Safe Harbour, APA, Secondary Adjustment and Thin Capitalisation (CA Final DT)

Understand Safe Harbour, APA, Secondary Adjustment and Thin Capitalisation

Key rules to remember

Interest limitation (thin capitalisation)

Excess interest = interest paid or payable to the associated enterprise − 30% of EBITDA (nil if negative). Deductible associated enterprise interest = associated enterprise interest − excess interest

Applies where interest to the non-resident associated enterprise (including on a loan guaranteed by it) exceeds ₹1 crore. The excess is not deductible. The cap is 30% of EBITDA, or the associated enterprise interest if that is lower. Interest paid to other lenders is not disallowed under this rule.

EBITDA for the cap

EBITDA = Profit before interest, tax, depreciation and amortisation

Use the figure from the profit and loss account, adjusted as the Act requires. Do not use total income.

Carry forward of disallowed interest

Disallowed interest can be carried forward for up to 8 tax years immediately following the year of disallowance, and deducted within the 30% EBITDA headroom of those years

Headroom = 30% of EBITDA of that year less the interest actually claimed in that year. Set off the carried-forward interest only up to that headroom.

Secondary adjustment trigger

Primary adjustment above ₹1 crore, subject to the other conditions in the proviso to section 92CE → excess money to be repatriated within the prescribed time (90 days)

Primary adjustment may arise from: a suo motu adjustment by the taxpayer in the return; an adjustment made by the Assessing Officer and accepted by the taxpayer; an adjustment determined by an APA; an adjustment made under the safe harbour rules; or a resolution under the mutual agreement procedure. The proviso excludes primary adjustments of ₹1 crore or less and older years. Its conditions have been amended over time, and they differ for older years. Check the current text before you rely on the threshold.

Imputed interest on deemed advance

Interest = Excess money not repatriated × prescribed rate × period outstanding

The rate is fixed in the prescribed rules and differs for rupee and foreign currency transactions. The interest is treated as the taxpayer's income.

Option to pay additional tax

Additional income-tax = 18% × excess money, plus surcharge and cess at the applicable rates. Illustration only: with a 25% surcharge and 4% cess, effective rate = 18% × 1.25 × 1.04 = 23.4%

The 18% is a flat rate under section 92CE. The surcharge and cess depend on the rates applicable, so the 23.4% holds only under the stated illustrative assumptions of a 25% surcharge and 4% cess. Once the tax is paid, no secondary adjustment is made and no further credit or deduction is allowed for it. The manner of payment is set out in the prescribed rules.

APA types and period

Unilateral = CBDT + taxpayer; Bilateral = CBDT + taxpayer + one treaty partner's competent authority; Multilateral = more than two countries. Future period up to 5 tax years; rollback up to 4 earlier years

Rollback applies to the same international transaction and needs the conditions in the prescribed rules to be met. The agreement is void if obtained by fraud or misrepresentation.

Key transfer pricing penalties

2% of transaction value for failure to maintain documents, report a transaction or furnish documents (each default attracts the penalty separately); ₹1 lakh for failure to furnish the accountant's report. Separately, the general penalties for under-reporting (50% of tax on under-reported income) and misreporting (200%) apply to the income that a transfer pricing adjustment brings in

The 50% and 200% rates are the general under-reporting and misreporting penalties, not special transfer pricing penalties. Quote the rate along with the default. Check the Act's text for the exact conditions, including the reasonable cause defence.

How to solve Safe Harbour, APA, Secondary Adjustment and Thin Capitalisation questions

1. 1Identify which tool the facts point to: safe harbour, APA, secondary adjustment, interest limitation or penalty.
2. 2Confirm the base condition. Is there an international transaction with an associated enterprise? Is the lender a non-resident associated enterprise? Was there a primary adjustment?
3. 3Test the threshold and eligibility: ₹1 crore for interest and for secondary adjustment, transaction type for safe harbour, and notified jurisdiction exclusions.
4. 4State the rule in plain words and apply it to the facts. For an APA, name the type and the parties. For a secondary adjustment, give the time limit and the consequence.
5. 5Compute step by step. For interest, take 30% of EBITDA first, then interest paid or payable to the associated enterprise less that figure. That is the disallowed excess, and it is nil if negative. For secondary adjustment, take the excess money, the rate and the period.
6. 6Show the effect: disallowed amount, carry forward, deemed advance, imputed interest or penalty.
7. 7Close with a one-line conclusion and mention any option, such as paying additional tax in place of repatriation.

Quickest way: Three-check shortcut

Common mistakes in Safe Harbour, APA, Secondary Adjustment and Thin Capitalisation

• Applying the 30% cap to total interest instead of only to the interest paid to the associated enterprise.

  Students remember '30% of EBITDA' and apply it to every interest cost.

  Fix: Take only the interest paid or payable to the non-resident associated enterprise. Deduct 30% of EBITDA. The balance is the disallowed excess, provided the associated enterprise interest exceeds ₹1 crore. Interest paid to other lenders is not disallowed under this rule.

• Treating a bilateral APA as one signed only by the taxpayer and the CBDT.

  The word 'bilateral' is read as two parties in total.

  Fix: Bilateral means a treaty partner's competent authority is also involved, so there are three parties. Unilateral has two parties. Multilateral involves more than two countries.

• Ignoring the time limit and threshold for secondary adjustment.

  Students treat every primary adjustment as triggering interest.

  Fix: Check the ₹1 crore limit and the year conditions in the proviso to section 92CE. These have been amended, so confirm the current text. Then check whether repatriation was made within the prescribed 90 days. Only then impute interest on the deemed advance.

• Saying that a safe harbour or APA applies to all transactions of the assessee.

  Students overlook the 'eligible' conditions.

  Fix: Safe harbour covers only eligible assessees and eligible transactions, and not transactions with associated enterprises in notified jurisdictions. An APA covers only the transactions and years named in it.

• Treating disallowed interest as lost forever.

  The carry forward rule is forgotten.

  Fix: Disallowed excess interest can be carried forward for up to 8 tax years immediately following the year of disallowance. It is allowed in later years only within the 30% EBITDA headroom, which is the cap less the interest actually claimed in that year.

• Quoting penalties without the default they relate to, or calling 50% and 200% transfer pricing penalties.

  Penalty rates are memorised as a list.

  Fix: Learn each as default and rate together, for example failure to maintain documents with 2% of transaction value. The 50% (under-reporting) and 200% (misreporting) rates are general penalties that reach a transfer pricing adjustment only through the income it adds.

Worked examples