Dr. Ikramul Haq
While this guidance sets out a transitional safe harbour and a framework for a permanent safe harbour, there may be further opportunities for simplification of the rules, and the Inclusive Framework will continue to explore whether other safe harbours and simplifications can be developed at a future time to supplement those described in this guidance—Safe Harbours and Penalty Relief: Global Anti-Base Erosion Rules (Pillar Two), OECD
The OECD Secretariat prepared the above-quoted document after its approved by the OECD/G20 Inclusive Framework on BEPS on December 15, 2022. Those entrusted with the task of handling international tax affairs and policy matters on behalf of the Government of Pakistan may like to study it and prepare a summary for drafting Safe Harbour Rules etc.
It is pertinent to mention that Pakistan on July 1, 2021 signed the first joint statement with other Inclusive Framework members on an agreement to implement a two-pillar solution to address the tax challenges arising from the digitalization of the economy. However, the Government of Pakistan did not sign the second joint statement of October 8, 2021 nor the outcome statement of July 11, 2023 singed by 142 members, and has not stated its position since then on this global initiative.
In this background, it is disturbing to know that neither the Ministry of Finance (MoF), nor the Federal Board of Revenue (FBR) after signing the agreement to implement a two-pillar solution has shown any interest to follow it up. It confirms the level of apathy on the part of Government to respect international agreements and make Pakistan an acceptable jurisdiction for foreign companies.
As mentioned in Part I, the following provisions may be considered/debated for insertion in the Income Tax Ordinance, 2001 anchoring statutory status of Safe Harbour Rules:
- Section 108 (Transactions between “associates”)
Problem: Section 108 mandates arm’s length pricing but provides no statutory certainty thresholds. This leaves taxpayers exposed to ex-post facto reinterpretation by auditors.
Proposed statutory insertion (Section 108A — Safe Harbour for low-risk transactions):
108A. Safe Harbour Regime for Certain Transactions– (1) Notwithstanding anything contained in section 108, the Federal Board of Revenue may, by rules, prescribe safe harbour margins, thresholds, and conditions for specified classes of transactions between associates.
(2) Where a taxpayer complies with such prescribed safe harbour rules, the transaction shall be deemed to satisfy the arm’s length principle.
(3) No adjustment under section 108 shall be made in respect of a transaction covered under sub-section (2), except in cases of fraud, misrepresentation, or concealment of material facts.
Why this matters: This provision converts safe harbour from an administrative concession into a statutory deeming fiction, insulating compliant taxpayers from discretionary transfer pricing adjustments.
- Section 177 (Audit)
Problem: Audit powers are unconstrained by objective risk filters, allowing harassment audits even where compliance risk is minimal.
Proposed amendment (Proviso to Section 177(1)):
Provided that no audit shall be initiated solely because of transfer pricing margins, allocation keys, or expense ratios where the taxpayer has validly opted for and complied with safe harbour rules prescribed under this Ordinance.
Why this matters: Safe harbour without audit protection is meaningless. This proviso realigns audit power with risk-based enforcement, a principle Pakistan repeatedly claims to follow but rarely implements.
- Section 120 (Self-Assessment Scheme)
Problem: Self-assessment exists in form but not in substance; returns remain perpetually vulnerable.
Proposed insertion (Section 120(2A)):
Where a return has been filed in accordance with safe harbour rules prescribed under this Ordinance, such return shall be treated as complete and correct for the purposes of self-assessment, subject to section 122.
Why this matters: This restores finality to self-assessment, a cornerstone of voluntary compliance systems globally.
- Section 122 (Amendment of Assessment)
Problem: Section 122 is frequently used to reopen settled matters without new evidence.
Proposed limitation (Proviso to Section 122(1)):
Provided that no amendment shall be made to an assessment in respect of a transaction covered under safe harbour rules unless it is established that such coverage was obtained through fraud or willful misstatement.
Why this matters: This prevents retrospective destabilization of legitimate tax positions—an endemic problem in Pakistan.
- Section 214A (Advance Rulings)
Problem: Advance rulings are under-utilized and inaccessible to most taxpayers.
Proposed linkage with safe harbour:
Safe harbour rules shall operate independently of advance rulings, and compliance therewith shall not require prior approval or confirmation from the Commissioner.
Why this matters: Safe harbours must replace discretionary approvals, not coexist with them.
Services tax interface (Critical for Constitutional coherence)
While services tax lies provincially, income attribution for services remains a federal issue. Safe harbour allocation principles must therefore be recognised federally.
Proposed Explanation under Section 67 (Apportionment of income):
Explanation: For banking, insurance, and digital services operating through multiple locations, income attribution shall be deemed reasonable where allocation is made based on consumption, customer location, or revenue origination in accordance with safe harbour rules.
This will address the recurring misuse of branch count as a proxy for value creation—an approach repeatedly struck down by appellate fora but still resurrected by tax authorities.
Embedding safe harbour rules in the Ordinance would:
- Reduce litigation clogging tribunals and courts
- Restore credibility to self-assessment
- Align audit with actual risk
- Advance Article 4 and Article 25 of the Constitution by ensuring equal treatment
- Improve Pakistan’s investment climate without granting tax amnesties
In constitutional-political-economy terms, safe harbour rules discipline the State, not the taxpayer—precisely why they have faced resistance from Pakistani tax authorities.
Draft Safe Harbour Rules
(Proposed insertion under the Income Tax Rules, 2002, read with the Income Tax Ordinance, 2001)
Rule 1 — Scope and objective
These rules shall provide objective thresholds under which specified transactions shall be deemed compliant, reducing disputes and administrative burden while safeguarding revenue.
Rule 2 — Eligible taxpayers
Safe harbour shall apply to:
(a) Resident companies with annual turnover not exceeding PKR 10 billion;
(b) Banking companies and financial institutions for specified services;
(c) Associated enterprises engaged in low-risk intra-group services.
Rule 3 — Transfer Pricing Safe Harbour
A transaction involving low-value intra-group services shall be deemed arm’s length where:
(a) The cost-plus markup does not exceed 5% of total allocable costs;
(b) The services do not involve unique intangibles or strategic management functions;
(c) Documentation requirements under section 108 are fulfilled in simplified form.
Rule 4 — Services taxation Safe Harbour (Consumption-based)
For services rendered through multiple branches:
(a) Tax shall be deemed correctly discharged where apportioned on the basis of actual consumption or customer location, not number of branches;
(b) No further audit shall be initiated where provincial allocation variance does not exceed ±5%.
Rule 5 — Presumptive expense deduction
Specified operational expenses shall be deemed allowable where they do not exceed:
(a) 2% of gross receipts for banking and insurance;
(b) 3% of gross receipts for IT-enabled services;
subject to withholding compliance.
Rule 6 — Audit protection
Transactions covered under these rules shall not be selected for audit solely on the basis of transfer pricing, allocation methodology, or expense ratios, unless fraud or misrepresentation is evidenced.
Rule 7 — Optional regime
Safe harbour application shall be optional. Taxpayers may elect out by written declaration, subjecting themselves to full audit and documentation requirements.
Rule 8 — Anti-Abuse clause
The Commissioner may withdraw safe harbour benefit where it is proven that:
(a) Transactions were artificially structured to fall within thresholds; or
(b) Material facts were concealed.
Rule 9 — Periodic review
Thresholds shall be reviewed every three years by FBR in consultation with provinces, industry bodies, and independent experts.
Conclusion:
Pakistan’s failure to enact safe harbour rules is not technical—it is institutional. The State has preferred discretion over design, litigation over legislation and coercion over compliance. That choice has weakened revenue, credibility, and constitutional fidelity.
Safe harbour rules are not going to solve all tax problems, but without them, Pakistan’s tax system will remain what it is today: uncertain for the compliant, negotiable for the powerful, and ineffective for the State.
In the concluding part, Pakistan-specific quantitative impact analysis will be presented to show that Safe Harbour Rules are infact revenue governance reform: fewer low-yield audits, fewer predictable disputes, and a measurable reduction in the deadweight loss of compliance.
[To be concluded]
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Dr. Ikramul Haq, Advocate Supreme Court, Adjunct Faculty at Lahore University of Management Sciences (LUMS), member Advisory Board and Visiting Senior Fellow of Pakistan Institute of Development Economics (PIDE), holds LLD in tax laws. He was full-time journalist from 1979 to 1984 with Viewpoint and Dawn. He also served Civil Services of Pakistan from 1984 to 1996.