Introduction
Central Board of Direct Taxes (CBDT) has recently released two circulars - Circular No. 02/2013, pertaining to selection and application of the profit split method (PSM) and Circular No. 03/2013, relating to the conditions relevant to identify development centres engaged in contract R&D services with insignificant risk. The guidance encompassed in the said circulars is explained in this tax alert.
Circular on application of profit split method
In this circular, the CBDT has provided the following points with regards to the selection of PSM as the most appropriate method (MAM).
(i) The use of transfer pricing methods such as Transactional Net Margin Method (TNMM) is discouraged for valuation of intangibles due to lack of correlation between cost incurred on R&D activities and return on the intangible developed through those R&D activities.
(ii) The circular refers to Rule 10B (1)(d) regarding the applicability of PSM mainly in international transactions involving the transfer of unique intangibles or highly interrelated international transactions.
(iii) Various factors mentioned under Rule 10C(2) for selection and application of PSM have been reiterated, including:
- the nature and class of the international transaction
- the availability, coverage and reliability of data necessary for application of the method
- the degree of comparability existing between the international transaction and the uncontrolled transaction and between the enterprises entering into such transactions
- the nature, extent and reliability of assumptions required to be made in application of the method
(iv) In cases where PSM cannot be applied for international transactions involving intangibles, the reasons for non-applicability of PSM should be recorded by the transfer pricing officer (TPO) before considering TNMM or Comparable Uncontrolled Price Method (CUP) as the MAM.
(v) Further, the taxpayer should have all the information necessary for application of PSM.
(v) CUP or TNMM may be used by selecting comparables engaged in developing intangibles in the same line of business, and upward adjustments can be made considering transfer of intangibles without additional remuneration, location saving and location specific advantages. |