CUP method not suitable to benchmark royalty payment in the absence of comparable uncontrolled transactions

DCIT v. Cabot India Ltd.  –  At the outset the Tribunal stated that the issue to be adjudicated upon is whether or not the royalty rate of five percent is arm’s length, and not whether the increase vis-à-vis two percent is justifiable. The Tribunal ruled that the royalty of two percent paid by the assessee to its AE in the previous year was a ‘controlled’ transaction and hence, could not be taken as a benchmark for determining the arm’s length nature of the five percent royalty charge in the current year.

Although, the assessee had applied CUP Method, the TPO did not refer to any method specifically when proposing the adjustment. The exercise of ascertaining whether the royalty paid was at arm’s length had to be undertaken independently and as per the procedure laid down in the Indian transfer pricing regulations.

The Tribunal held that the CUP Method was the most direct and reliable measure of an arm’s length price for any controlled transaction. However, its success depended upon the degree of comparability between the controlled and the uncontrolled transaction which had to be examined in light of several factors such as quality of the product, contractual terms, etc. Further, differences, if any, between the controlled and the uncontrolled transactions should be minor and ascertainable for which adjustments can be made.