Tax relief for R&D centres as FinMin relaxes norms

The government on Sunday brought some tax relief to development centres engaged in contract research and development (R&D) services with insignificant risk by relaxing norms for identifying these. As captive centres of multinational companies perform minimal functions for the parent and share a low risk, these would be subjected to a less stringent way of computing taxable income.    

The Central Board of Direct Taxes (CBDT) revised its circular no 3 of March to classify R&D centres set up by foreign companies in three broad categories based on functions, assets and risk assumed by the centre established in India. These include centres which are entrepreneurial in nature; centres which are based on cost-sharing arrangements; and centres which undertake contract R&D.

For determining the arm’s length price, taxpayers often insist that they are contract R&D service providers with insignificant risk, while assessing officers treat them as full or significant risk-bearing entities and make transfer pricing adjustments accordingly.

The CBDT has now laid down six parameters for identifying such insignificant risk centres, against five conditions in the earlier circular. Profit split method, where a part of profit of the parent is taken into account for computing tax of the captive unit, would not be applicable to these centres.

Earlier, it was difficult for the R&D centres to meet all the five conditions so that they were not subjected to the profit split method. The government said that “the use of the phrase ‘cumulatively complied with’ was perhaps too restrictive.” It has also defined phrases such as ‘economically significant functions’ and ‘low or no tax jurisdiction’ to make the definition clear.

“Rescinding these circulars to a large extent removes uncertainty and apprehension in the minds of top decision makers in foreign companies looking to create a ‘win-win’ environment by outsourcing even more contract R&D and other forms of IT-enabled services to India,” said Hitesh Gajaria, Partner, KPMG.

He said rigidly defining contract R&D centres who work in a risk free environment as only those satisfying ‘cumulatively’ all the conditions specified in the erstwhile circular was too restrictive and one wondered whether any centre would ever be able to qualify as such.

On Saturday, the tax department had killed one of its recent circulars on taxation of development centres and clarified that profit-split method would not be the only method of computing tax liability.

With over 57 per cent rise in transfer pricing demand notices by the government last year making companies jittery, the income tax department is issuing ‘guidance’ to assessing officers to help them frame orders based on international best practices. Of about 3,200 cases taken up for transfer pricing auditing in 2012-13, an adjustment of Rs 70,000 crore was made in 1,600 cases. In 2011-12, an adjustment of Rs 44,531 crore was made in 1,343 cases.

Transfer pricing orders were also issued to companies like Microsoft, Bharti Airtel, Essar, HSBC Securities, Standard Chartered Securities, Havells India, Patel Engineering, Ikea, Hindalco, Gillette, GE, Hindustan Unilever and LG last year.