Safe Harbor

A regulation or legal provision that provides protection from or reduces liability

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What is a Safe Harbor?

A Safe Harbor is a provision in law or regulation that affords protection from liability or penalty and reduces liability if certain conditions are met.

Examples discussed in this article:

  1. Business Judgment Rule
  2. The Digital Millennium Copyright Act of 1998 (USA)
  3. Transfer Pricing (India)

Safe Harbor Rule

Business Judgment Rule

Safe harbor provisions appear in a number of laws or contracts. One such example is the Business Judgment Rule. Directors of companies have a number of duties and responsibilities. One such duty is to act with care, skill, and diligence. A director who breaches this duty may be held accountable for their actions.

The business judgment rule is a presumption that, in making a business decision, the directors of a corporation acted on an informed basis, in good faith, and that the action taken was in the best interests of the company.

Example: A, a director at ABC Ltd., decides to go with a particular raw material supplier – Tools Ltd. However, another product employing raw materials from Tools Ltd. is deemed to be of poor quality. The share price of ABC Ltd. drops significantly on account of its association with Tools Ltd.

Now, A can be held accountable for his decision and its impact on the company. However, he can rely on the safe harbor provision for protection. Under this, if it is ascertained that he acted in good faith, did not have any conflict of interest, was appropriately informed, and a reasonable third person would have acted the same in the given situation, A would not be held personally liable.

Therefore, the Safe Harbor Rule (Business Judgment Rule) provides protection to directors from being held personally liable, considering certain criteria are met.

The Digital Millennium Copyright Act of 1998 (US)

Provisions in the Digital Millennium Copyright Act (DMCA) protect internet service providers (ISPs) from liability for copyright violations and other illegal activity of their customers. Each DMCA safe harbor substantially limits the liability for copyright infringement. Each is separate, and if you fall within any one, your liability is limited. And even if you don’t meet the requirements of one of the safe harbors, that is not an indication that you are infringing copyright. Other defenses, such as fair use, are still available.

The four safe harbors provided by Congress in the following subsections of Section 512 are:

(a)   Transitory digital network communications

(b)   System caching

(c)   Information residing on systems or networks at the direction of users

(d)   Information location tools

Each of these safe harbors represents a particular aspect of the normal operation of the internet that Congress wanted to protect and promote, albeit with some limitations.

Safe Harbor in Transfer Pricing (India)

A “safe harbor” is defined in Indian Tax Law (ITL) as circumstances in which tax authorities shall accept the transfer price declared by the taxpayer. India’s Central Board of Direct Taxes (CBDT), the main Indian tax administration body, issued transfer pricing (TP) safe harbor rules in September 2013.

Transfer pricing refers to the practice of “arm’s length pricing” for international transactions between individual entities of a larger multi-entity firm (measured as separately run entities). The concept of an arm’s length transaction is to ensure that both parties in the deal are acting in their own self-interest and are not subject to any pressure or duress from the other party.

If a company complies with certain calculation methods and follows certain checkboxes, the IT Department will accept the transfer price adopted by the company as is. Calculation of transfer pricing for numerous transactions used to be the responsibility of the IT Department, which believed that the arm’s length price calculated by a firm itself is wrong, owing to incorrect methods used. It led to litigation.

Safe harbor rules decrease administrative pressures on the Tax Department. Most importantly, they reduce the tax uncertainty associated with the taxation of transfer prices. Most foreign firms were hesitant to expand business in India, given the high level of uncertainty with respect to transfer price calculation and tax liability by the IT Department. However, the Safe Harbor move drastically reduced this uncertainty.

Shark Repellant 

In the context of company takeovers, safe harbors work as a shark repellant to avoid hostile takeovers from other firms. Under the implementation of this provision, a company may acquire a troublesome or loss-making firm in order to raise its acquisition price and make a takeover by other firms economically unattractive.

Other Resources

Thank you for reading CFI’s guide to safe harbor. To further your financial education, the following CFI resources will be helpful.

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