India’s Central Board of Direct Taxes (CBDT) has issued Circular No. 2 of 2013, setting out guidelines for application of the Profit Split Method (PSM) in international transactions. The profit split method is one of the permitted methods for computing transfer prices under the tax legislation. This is often the most appropriate method for transactions involving the use of unique intangibles or in international transactions that are integrated to the extent that the transactions cannot be separately evaluated. According to the Circular, the PSM is considered to be the most suitable method for evaluating complex international transactions. The Transactional Net Margin Method (TNMM) would normally be less suitable as there is no necessary correlation between the costs incurred on R&D and the return on the intangible assets developed.

In cases where the PSM cannot be selected as the most appropriate method in this type of international transaction, the Transfer Pricing Officer (TPO) will have to record the reasons for non-selection of PSM, explain the selection of the Comparable Uncontrolled Price Method or the Transactional Net Margin Method as the most appropriate method and consider upward adjustments for the transfer of intangibles without additional remuneration, location savings and location specific advantages.

India has also released Circular No. 3 of 2013 which provides guidelines for the characterization of contract research and development (R&D) centers. The characterization of a development center as a contract R&D center would be based on a low level of risk borne by the center in relation to the transactions undertaken. The factors taken into account would include the functions of the center, the source of funding, the level of supervision and control by the foreign associated enterprise, the risks borne and the economic and legal ownership of intangibles.