Friday, March 29, 2013

CBDT’s circular on Transfer pricing issues - Identification of development centre and application of PSM

CBDT has issued two important circulars in relation to identification of development centres engaged in contract ‘R&D Activities’ and application of profit split method

When TPO can prefer TNMM or CUP method over PSM where intangibles are involved, CBDT clarifies

Rule 10B(1)(d) prescribes that the Profit Split Method is applicable mainly in international transaction involving transfer of unique intangibles. However, vide Circular No. 02/2013, the CBDT clarifies that TPO may consider TNMM or CUP method as most appropriate method instead of Profit Split Method for selection of comparables engaged in development of intangibles in same line of business, provided:

1) TPO should be of the view that PSM cannot be applied due to non-availability of information and reliable data required for application of the method;

2) He records reasons for non-applicability of PSM.

(View circular)

How to identify development centres engaged in contract R&D services with insignificant risk, CBDT clarifies

A development centre in India (‘IDC’) may be treated as a contract R&D service provider with insignificant risk if following conditions are satisfied:

1) Foreign principal performs most of the economically significant functions involved in research and development cycle whereas IDC would largely be involved in economically insignificant functions;

2) Economically significant assets including intangibles for R&D activities are provided by principal and IDC would not use any other economically significant assets;

3) IDC works under direct control and supervision of foreign principal;

4) IDC doesn’t assume or has no economically significant realized risks; and

5) IDC has no ownership right (legal or economic) on outcome of research which vests with foreign principal.

Further, the CBDT clarifies that the above conditions should be borne out of the conduct of the parties and not merely by the contractual terms.

(View circular)

Exp. on ‘clinical drug trial’ is deductible even if the impossible “incurred in-house” condition isn’t satisfied

Explanation to Section 35(2AB)(1) does not require that the expenses which are included in this explanation are essentially to be incurred inside an in-house research facility because it is not possible to incur these expenses for in-house research facility

In the instant case, the issue that arose for consideration of HC was as under:
"Whether the expenditure which was not incurred in an in-house research facility could be discarded for weighted deduction under sec. 35(2AB) of IT Act?”

Deliberating on the issue, the HC held in favour of assessee as under:

1) The Explanation to section 35(2AB)(1) provides that expenditure on scientific research in relation to drugs and pharmaceuticals shall include expenditure incurred on clinical drug trials, obtaining approval from any regulatory authority and filing an application for a patent under the Patents Act, 1970. The whole idea thus appears to be to give encouragement to scientific research. By its very nature, clinical trials may not always be possible to be conducted in closed laboratory or in similar in-house facility provided by the assessee and approved by the prescribed authority;

2) Before a pharmaceutical drug could be put in the market, the regulatory authorities would insist on strict tests and research on all possible aspects, such as possible reactions, effect of the drug and so on;

3) Extensive clinical trials, therefore, would be an intrinsic part of development of any such new pharmaceutical drug. It cannot be imagined that such clinical trial can be carried out only in the laboratory of the pharmaceutical company;

4) The activities of obtaining approval of the authority and filing of an application for patent necessarily have to be outside the in-house research facility. Thus, the restricted meaning suggested by the Revenue would completely make the explanation quite meaningless;

5) Segregation of the expenditure by prescribed authority into two parts, namely, those incurred within the in-house facility and outside, by itself would not be sufficient to deny the benefit to the assessee under section35(2AB) of the Act - Cadila Healthcare Ltd. v. CIT [2013] 31 300 (Gujarat)

Related case:
Exp. on ‘drug trials’ can’t be disallowed even if it isn’t incurred in-house as trials can be carried outside labs only - Cadila Healthcare Ltd. v Addl CIT [2013] 29 229 (Ahmadabad - Trib.)