Withholding tax on property

There were growing instances of buyers and sellers failing to quote Permanent Account Number (PAN), which is mandatory for property transactions above stipulated limits. To set up a mechanism to both report and collect tax at the earliest, particularly for resident transferors, from June 1, 2013, the purchase and sale of property will have an additional compliance and a widened net for the taxman. Budget 2013 (through the introduction of section 194-IA in the Income-tax Act) has proposed levy of withholding tax on purchase of immovable property (other than agricultural land) from a resident at 1 per cent of the consideration when it is Rs 50 lakh or more.

Budget 2012 had proposed this, too, and was eventually withdrawn. It was prescribed that the seller would get credit for taxes paid by the buyer. A restriction on the registration was also proposed unless proof of tax deducted at source (TDS) was furnished.

Under current tax laws, it would be adverse if the seller does not provide his PAN, as the overriding provisions of section 206AA mandates a higher 20 per cent withholding. The compliance mechanism for the current proposal has not been notified yet. It would be prudent if exceptions are carved out and special consideration given to genuine cases such as a seller reinvesting in another property, availability of nil withholding dispensations and so on. The practicalities involved in obtaining a tax deduction number should also be considered. As the implementation date draws closer, it remains to be seen whether the proposal will survive.

Transfer pricing for contract R&D

The Central Board of Direct Taxes released two circulars related to transfer pricing — the general application of the profit split method (PSM); and the proper methodology for research and development. Though the two circulars operate independently to a certain extent, yet they are addressed together for convenience.

TP methodology for R&D services has, of late, been under the scanner of Indian Revenue, which often tries to disregard a “contract R&D service provider” structure with a cost plus model (or TNMM), and substituting it with PSM on the ground that the Indian R&D centre had been developing the intangibles virtually on its own; thus, it should be entitled to the entrepreneurial-related returns for intangibles (say patents).

OECD (Organisation for Economic Co-operation and Development), in its discussion draft on Chapter VI relating to intangibles, had laid down guidelines on R&D services, with clear emphasis on establishing substance in the principal company for the “contract R&D structure”, with a TNMM model accepted by the Revenue.

The Rangachary Committee was inter alia mandated by CBDT to introduce guidelines for Indian Revenue in this regard, in order to mitigate long-standing tax disputes. Many professional organisations made recommendations to the Committee on the subject. In general they recommended that the foreign principal could be considered both the legal and economic owner of the intangibles and, accordingly, the Indian R&D centre could be seen engaged in “contract R&D services” entitled to TNMM form of remuneration, if the foreign principal is carrying out strategic functions in

Hiring/ terminating services of contract researcher;

Type of research carried out and assigning objectives to the researcher;

Budget allocated for research and funding;

Monitoring progress of research at periodic intervals;

Assessing outcome of the research — that is, test, review and evaluate results;

Setting stage-posts for decision-making;

Decision to continue project or abandon it.

It was also recommended that the conduct of related parties, generally on the above lines, should be given more importance than contractual terms contained in inter-company agreements.

The above recommendations were otherwise in line with the guidelines contained in OECD’s discussion draft on intangibles.

The CBDT has now come out with a circular, more or less on the above lines, which is a positive move for providing clarity and guidance on a disputed issue.

Perhaps the articulation in paragraph (1) of the circular could have been better. Incidentally, the CBDT has mentioned here that the foreign principal should perform most of the economically significant functions, while the Indian development centre would largely be involved in economically insignificant functions. Now, there could be some disputes relating to significance or insignificance of a function. The magnitude of the functions should not be the deciding factor, instead the strategic importance in the overall service/ supply chain should be the catalyst.

The CBDT has emphasised on “substance” at the level of the foreign principal, as a pre-condition for according the Indian R&D centre a “contract R&D service provider” status which, again, is fair and follows the OECD guidelines. The CBDT has mentioned that if the principal is located in a tax haven, the general presumption would be that it might not have necessary substance; however, the CBDT hastened to add that the presumption was rebuttable by the taxpayer through adducing necessary evidence.

Thus, overall, it appears to be a very welcome move on the part of the CBDT in proactively introducing guidelines and clarifications on a subject of paramount importance.

— Rahul K. Mitra, Leader, Transfer Pricing, PwC India

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