How to identify development centres engaged in contract R&D services with insignificant risk

*SECTION 92C OF THE INCOME-TAX ACT, 1961 - TRANSFER PRICING - COMPUTATION
OF ARM'S LENGTH PRICE - CLARIFICATIONS ON FUNCTIONAL PROFILE OF DEVELOPMENT
CENTRES ENGAGED IN CONTRACT R&D SERVICES WITH INSIGNIFICANT RISK -
CONDITIONS RELEVANT TO IDENTIFY SUCH DEVELOPMENT CENTRES*

*CIRCULAR NO. 3/2013 [F NO. 500/139/2012], DATED 26-3-2013***

It has been brought to the notice of CBDT that there is divergence of views
amongst the field officers and taxpayers regarding the functional profile
of development centres engaged in contract R&D services for the purposes of
transfer pricing audit. Moreover, while at times taxpayers have been
insisting that they are contract R&D service providers with insignificant
risk, the TPOs are treating them as full or significant risk-bearing
entities and making transfer pricing adjustments accordingly. The issue has
been examined in CBDT. It is hereby clarified that a development centre in
India may be treated as a contract R&D service provider with insignificant
risk if the following conditions are cumulatively complied with :****

1.****

Foreign principal performs most of the economically significant functions
involved in research or product development cycle whereas Indian
development centre would largely be involved in economically insignificant
functions;****

2.****

The principal provides funds/ capital and other economically significant
assets including intangibles for research or product development and Indian
development centre would not use any other economically significant assets
including intangibles in research or product development;****

3.****

Indian 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. If a contract shows the principal to be
controlling the risk but conduct shows that Indian development centre is
doing so, then the contractual terms are not the final determinant of
actual activities. In the case of 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; and****

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 satisfaction of all the above mentioned conditions should be borne out
by the conduct of the parties and not merely by the contractual terms.****

The above may be brought to the notice of all concerned.****

** **

*Circular No. 02/2013 - Sub: Circular on application of profit split method*
**

* *

It has been brought to the notice of CBDT that clarification is needed for
selection of profit split method (PSM) as most appropriate method. The
issue has been examined in CBDT. ****