India: Renewed focus on MNEs by Revenue Authorities in relation to IP related arrangements

Indian transfer pricing scenario

Considering the large presence of MNE Group entities that are operating in India, and based on the guidance emanating from the Base Erosion and Profit Shifting “BEPS”) initiative of the G20/OECD, it is observed that the Indian Revenue Authorities have aggressively picked their pace in recent years to scrutinize various license fee arrangements of Indian entities with their overseas group entity(s), either for use of patents, know-how, techno­logy, trademarks, etc.
 
This extended scrutiny during the transfer pricing audits then led to transfer pricing additions being made in the hands of such taxpayers, which were eventually litigated by the aggrieved entity before the Indian courts (i.e. tax tribunals and higher judicial forums) and this led to spate of tax rulings on the issue of payment of royalty and/or knowhow/license fee and/or trademark fees, etc. The decisions that were laid down in these rulings are primarily on two aspects discussed further.

 

In the various rulings on the cases wherein the taxpayer was engaged in manufacturing activity and had aggregated the intangible related payment transaction i.e. royalty, along with various other international transactions, the Courts have mainly ruled that the aggregation approach for benchmarking of the royalty related transactions along with various other transactions under TNMM is not the correct approach.

A recent Tax Tribunal ruling in the case of MAN Energy Solutions India Private Limited [ITA No.204/PUN/2022], concurred with the view that there is a need to separately determine the arm’s length price of royalty transac­tion. This decision further relied on the principles enunciated by the Punjab and Haryana High Court in the case of Knorr-Bremse India Pvt. Ltd. [(2016)380 ITR 307 (P&H)], wherein it was held that there has to be a separate benchmarking to be done for the royalty transactions under Comparable Uncontrolled Price (“CUP”) Method, and only in absence of reliable comparable data, benchmarking under other methods can be evaluated.

However, it is important to note that in cases where it can be factually proved that the royalty/license fee related transaction is inextricably linked with other transactions of the taxpayer and each transaction cannot be separately benchmarked, application of TNMM is generally accepted.

 

Application of the CUP Method

In light of the judgement provided in the case of Knorr-Bremse (supra) and by various other courts on applica­tion of CUP Method, the taxpayer is essentially required to undertake a separate benchmarking analysis to identify uncontrolled transactions relating to use of intangibles, and the arm’s length price is determined using either internal or external comparable uncontrolled transactions.

For application of external CUP Method, generally, a comparable agreement search is performed on global databases (such as RoyaltyStat, RoyaltyRange, etc.) to find out the license fee/royalty rate agreed by the uncon­trolled entities, and which are comparable to the tested transaction.

It is also worthwhile to mention that the particular approach for application of CUP Method for benchmarking transactions pertaining to Intangibles is also in line with the current transfer pricing guidelines of OECD, which were revised post BEPS project.

 

Judicial precedents

A summary of various recent rulings pronounced on the issue of benchmarking of intangible related payments along with the principles laid down by various courts is provided below:

​Case Citation	​Decision summary
​General Motors India Pvt Ltd [ITA No 1294/Ahd/2015]	​Recognised the preference that is given to internal comparable transac­tion vis-a-vis external comparables, along with acceptance of bench­marking analysis of royalty related transactions under CUP method
​Cummins India Limited [ITA No.2111/PUN/2019]	​Mere use of technical support which eventually echoes as the manufac­tured product, does not simply imply that manufacturing segment of the Assessee and the payment of royalty are “inextricably” linked
​Praxair India Private Limited [IT(TP)A No. 200/Bang/2021]	​Accepted the arm’s length price of payment of royalty of 4 per cent to its AE, which was based on application of external CUP method as a supple­mentary benchmarking analysis in addition to primary benchmark­ing under TNMM
​Doosan Power Systems India Pvt Ltd [IT(TP)ANo.: 02/Chny/2020]	​Even if assessee adopted TNMM as most appropriate method on entity level, but there is no restriction under the Act to separately benchmark royalty payment if comparables are available

Way forward

In light of the above, and in the endeavor to implement the inter-company license fee arrangement in line with the available transfer pricing guidance, the following points require due consideration:

• development, Enhancement, Maintenance, Protection, and Exploitation (“DEMPE”) analysis concerning the facts of the proposed inter-company arrangement and relative contribution of respective entity(s) in relation to the Intangibles
• benchmarking study being conducted from the relevant databases for determination of arm’s length consid­eration
• entering into an inter-company agreement and clearly specifying the nature of licensed Intellectual Property
• implementation of actual transactions, along with checking for withholding requirements and agreement of net or grossed up payments to licensor.
• documentary evidence for transfer and/or exploitation of licensed technology by the licensee

 

Accordingly, it is strongly recommended that the benchmarking exercise for determination of arm’s length nature of royalty payment has to be conducted separately, as the onus lies on the taxpayers to maintain appro­priate documentation (including thorough benchmarking exercise) demonstrating the evidence, need for tech­nical assistance, benchmarking  methodology, and appropriateness of inter-company pricing, which would serve as a tangible basis for considering the royalty or any other IP related payments to be held at arm’s length.