Microsoft’s Indian arm has been asked to pay increased taxes with the taxman saying the local arm had understated its income for the four years from FY06 to FY09 by Rs 5,135 crore. For FY09,the adjustment asked for is Rs 1,355 crore on Microsoft India R&Ds Rs 1,360 crore of international transactions.
Microsoft India R&D has challenged previous orders Rs 150 crore is the addition to its income demanded by the taxman in FY06,Rs 1,701 crore in FY07 and Rs 1,928 crore in FY08. A company spokesperson in India said: Microsoft complies with the tax laws in each jurisdiction in which we operate. We are seeking relief against the TP (transfer pricing) adjustments through the appropriate appellate forums. Since the matter is sub judice,we are unable to provide further details or comments regarding the same. We are hopeful that the Rangachary committee recommendations on R&D Centres and Safe Harbours will help facilitate resolutions to TP litigations in the IT industry.
The tax department has used two methods to arrive at the conclusions. First,it has rejected Microsoft Indias contention on the margins it is earning. Microsoft India has said it gets a mark-up of 15% on the India costs from its global parent and has cited the accounts of various Indian companies to justify this as an arms length margin. The transfer pricing officer,however,has rejected some of the comparisons made and said the mark-up should be 23.3% this,the order issued to Microsoft India says,adds around Rs 83 crore more to its income.
This,however,is the least of the additions made. The assessment order says it is obvious that the work being done at Hyderabad Development Centre (is) much more intensive than routine software work. A total of 16 patents,the tax order says,were granted in the year 2009 which had Indian input. Some of the very critical features of Windows Vista were developed or upgraded by MIRPL (Microsoft India R&D) these are all high-value functions which have been performed by MIRPL without which it was not possible to market the Windows Vista or any other products for which even limited R&D has been done in India The assessee must be compensated for the intangibles embedded in the software development activities.
Between 2005 and 2009,the order says,the government-owned Council of Scientific and Industrial Research got 462 patents,IBMs India operations 190,and Microsoft got a total of 28.
Having come to this conclusion,how much of Microsofts global profits are attributable to its India R&D arm? The taxman does this in two ways.
First,the Indian R&D-spend of Rs 1,067 crore in FY09 is adjusted upwards for the fact that getting work done in India is 30-50% cheaper than doing it in the US. The R&D spend which gets raised to Rs 1,778 crore,the taxmans calculations state,is 4.3% of Microsofts global R&D spending. Since the taxman asserts,50% of Microsofts profits can be attributed to its R&D,4.3% of this additional profit should be attributable to the Indian arms turnover. Another method looks at the headcount of Microsoft Indias R&D arm to the total R&D personnel employed in Microsoft globally.
Having done this exercise,the FY09 transfer pricing adjustment order says Rs 77 crore needs to be added to Microsoft Indias income for routine software development and another Rs 1,237 crore for the R&D intangibles and Rs 41 crore for IT-enabled services work.