A breather for information technology companies

In a breather to the information technology sector, the Income Tax Department, on Saturday, announced withdrawal of a controversial circular, and modification of another one relating to taxation of R&D centres, which play a key role in software development.

While the circular relating to adoption of profit-split method (PSM) as a preferred mode for computation of tax liability has been rescinded, another one relating to development centres will suitably be modified, said the Central Board of Direct Taxes (CBDT).

The decisions were taken following representation from the industry for greater clarity on two circulars concerning international taxation or transfer pricing.

“This is a very positive step. The compliance cost will come down and chances of double taxation may reduce,” said S. P. Singh, Senior Director, Deloitte Haskins & Sells.

Rangachary Committee

The circulars were based on a report of N. Rangachary Committee on ‘Taxation of development centres and IT sector’

The tax department by rescinding the circular had made sure that the profit-split method (PSM), which led to higher taxation, would not be the preferred mode, Mr. Singh said, adding that the I-T Department would use more appropriate methods depending on the circumstances.

Besides PSM, there are five other methods for computing tax liability under the transfer pricing rules. These include, resale price method, cost plus method, comparable uncontrolled price method and transactional net margin method.

The circular which has been withdrawn, the CBDT said, was “appeared to give the impression that there was a hierarchy among the six methods listed in Section 92C and that the PSM was the preferred method in the case involving unique intangibles or in multiple interrelated international transactions.’’

Referring to the other circular, the CBDT said the use of phrases such as ‘cumulatively complied with’, ‘economically significant functions’ and ‘low or no tax jurisdiction’ will be redefined.

“The CBDT believes the rescission of circular No 2 and amendment and reissue of circular No.3 will clear all ambiguities in the matter,” the CBDT added. It further said that ‘Safe Harbour Rules’ are under consideration and will be issued shortly.

The Safe Harbour Rules will bring further certainty in assessment of development centres that are engaged in providing contract R&D services, it added.

Safe harbour principles are international disclosure practises to check litigations in transfer pricing — an accounting mechanism undertaken by MNCs to reduce tax liabilities.

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