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IT companies: Government's tax circulars add to woes
March, 30th 2013

The government's attempt to settle the confusion over a vexing tax issue for software and technology companies has come a cropper, analysts and industry experts fretted on Friday.

The complaint is that instead of providing clarity on how the research and development centres and back-offices of foreign multinational companies such as IBM and Microsoft would be taxed, the government has issued two so-called 'circulars' which do nothing to address the problem.

The continuing failure to clear issues relating to taxation is taking place in the backdrop of a perception that Indian tax authorities are being extremely aggressive in their pursuit of revenue, especially with foreign multinationals such as Nokia and Shell.

"We welcome the fact that the government is trying to bring clarity on transfer pricing, but these circulars do not provide any consistency," said Som Mittal, president of India's software industry body Nasscom.

Mittal was referring to transfer pricing rules that are meant to prevent multinational companies from mis-pricing products and services to shift profits out of India. Existing rules are seen as open to arbitrary interpretation, hurting the profitability of the sector. The industry has been seeking the fixing of a markup, or an acceptable level of deviation from the market price, also called 'safe harbour.'

Instead, what the Central Board of Direct Taxes did on Wednesday with the two 'circulars' was far from expectations. One communication dealt with the application of the "profit split method" to calculate transfer pricing. The other was on "conditions relevant to identify development centres engaged in contract R&D services with insignificant risk."

Dinesh Kanabar, chairman (tax) at auditing firm KPMG India, said there is no uniformity when it comes to taxing R&D centres based in India and the lack of clarity has resulted in different tax officers using varying tax rates. "The intention of these circulars was to provide certainty on the conditions that need to be fulfilled by R&D centers and how they should be taxed. Instead, it creates confusion due to lack of clarity," said Kanabar.

The circulars come at a time India is seeking to boost its image as a preferred destination for foreign investments. India is home to product development centres and captive units of some of the world's largest corporations, including GE, IBM, HP, Microsoft and Samsung, due to the availability of a large pool of technical talent and relatively low wages.

According to Nasscom, one-third of India's $70 billion (Rs 3.8 lakh crore) software export revenue comes from R&D centres and captives of multinational firms. "The government circular talks about contract R&D centres, but it does not tell us how these centres will be taxed. There is a gap between the two circulars," said Vijay Iyer, tax partner at auditing firm Ernst & Young.

Last year, the government had set up a panel under former CBDT chairman N Rangachary to hold consultations with industry stakeholders to bring clarity on tax rules pertaining to R&D centres and captive units in the country.

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