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History: 

CBDT had issued 2 circulars on 26th March 2013 relating to the selection of transfer pricing method to be adopted by Tax authorities for determination of Arm’s Length Price in case of research & Development units of MNC’s located outside India.

The First circular defines what does an R&D unit means & whether a development centre would be a R&D unit. So an MNC may be having a R&D or just a Development centre. A Development Centre to be a R&D unit has to satisfy the following conditions. These conditions have to be satisfied cumulatively.

1. Foreign  principal  performs  most  of  the  economically  significant  functions  involved  in research  or product  development  cycle.

2. The Principal  provides  funds/capital  and other  economically  significant  assets including  intangibles  for  research  or  product  development  and  lndian  development centre  would  not  use  any  other  economically  significant  assets  including intangibles in  research  or  product  development;

3. lndian development centre works under direct supervision of foreign principal who not only has capability to control  or  supervise but  also actually controls or supervises research or product  development  through its strategic decisions to perform core functions  as well  as  monitor activities on regular  basis;

4. Indian development centre does not assume or has no economically significant realized  risks.

5. Indian development centre has no ownership  right  (legal  or  economic)  on  outcome  of research  which  vests  with  foreign  principal,  and  that  it  shall  be  evident  from  conduct of  the  parties.

The Second Circular mainly described that if the MNC has a R&D units assuming significant risk in India then TNMM method (Transaction Net Margin Method) is discouraged & only PSM (Profit Split Method) method is to be used for the purpose of determining the Arm’s Length Price. The PSM method is mainly applicable in International Transaction involving mainly transfer of Intangibles.

If TPO is of the view that PSM method cannot be applied due to the lack of information then he can allow other methods like TNMM or CUP method.

The Conclusion one can draw from both these circulars is that if a MNC has service centre which satisfies all the 5 conditions cumulatively then, it will be R&D centre not assuming significant risk then TNMM or CUP method may be used. But if it is R&D centre assuming significant risk then PSM Method has to be used.

Recent Development:

CBDT now has issued a circular rescinding the Circular 2 which says that the PSM method has to be applied. CBDT has recognized the difficulty faced by many IT companies & PSM method would not be preferred for in case of international transaction involving transfer of intangibles & Multiple interrelated transactions. Hence the circular stands rescinded.

The New circular classifies R&D centre of MNC’s into 3 broad types:

The First category of Centres assume significant Risk & perform important functions, while the other two does not assume risk & do not perform important functions.

The criteria for recognition of R&D units are also the same mentioned in the earlier circular but with an additional criteria inserted. The additional criteria is as follows.

“In the case of a foreign principal being located in a country/ territory widely perceived as  a  low  or  no  tax  jurisdiction,  it  will  be  presumed  that  the  foreign  principal  is  not controlling  the  risk.  However, the Indian Development  Centre  may  rebut  this presumption to the satisfaction of the revenue authorities. Low tax jurisdiction shall mean any country or territory notified in this behalf under section 94A of the Act or any other country or territory that may be notified for the purpose of Chapter X of the Act;”

This condition has been incorporated & so now there are total 6 conditions to be satisfied for recognizing a R&D centre as assuming insignificant risk.

Download the amended Circulars here:

Circular 2

Circular 3

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Category Income Tax, Other Articles by - Rahul Chilal 



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