CA Kamal Garg

TRANSFER PRICING: CBDT Clarifications on Functional Profile of Development Centres engaged in Contract R&D Services with insignificant risk – conditions relevant to identify such Development Centres

The Central Board of Direct Taxes (CBDT) issued CIRCULAR NO. 3/2013 [F NO. 500/139/2012], DATED 26-3-2013 to clarify on functional profile of development centres engaged in contract R & D services with insignificant risk. CBDT also laid down the conditions which are relevant to identify such development centres. 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. These conditions have thrown several unanswered questions before the taxpayers at large. In the succeeding paragraphs, various laid down conditions and issues involved therein have been discussed in a succinct manner:

Condition 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;

Issue(s) Involved

The Circular has not defined the meaning and/ or features of expressions “economically significant functions” and “economically significant functions”. This had been a contentious issue even prior to issue of this circular. The tax payers used to argue that service provider is not bearing any economic risks which are borne by the foreign parent. Further, it was argued that the development centers provide only a part of services required under the project under the close guidance & supervision of foreign affiliates and thus no risk of the failure of efforts was assumed by such centers.

Condition 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;

Issue(s) Involved

This condition essentially deliberates that the development center should neither employ nor should have ownership of any economically significant tangible and/ or intangible assets required for the R & D activity. Consequent upon to the amendment made by the Finance Act, 2012 last year, manpower is also classified as a valuable intangible. All the development centers employ skilled manpower and a question arises that in light of this do the tax authorities may take a view that all such development centers have significant risk.

Condition 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;

Issue(s) Involved

This condition is not clarifying the extent of control or supervision. For instance, the foreign principal may be aware that relevant research is being carried out and may not see any requirement or justification to intervene in it. Other instance could be that it is always not necessary that whole work should be under the direct supervision of the parent. The usage of another expression “core functions” with no meaning assigned to it has again leaded to some open questions.

Condition 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

Issue(s) Involved

The Circular has neither defined nor provided any parameters to understand the meaning of the expression “significant realised risks”. It has left open the yet to be answered issue about the distinction between legal risk and economic risk.

Condition 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.

Issue(s) Involved

This condition primarily states that development center can contribute towards development of an intangible without becoming the legal or economic owner of such intangible and this has to be established both legally and by conduct of the parties. The Circular has not guidelined about “economic ownership”. For example, there is nothing said about the ownership of such intangible in case of continuing involvement of/ by the development center

 Conclusion: As can be seen from above that the circular has left many threads open to be debated and clarified. One positive side of this Circular is that it brings out to the minds of MNEs having their R & D Centers in India, the likely approach of the tax authorities during transfer pricing assessment.

The author is the fellow member of ICAI. He is engaged in Audits, IFRS, FEMA and International Taxation services. For any queries and suggestions, he may be approached at or 9811054015

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February 2024