Under the earlier provisions, specific limits were prescribed and payments above the said limits were permitted, with prior approval from the government.

The press note states that all such payments would be subject to the Foreign Exchange Management (Current Account Transactions) Rules 2000, as amended from time to time. A suitable post-reporting system for technology transfer/collaborations and use of trade marks or brand names is to be notified by the government separately.

The government’s intention for the change in policy is to freely promote the transfer of state-of-art technology into the country. Though removal of government approval process is a positive step towards making the climate for technology transfer to India more conducive, the immediate area of concern is transfer pricing. The revenue authorities could view these payouts as a means to repatriate the profits by Indian companies otherwise than as dividends to circumvent dividend distribution tax and also claim these payouts as a tax expense.

Before, the taxpayer considered the statutory limits as evidence to substantiate the arm’s length nature of international transactions such as the payment of royalty or technical fees.

The primary logic being that ‘what one arm of the government provides cannot be taken away by another arm.’ In other words, Foreign Exchange Regulations against Income Tax and there is no question of such payment being treated as excessive or unreasonable having regard to the legitimate business needs.

Though the transfer pricing officers in some jurisdictions in India have challenged this approach, it was argued that government examined the economic and commercial need for such transactions and hence compliance with guidelines could be considered as an external comparable uncontrolled price and a factor for justifying arm’s length basis.

Now, the challenge to taxpayers is to justify the arm’s length nature of such transactions based only upon transfer pricing principles. The test of arm’s length analysis is considered a better alternative, since transfer pricing seeks to analyse the fair value of the transaction, whether the cost is determined in a manner similar to transactions between independent enterprises.

However, application of the transfer pricing principles in controlled transactions involving intangible property is more subjective because such intangible property may have unique characteristics and thereby the search for comparable companies would be a challenge. It is usually difficult to find comparable uncontrolled transactions even though certain royalty databases are available.

It is important for the Indian companies to seek further details from the group companies on the global transfer pricing policy, the basis of arriving at the cost to be recharged and so on, since it will be prudent to maintain adequate cost-benefit documentation to substantiate the payout transactions. Companies are well advised to evaluate the manner in which the arm’s length nature of the royalty or technical fees have been analysed historically between group entities to set in place a robust transfer pricing framework for such transactions.

Hasnain Shroff (hshroff@kpmg.com) and A Pradeep (pradeepa@kpmg.com), BSR & Company