Circular 3/2013

Circular on conditions relevant to identify development centres engaged in contract r d services with insignificant risk

What this is

Circular 3/2013 was issued by the Central Board of Direct Taxes on 26 March 2013. Its subject is Circular on conditions relevant to identify development centres engaged in contract r d services with insignificant risk.

What it does

Lays down five conditions, all of which must be met together, before an Indian development centre can be treated as a contract research and development service provider bearing insignificant risk for transfer pricing purposes. The foreign principal must perform most of the economically significant functions in the research or product development cycle, the Indian centre being left with the economically insignificant ones. The principal must provide the funds, capital and other economically significant assets including intangibles, and the Indian centre must not use any economically significant assets or intangibles of its own. The Indian centre must work under the direct supervision of the principal, who must not merely be able to control or supervise but must actually do so, through strategic decisions on core functions and regular monitoring. The Indian centre must assume no economically significant realised risk — and where the contract puts the risk on the principal but the conduct shows the Indian centre bearing it, the contract does not govern; where the principal is in a jurisdiction widely perceived as low or no tax, it is presumed that the principal is not controlling the risk, a presumption the Indian centre may rebut to the satisfaction of the revenue authorities. Finally, the Indian centre must have no legal or economic ownership of the outcome of the research, which must vest in the principal, and that must be evident from conduct. The circular ends by insisting that all five be borne out by the conduct of the parties and not merely by the contractual terms.

Why it was issued

Field officers and taxpayers were taking divergent views on the functional profile of such development centres, taxpayers insisting they were insignificant-risk contract service providers while Transfer Pricing Officers treated them as full or significant risk-bearing entities and adjusted accordingly.

Who it reaches

Indian captive research and development centres of foreign groups
Multinational principals commissioning research from Indian affiliates
Groups whose principal sits in a low-tax or no-tax jurisdiction
Transfer Pricing Officers characterising such centres

The instrument, as the Board published it

The department publishes this one only as a PDF, so the words below were read out of that PDF by machine. That reading can carry its own mistakes — a misread number, a broken line. Check the signed document before you rely on a figure in it.

F No. 500113912012
Government of India
Ministry of Finance
Department of Revenue
Central Board of Direct Taxes
(Foreign Tax and Tax Research-l Division)
New Delhi, the 26th day of March, 2013
Circular No. 03 /2013
Subject: Circular on conditions relevant to identify development centres engaged in contract R&D services with insignificant risk

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.

(Batsala Jha Yadav)
Director APA
Central Board of Direct Taxes

Copy to:
1. The Chairperson, Members and all other officers of the CBDT of the rank of Under Secretary and above.
2. All Chief Commissioners/Directors General of Income-tax.
3. The Director (PR, PP & OL), Mayur Bhawan, New Delhi for printing in the quarterly tax bulletin and for circulation as per usual mailing list (100 Copies).
4. The Comptroller and Auditor General of India (40 copies).
5. All Directors of Income-tax, New Delhi
6. The Director General of Income-tax, NADT, Nagpur
7. Guard File.
8. Joint Secretary and Legal Advisor, Ministry of Law and Justice, New Delhi
9. The Institute of Chartered Accountants of India, IP Estate, New Delhi

(Batsala Jha Yadav)
Director APA
Central Board of Direct Taxes

What to watch

The conditions are cumulative — failing any one takes the centre out of the insignificant-risk category, however the agreement is drawn.
Conduct governs over the contract throughout, which is what makes documentation of actual supervision and decision-making decisive.
A principal in a jurisdiction widely perceived as low or no tax is presumed not to control the risk, and the burden of displacing that presumption falls on the Indian centre.
Economic ownership matters as much as legal ownership: any economic interest in the research outcome retained in India defeats the characterisation.

Where you meet it

In a transfer pricing audit of a captive research and development centre, where the Transfer Pricing Officer recharacterises it as a risk-bearing entity and applies a higher margin or profit split.

What it names

It mentions. Circular No. 03/2013

A circular binds the department, not you and not a court. The Board issues a circular to its own officers. An assessee may hold the department to a circular that helps him; the department cannot hold an assessee to one that hurts him, and the Tribunal and the courts decide the law for themselves.

Source: the Income Tax Department’s own published text — its page for this instrument.