CBDT issues circulars on Rangachary committee recommendations

The Central Board of Direct Taxes (“CBDT”) has recently issued two Circulars on certain transfer pricing (“TP”) issues. These Circulars are based on the Rangachary Committee recommendations which were presented on September 14, 2012.

The Circulars deal with the following aspects:

(i) Application of profit split method (“PSM”) [Circular No. 2/2013 dated March 26, 2013]

(ii) Conditions relevant to identify development centres engaged in contract Research and Development (R&D) services with insignificant risk [Circular No. 3/2013 dated March 26, 2013].

Application of PSM to Indian development centres

Following are the key points in the Circular regarding application of PSM to R&D centres:

· There is no correlation between the costs incurred on R&D activities and the returns on an intangible developed through such R&D activities. Hence, the Transactional Net Margin Method (“TNMM”) is not the most appropriate method for the determination of arm’s length consideration for such activities;

· Guidance provided under the existing regulations on application of PSM for international transactions which involve transfer of unique intangibles and for inter-related transactions has been reiterated;

· In case the Transfer Pricing officer (TPO) is of the view that the PSM cannot be applied owing to non-availability of information, the TPO must record reasons for the same;

· Where the taxpayer is unable to furnish relevant data for its operations and in relation to the Associated Enterprises for application of PSM, the burden of proof is on the taxpayer to provide sufficient reasons for the same; and

· Depending upon the facts and circumstances of the case, the TPO may consider TNMM or Comparable Uncontrolled Price (“CUP”) as the most appropriate method. Even in such circumstances, TP adjustments may be made taking into account the remuneration for intangibles, location savings and location specific advantages.

Identification of Indian development centres bearing insignificant risks:

The Circular lays down five criteria, the cumulative satisfaction of which shall result in the Indian development centre being characterised as a service provider bearing insignificant risks:

· Indian development centre is engaged in performing economically insignificant functions.

· Foreign principal provides funds/ capital and other economically significant assets required by the Indian development centre, and the Indian development centre would not use any other economically significant asset including intangible in research or product development;

· Indian development centre works under the direct supervision of the foreign principal which controls and supervises the work performed by the Indian R&D centre, by undertaking strategic decision making and regular monitoring;

· Indian development centre does not assume any economically significant risks. This shall be determined based on the conduct of the parties.

· Further, in case the foreign principal is located in a country widely perceived as a low or no tax jurisdiction, it shall be presumed that the foreign principal is not controlling the risk unless the taxpayer provides evidence to the contrary; and

· Indian development centre does not have the ownership right on the outcome of research (legal or economic). Such rights vest with the foreign principal. The conduct of the parties shall be considered while analysing these rights