfied

6. Conclusion- Fixed PE- Thus if power of disposition test is satisfied, there is possibility that AO may hold that H has PE in India, for the afore-said core or peripheral activities being carried out by S.

7. Agency PE – Agency PE is satisfied when following conditions are met:-

a. S is acting on behalf of H

b. S has authority to CONCLUDE contracts on behalf of H.

c. S is not an independent agent, satisfying the following conditions:-

i. The activities of S are devoted exclusively on behalf of H

ii. The transactions between S & H are not at ALP

8. Authority to Conclude contracts – in the instant case, S can be deemed to have authority to conclude contracts on behalf of H, where S is engaged in following activities, rendering services to Indian Customers on behalf of H:-

a. Adding user functionality to application programmes.

b. Debugging of Systems

c. Adaptation of Existing Software

9. Independent Agent – In the instant case, S status of being independent agent is doubtful on account of following:-

a. The entire activities of S are wholly devoted on behalf of H

b. Whether adoption of margin by S stated in SHR, will deem that transaction will between S & H will be at ALP, is not free from doubt.

10. Conclusion- Agency PE- There is possibility that S , being treated as agency PE of H.

Attribution of Profit to Permanent Establishment

Article 7(2) regulates the attribution of Profit of H to PE and provides that profit be attributed based on following assumptions:

a. The PE is separate distinct enterprise.

b. It was dealing wholly ad independently with foreign enterprise of which it is PE.

Critical Point

If PE is found to exist based on afore-said reasoning, the important point for consideration is whether adoption of stipulated margin by S as per SHR is sufficient attribution of profit to S, being PE of H or further attribution of profit of H to PE is required.


1. As per decision of Hon’ble Supreme Court in Morgan Stanley (2007) 292 ITR 416, if the transactions with PE are at ALP, then there is no need to further attribute the profit to PE.

2. As per afore-said FAR analysis, S is only performing low risk functions, without ownership of any asset and in that scenario SHR mandated that S should earn 20%/22% of its operating expenses and based on that it will deemed that transaction between S & H are at  ALP

3. All important functions, major assets and risk are on the part of H. If it is established that H is having PE in India in the business of S, then there is every possibility that AO will further attribute the profit of H, for functions performed, assets owned and risk taken relating to business of S in India.

4. Further under rule 10, AO may attribute the profit of H to S based on assets, revenue etc. if unable to attribute profit based on FAR analysis.

5. Thus in spite of opting for safe harbour rules, based on function profile as stated in said rules, there is every possibility of AO invoking PE existence in the hands of H and levying tax in the hands of H on Profits attributable to S less than profits of S.

6. I think it is high time that Government should come up with clarity on this aspect, otherwise  objective of carving SHR will be defeated , since Income Tax department always try to prove the existence of PE, whenever they  see business connection of Foreign Enterprise in India.


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