One of the biggest MNCs to get caught in this aggression recently was Microsoft and, as FE first reported on April 20, the taxman added R5,000 crore to Microsoft Indias income between FY06 and FY09 the adjustments for later years would have been much higher given Microsofts increased India work. The taxman used what is called the profit-split method, or PSM, to argue that since 4.3% of Microsofts global R&D was done in India, 4.3% of its profits that were attributable to R&D should be deemed to be the income of the Indian operations.
While the transfer pricing rules prescribed at least five methods of looking at arms-length pricing, which is the crux of transfer pricing cases, the March 26 circular, to quote Saturdays circular, appeared to give the impression that Profit Split Method was the preferred method. In other words, the taxman looking at MNC R&D centres or India subsidiaries
Ikea was accused of understating FY09 profits by 85% dont have to look at PSM as the first method of calculating arms-length pricing. The taxman could look at profits of similar companies or just look at cost-plus margins for job work.
Under PSM, the tax officer assumes that the Indian captive unit has shared significant business risk in the research work Microsoft has argued that this doesnt apply to its Indian operations which are simply contract research and has contributed materially in decision making, and, therefore, is eligible for a share in the global parents profits, not just a margin over the cost of the contracted research. On the other hand, cost-plus method leads to only taxation of the operational profits of the entity doing contract research.
The ministry said it will also amend and reissue a second circular (No. 3 2013) issued on March 26 that listed out the conditions for considering a captive unit of MNC to be of insignificant risk, as certain phrases were too restrictive and some others needed clearer definition.
Rescinding notification 2 of March 26 is certainly a positive step. Applying profit-split method is no longer binding on assessment officers, who are now free to use their discretion on the most appropriate method for arms length pricing. In the awaited modified circular, we expect clarity that profit split shall not be used on contract research centres, said Vijay Iyer, transfer pricing leader, Ernst & Young.
The ministry also said the Central Board of Direct Taxes will soon bring out safe harbour norms under which the quoted transfer price will be accepted without questions. This, along with the re-issue of notification number 3 of March, will bring more certainty to development centres.
Tax officers have made upward adjustments in the value of the service rendered by many captive units to their overseas parents, leading to a higher tax outgo for the Indian unit or to protracted litigation. Transfer pricing adjustments in India lead to double taxation of the global IT firm outsourcing business to Indian subsidiaries.
Tax authorities in the country where the MNC parent is located often allow deduction of business expenditure on the outsourced work only at the value of the transaction claimed by the Indian captive unit, not at the value upwardly adjusted by the Indian tax authority. The amount adjusted by the Indian tax department gets taxed twice.
Transfer pricing adjustments or attribution of additional taxable income on companies by the authorities have been rising in India rapidly. The tax department has made an adjustment of over R70,000 crore on MNC arms in the 2012-13 audit, showing a 58% jump from the adjustments made in the audits a year ago. In 2011-12, the department had made an adjustment of R44,500 crore, representing an 85% jump from the same done a year ago.