This alert summarizes the latest Press Note No. 8 of 2009 issued by the Department of Industrial Policy and Promotion (DIPP), Ministry of Commerce and Industry on royalty payments on transfer of technology and trademark/brand name.

Existing Policy

As per the existing policy, Indian companies are permitted to pay royalties under the automatic route (without specific approval of the regulatory body – Project Approval board or PAB, a board constituted under the aegis of Ministry of Commerce & Industry) as under:

• Lump sum payment of USD 2 million
• Recurring royalty of 5% on domestic sales and 8% on export sales for technology transfer agreements/collaboration

• Recurring royalty of 1% on domestic sales and 2% on export sales for use of trademark/ brand name, to the foreign collaborator

Any payments beyond the above threshold limit were subject to prior approval of the PAB.

Liberalization

With a view to further liberalize cross border trade and promote free transfer of technology, the Government, in November this year, had decided to dispense with the prescribed threshold limits. This decision has now been formalized by the issue of above press note with immediate effect.
Henceforth, all royalty payments, lump sum fee for transfer of technology and for use of trademark/brand name would be permitted under automatic route without any limits. The above payments, however, would be subject to Foreign Exchange Management (Current Account Transactions) Rules, 2000. The Government will notify a suitable post-facto reporting system separately.

Tread with Care

However, Indian Companies paying royalties to their overseas affiliates would also need to consider the transfer pricing regulations in India.

The Indian tax authorities have been very aggressive on royalty payments requiring the taxpayers to demonstrate the benefits received (benefit test) apart from justifying the arm’s length nature of royalty rates. In cases where the benefit test has not been appropriately demonstrated, the tax authorities have been making a transfer pricing adjustment which, in many cases, even extended to the whole amount of royalties paid to the overseas affiliate. The situation is worsened due to the absence of appropriate databases in India for benchmarking royalty rates.

Way forward

In view of the above, although the regulations relating to royalty payments have been liberalized, the royalty arrangement should not be used merely as a profit extraction tool, but should be based on business and commercial considerations. Further, the need for the royalty arrangement, the benefit test, and the basis for arriving at the arm’s length price of the royalty payment must be adequately documented, preferably with the help of experts; to be suitably prepared for a tax enquiry.