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Dvpt Centre Circulars Counterproductive?

Published on Mon, Apr 01,2013 | 16:16, Updated at Fri, Apr 26 at 14:25Source : 

By: Samir Gandhi, Partner, Deloitte Haskins & Sells

The Central Board of Direct Tax (CBDT) has issued the following Circulars after considering the recommendations made vide report of the Rangachary Committee on 'Taxation of Development Centres and IT Sector'.

• Circular on Application of Profit Split Method : Circular No. 2/2013 dated 26  March 2013

• Circular on condition relevant to identify development centres engaged in contract R & D services with insignificant risk : Circular No. 3/2013 dated 26  March 2013

CBDT has expressed the view that these Circulars will help in providing certainty to the taxpayer on issues relating to transfer pricing of development centre.

Circular No 2/2013 deals with Application of Profit Split Method. Though the subject mentions the application of said method, the Circular implicitly in some places and explicitly at other places conclude that in case of R & D activities , use of Cost Plus / TNMM is not the appropriate method e.g. Para 1 mentions that there is no correlation on cost incurred on R & D activities and return on an intangible developed through R & D activities. In-fact it goes to mention that Profit Split Method (PSM) has to be applied to estimate the value of intangibles. 

Application of PSM requires information about the tax payer and the associated enterprises (AEs). The Circular requires the taxpayer to furnish the good and sufficient reason for non-availability of such information. It means that tax payer will be required to furnish the detailed information / documents of the AEs.

Even if Transfer Pricing Officer (TPO) considers the TNMM or CUP as an appropriate method, he will be required to make an upward adjustment taking into account transfer of intangibles, location savings & location specific advantages.

Though the CBDT is of the view that the Circular will help in providing certainty on transfer pricing issues relating to development centre, it seems this may not be exactly true. The Circular in-fact lays down that PSM is the most appropriate method for R & D centre and not return on cost incurred on R & D activities - Cost Plus method. It is possible that this will increase the litigation rather than resolving /preventing the disputes and may lead to India may not considered as a preferred location to set up development centres. 

Circular No 3/2013 lays down conditions to identify contract R & D services with insignificant risk.  The Circular lays down 5 conditions to be cumulatively complied with. The important being that foreign principles perform most of the economical significant functions involved in development cycle and provides economically significant assets including intangibles. The Indian development centre will work under direct supervision of the principle through strategic decisions and monitoring of activities on regular basis. The Indian development will have no legal or economic ownership right on outcome of research.

The satisfaction of the above conditions should be evidenced by the conduct of the parties and not merely by the contractual terms.

Though the emphasis is on the risk in the subject matter of the Circular, a lot of weightage is given to the function performed by the foreign principle and the Indian development centre. The only reference to risk is that mere bearing of contractual risk will not be the final determinant.

It is also to be noted that if the foreign principle is located in widely perceived as low or no tax jurisdiction, it will be presumed that foreign principle is not contracting the risk.


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