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Taxing Times for Development Centres & IT Companies?

Published on Fri, Aug 03,2012 | 15:07, Updated at Fri, Aug 03 at 15:14Source : Moneycontrol.com 

By Dhinal Shah, Tax Partner, Ernst & Young

After setting-up an independent committee to review the provisions relating to the General Anti-Avoidance Regulations (‘GAAR’), the Prime Minister has now announced setting-up of a separate committee to review the taxability of Development Centres, the IT sector as well as expediting the process of notifying the safe-harbour provisions. The move seems to be aimed at providing a re-assurance to various domestic and multinational companies facing huge transfer pricing adjustments.

Taxing the Development Centres

Easy availability of skilled staff and the cost competitiveness of India have attracted many global multinational companies to establish their captive subsidiaries here for carrying out activities like product development, software development, performing analytical work etc. These captive entities are popularly referred as Development Centres. The Development Centres are normally as service providers to their global affiliates assuming limited risks and not owning intangible property. Hence, they are typically remunerated so as to earn a return which is commensurate with that earned by comparable uncontrolled service providers.

Going by the recent experience, the tax authorities are actively questioning the appropriateness of the transfer price for these Development Centres. The argument of the tax authorities has been that though the Development Centres have been set-up as an independent company for performing the development work on a peer to peer basis, in many instances they work only as an extension of their parent or group companies’ businesses. Further, their second argument is that these Development Centres perform high level end-to-end services for its parent which leads to creation of intangibles in the form of new products and/ or processes. In the said scenario, the tax authorities perceive that such development centers should earn a return that is commensurate with their overall contribution to the value chain of the multi-national enterprise.

The tax authorities have called for more profits to be allocated to the Indian Development Centres and are seen making huge transfer pricing adjustments in the hands of these Development Centres.

It is anticipated that the Committee will examine the contentious issues relating to taxation of the Development Centres and provide some proposals which would be aimed at making an objective assessment of the activities of the Development Centres and to develop a system of taxation which is fair and in line with the existing international practices.

Safe Harbour provisions

The Committee has been mandated to finalize the Safe Harbour regulations for individual industry sectors in a time bound manner with a direction to roll out Safe Harbour for atleast three sectors/ sub-activities every month beginning with 30 September 2012 and to complete the same for all industries by 31 December 2012.

It is also interesting to note that the OECD in June 2012 released a discussion draft that proposes revisions to the section of Safe Harbours in the Transfer Pricing Guidelines. When these Guidelines were adopted in 1995, the view expressed regarding safe harbour rules was generally negative. However, in the discussion draft they are generally considered more favourably. The proposed revisions suggest that the benefits of safe harbours outweigh the related concerns when such rules are carefully targeted and prescribed and when efforts are made to avoid the problems that could arise from poorly considered safe harbour regimes. The appropriateness of safe harbours can be expected to be most apparent when they are directed at taxpayers and/or transactions which involve low transfer pricing risks and when they are adopted on a bilateral or multilateral basis. It will be useful for the Committee to consider the OECD suggestions while preparing its recommendations.

Taxation of IT Sector

The IT Sector has in the recent past, if one might say, been at the hard end of the tax laws. Denying export-linked exemption in respect of services provided onsite of the customer, retrospective amendment to the tax laws by expanding the definition of royalty to include software payments etc. have substantially increased the headache for the software companies, both domestic as well as Multinationals.

While it seems that the retrospective amendment may not be rolled back and the IT companies may have to live with that, the Committee has been mandated to look into the other issues in connection with taxation of IT companies especially the tax treatment of ‘onsite services’ of domestic Indian companies.

Constitution of the Committee directly by the Prime Minister suggests the sincerity of the Government in resolving the various tax disputes. Further, inviting the stakeholders as well as the tax department to provide their suggestions to arrive at a consensus based solution shows that the Government is keen to make amends for its recent image of being a vexing tax jurisdiction. However, unlike the Committee set-up for reviewing the GAAR guidelines, this Committee is made up Departmental representatives. Given the same, time will tell whether the Committee achieves the objectives that have been outlined for it.

(Views expressed are personal)

 
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