Drawing flak from technology and pharma companies, the income tax department in rare show of promptness today killed one of its recent circulars on taxation of development centres of multi-nationals and clarified another one to assure corporate that "profit-split method" would not be the only method of computing tax liability.
In March this year, the government had issued two circulars – one on the application of profit split method of transfer pricing and another identifying development centres engaged in contract R&D services with insignificant risk. As per the profit-split method of transfer pricing, part of profit of parent company will be taken into account while computing tax of the centres. This would have meant a significant jump in tax dues of foreign R&D centres operating in India.
The industry raised serious concerns over the circular, forcing the government to withdraw it today. Experts said that the move will avert future trouble in the area of transfer pricing, which is already embroiled in significant litigation. "The peak assessment season is yet to begin, so the clarification at this stage is more than welcome," said SP Singh, senior director, Deloitte Haskins & Sells.
Rough calculations suggest that over $2 billion is stuck in transfer pricing litigation only involving software development centres. Bishakha Bhattacharya, director of software industry body Nasscom said that the withdrawal of the profit split method as "the default means of arm's length pricing" and also the promise to "remove the ambiguity involved in the definition of R&D centres will prevent the situation from further worsening." R&D centres contribute almost one-third of the revenues of the Indian software services export revenues and most large multi-nationals in the country including the likes of IBM and Microsoft have been embroiled in transfer pricing litigation in the past.
To resolve these issues, the government formed a committee under the chairmanship of former chairman of the central board of direct tax, N. Rangachary, which submitted its report on 'Taxation of Development Centres and IT Sector' in September last year. These circulars and a few others in the past were based on the report of the committee post its consideration of the government.
Circular number 3 issued by the tax department listed the conditions that would decide whether a Development Centre is a contract R&D service provider with insignificant risk based on five conditions. Singh said that as per the earlier circular, the profit split method would not be applicable on entities which qualified the five parameters under the definition of contract R&D service provider with insignificant risk. "However, it was very difficult for companies to meet all the parameters." Taking cognizance of this fact, the government said that "the use of the phrase 'cumulatively complied with' was perhaps too restrictive." It has also proposed to define and elaborate on phrases such as 'economically significant functions' and 'low or no tax jurisdiction' to make the definition clear.
As far as the circular number 2 is concerned, the department has said that since it was giving the impression that "there was a hierarchy among the six methods" of transfer pricing and that Profit Split Method (PSM) was the preferred method, it has "Rescind" the circular. Bhattacharya said that the industry is looking forward to how the government will not expand the definition and it should "hopefully be in its favour
Regards
Prarthana Jalan
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