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Indian Tribunal Holds Government Approved Rates may Not be Used as Transfer Pricing Benchmark for Royalty Payments

The Mumbai Income Tax Appellate Tribunal recently issued a decision concerning whether a royalty payment rate agreed to with the Indian government can be used as a comparable uncontrolled price benchmark for transfer pricing purposes. The case involved India-based Sara Lee TTK Ltd, (TTK), a company engaged in the business of manufacture and sale of household and personal care products.

In 1995, TTK entered into an agreement with Dutch company Buttress B.V. for the use of know-how, formulas, and trademarks for the manufacture, packaging and sale of the product Brylcreem, according to which a royalty at a rate of 5% on net sales was paid. At the time, India had not yet introduced its transfer pricing regime (introduced 2001), although approval of the agreement was needed from the Indian Department of Industrial Policy and Promotion (DIPP) and the Reserve Bank of India (RBI), which TTK obtained and subsequently extended in 2002.

In 2003, TTK entered into a new trademark licensing agreement with Buttress B.V. and obtained approval from DIPP and RBI for the payment of royalty at the same 5% rate. Given that the transfer pricing regime was in place at that time, TTK used the approved 5% rate as the benchmark in its transfer pricing analysis, and contended that the payment was at arm's length. However, the transfer pricing officer found that under the new agreement the royalty was only for the use of trademark without transfer of know-how and that the 5% rate was too high, and as a result, restricted the royalty payment to 1%.

Further, on appeal by TTK to the tax authority, the tax authority found that TTK had not carried out a proper benchmark analysis and that the rate approved by DIPP and RBI was not a sufficient benchmark. TTK was then required to furnish comparable license agreements, but the agreements provided were found to be lacking since important details were blacked out and the agreement were not related to any Indian company. The case then made its way to the Mumbai Tribunal.

Regarding the use of the approved 5% rate as a benchmark, the Mumbai Tribunal sided with the tax authority. The tribunal held that the approval of the rates are granted for the ease of doing business and come from legislation or policy that are not in relation to the determination of arm's length price. Further, the Tribunal held that it is mandatory that TTK independently benchmark its international transactions with independent comparables to arrive at the arm's length price, which TTK had not done at any stage in this case. However, regarding the determination that the royalty was only for the use of trademark under the new agreement, the Tribunal found that the transfer pricing officer had not properly reviewed the relevant clauses of the agreement to make that determination.

As a result, the case is to be referred back; TTK is to provide a proper benchmark analysis; and after giving adequate opportunity to TTK, a decision is to be given in accordance with India's transfer pricing rules.  

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