More than 100 tax disputes involving Indian associates of US companies such as IBM and Microsoft are set to be settled out of court by April this year with the income tax department and the US Internal Revenue Service identifying disputes in the contract research, IT and software sectors for resolution under a bilateral tax treaty.

The disputes that would be resolved through discussions between authorities in both countries would cover tax claims on cross-border transactions of multinational companies called transfer pricing adjustments.

Sources in the government told FE that the 100-odd cases identified would include tax demands on the same company for different years. India’s tax treaty with the US allows settlement of tax disputes involving double taxation through talks between the tax authorities.

IBM, for example, faces an additional R11,000 crore to its taxable income for 2006-07, while Microsoft faces an addition to its income by R5,535 crore for 2006-07 to 2009-10.

Cisco, Google, Honeywell, AT&T, Dell, Intel, Alcatel and Tesco are among the large multinational companies that run contract research and development centres in India.
The outcome of such bilateral settlement under the Mutual Agreement Procedure (MAP) on how much tax should be levied in each country on a specific transaction is not binding on a company. If the taxpayer accepts the outcome, the solution becomes binding on both the company as well as the tax authorities.

The profitability of contract research and development centres set up in India by global IT and IT-enabled services firms has been a major area of dispute between them and the Indian tax authorities, which demand higher taxes by attributing a higher profitability to such units.

The government had already made several changes in transfer pricing norms to reduce litigation but the disputes already in courts had set some kind of precedence for tax officers who tend to repeat the same approach in assessment of income in subsequent years too.

According to industry experts, the tax department has been attributing about 30-40% profitability to contract research units, while it was much less on the ground. The higher profit margin estimate so far used enabled the tax authorities to make upward adjustments in the value of the service rendered by the captive unit to its overseas parent, leading to a higher tax outgo for the Indian unit.

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. India and the US are now set to resolve disputes in this area through MAP.