Overall, by effectively showcasing the value and impact of the licensed IPR on the company's operations and growth in the Indian market, companies can increase their chances of successfully negotiating a more favorable tax arrangement with the authorities.
Transfer pricing in India on the licensing of Intellectual Property Rights (IPR) is now a hotly discussed issue. Advanced technological developed countries are allowing license their intellectual property rights to rapidly growing countries like India to market their innovation in exchange of license fees or royalties. However, India being a source country for royalty income of licensor is equally keen to tax such royalty payments. Further, India also wants to ensure that royalty payments are at arm's length in case they are being paid to a related party.
There are different approaches to establishing arm's length price of royalty payments. Arm's length price of royalty payments can be determined using Comparable Uncontrolled Price (CUP) method. As per this method, the price exchanged by transferring goods or services between two parties is compared to the price exchanged between the transfer of similar goods or services between an unrelated party. Using independent database containing information of such royalty payments in independent scenario, companies can determine arm's length price of royalty paid to the foreign entity.
Another approach may be by applying the Transactional Net Margin Method (TNMM), which involves comparing net profit margins of the tested party with those of consistent companies on similar or like transactions. Using this method, it can be shown that margins accord to industry standards after paying the royalties and, hence, IPR royalty payments can be justified.
However, the challenge arises when Indian tax authorities would ask taxpayer to establish real tangible benefits accruing to the Indian entity in return for payment of the said royalty.; In the absence of any perceptible benefits, tax authorities contend that the arm's length price should be taken to be nil. That has, by turn, created a situation in which the companies must consider a host of considerations so that they arrive at the material benefits to the respective intellectual property rights.
There could be different strategies to counter the challenge posed by the Indian tax authorities. One approach is to engage with experts (such as marketing experts to determine customer reach for brand license or technical expert to establish proprietary of the technology) in the field to provide evidence of importance of the IPR for Indian payer and that an IPR actually exists.
For instance, in a manufacture process, technical knowhow to be documented would include the support extended in acquiring such knowledge, product launches that have succeeded and the sales accepted by the market. The key differentiators that the technology has brought about, and the global registration of the IPR, will all add further support to the justification of royalty being paid.
As regarding trade names, there are many involved factors in determination of arm's length price for brand royalty. Market research reports correlating various efforts put in brand owner and the benefits accruing in terms of expanded customer reach or increased sales, details of expenditure incurred, overall reach of the brand, any independent valuation of the brand names etc. are certain aspects that can help in establishing value of the IPR itself. The acceptance of a brand within the Indian market, its uses and benefits, both in India and abroad have substantial effects on the final amount that can be charged for trade name licensing.
Next is to prove that the IPR licensed do bring value to the Indian market. The companies can bring out the competitive benefit that they have leveraged over others, quantifying the increased revenue which has been generated through technology, improvement in quality that has been achieved, and overall growth in business due to the technology-licensed IPR. Similar data can also be collated for the brand related IPRs as well. This approach will basically provide in-detail reports and data for showcasing how the licensed IPR has contributed to enabling the success of the company's growth in the Indian market.
Based on our experience, it is prudent that process of documentation substantiating the benefits of IPRs is maintained on real time basis. Digging out data after few months of actual payment can be cumbersome and chaotic. Further, maintaining real data will allow the Corporates to challenge the payouts from benefit test perspective and seek appropriate documentation from IPR owner. Also, since the user of IPRs and team representing tax function are generally separate, there could be confusion on documentation if the data is not maintained on real time basis.
In general, companies will have better chances of successfully negotiating a more favorable tax arrangement with the Indian authorities by satisfactorily demonstrating the value and impact of the licensed IPR on their operations and growth in the Indian market.
Transfer pricing in India on IPR licensing is complex but important aspect for Companies to consider and work around effectively. To optimise likely future litigation costs, companies can invest time and resources in building up internal documentation systems and review mechanisms to test benefit test on periodic basis. By establishing the tangible benefits of the licensed IPR and navigating the transfer pricing rules diligently, companies can ensure compliance with the tax regulations while maximizing the value derived from their intellectual property.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.