The finance ministry has done well to clear the confusion on how R&D centres and back-offices of multinational companies (MNCs) would be taxed. The new set of guidelines by the Central Board of Direct Taxes (CBDT) will lower tax disputes and not tarnish India's appeal as an R&D hub. The relief is on two counts. One, CBDT has eased the norms for development centres to qualify as contract R&D centres.
Disputes arose as taxpayers insisted that they were contract R&D service providers bearing insignificant risks, while transfer pricing officers held otherwise, and sought to attribute higher profits to the Indian operations. More leeway will soften the tax blow. Two, these units do not have to mandatorily use the profit-split method to compute transfer prices.
Such a fiat would have meant quantifying the relative contribution of the parent and the captive R&D centre to the profits of the MNC. And adjustments would arbitrary in the absence of relevant data. CBDT's revised circular provides clarity on the principles to distinguish between three categories of R&D centres: entrepreneurial, costsharing and contract R&Ds.
This will prevent arbitrary tax demands. The larger point is that it is conceptually wrong for the tax authorities to demand a share of the profits arising from R&D at a captive unit. That would be the opposite of applying the arm's-length principle to the pricing of services procured from an Indian captive. India exported software worth $76 billion in 2012-13, a third from captives. We need to attract investment in such captives.
This calls for both certainty and clarity in the tax regime. MNCs also need simple rules that they can follow in pricing their services while doing business with their parent or subsidiaries overseas. A "safe harbour" brooks no delay.