I-T department clarifies rules on development centres

The income tax department today clarified as to when will the development centre located in India will be taken as the one engaged in contract research and development activities and hence liable to lower tax.

Those which are not in this category would be treated as the ones coming out with new products, solutions, software and hence will be liable to pay higher tax.

The issue was a long-pending dispute between tax authorities and companies relating to the field of information technology, pharma etc.

As such, Prime Minister Manmohan Singh had appointed the Rangachary committee to resolve the matter as India is seen as attractive location for the development centres.  

Rangachary had submitted its report to the Government. On the basis of these recommendations, the IT department recently came out with a circular which says that the development centres will be construed as contract R&D service providers if the parent performs the economically significant  functions in research and product development cycle.

Further, the parent will have to provide funds, capital and other significant assets including intangibles.

Also, the development centre will be treated as contract R&D service provider if it is under direct supervision of the parent and does not have any significant realized risks.

In case, the parent is situated in low tax or no tax country, development centres would not be treated as contract R&D centres.

Besides, the development centre situated in India will not have any ownership right on the research carried to treat it as contract service provider.

Explaining the circular, Deloitte Haskins & Sells partner Neeru Ahuja told Business Standard that the issue has been long pending between the companies and the tax authorities.

If the development centre is considered as the one which comes out with new product, solution etc, the parent company will have to give it royalty, technology fee and the tax on the centre would be much more than the simple R&D contract service provider. In the case of the latter, cost of the development centre plus some mark up is added to impose a tax.  

The income tax department also came out with another circular to clarify where the profit-split method would be used in case of R&D activities located in India. It says profit-split method would be applied in interational transactions involving unique intangibles etc or in case where these transactions are so inter-related that these cannot be evaluated separately.

In a profit-split method, profits of associated enterprises are taken together and then profit of each unit is arrived at. In this case, tax would be higher than the usual cost plus basis in transfer pricing.

Ahuja said," The circulars by the Income Tax department will provide clarity to the companies engaged in the software development centre."