FMCG companies frequently operate global brand licensing and royalty structures where Indian subsidiaries pay royalties to overseas group entities for the use of brands, trademarks, and other intangibles. The Income-tax Act, 2025 provides a comprehensive framework for determining the arm's length nature of these transactions, with particular emphasis on intangible property valuation.
The Legal Framework for Brand Licensing
Section 161 of the Income-tax Act, 2025 establishes that any income arising from an international transaction shall be determined having regard to the arm's length price. This applies to royalty payments and brand licensing arrangements where the intellectual property is owned by an associated enterprise.
Section 163 defines an "international transaction" as including the purchase, sale, transfer, lease or use of intangible property, including the transfer of ownership or the provision of use of rights regarding land use, copyrights, patents, trademarks, licences, franchises, customer list, marketing channel, brand, commercial secret, know-how, industrial property right, exterior design or practical and new design or any other business or commercial rights of similar nature.
Types of Brand Licensing Arrangements
Trademark Licensing
Trademark licensing involves the use of a registered trademark owned by the group company. The royalty paid should reflect the value of the trademark in the Indian market. Factors to consider include the strength of the brand, market position, consumer recognition, and the duration of the licence.
Brand Licensing
Brand licensing may involve a broader set of rights including the use of brand name, brand identity, brand guidelines, and associated marketing materials. The value of the brand may be higher than just the trademark, considering the consumer goodwill and brand equity.
Know-How and Technical Assistance
FMCG companies often receive know-how and technical assistance from group companies for product formulation, manufacturing processes, and quality control. These may be bundled with brand licensing or provided separately.
Franchising
Franchising arrangements in the FMCG sector may involve the use of brand, business model, operational systems, and ongoing support. The royalty or franchise fee must be at arm's length considering the bundle of rights and services provided.
DEMPE Analysis for Brand Licensing
The OECD Transfer Pricing Guidelines and Indian transfer pricing rules require a DEMPE analysis for intangible property. DEMPE stands for Development, Enhancement, Maintenance, Protection, and Exploitation of the intangible.
Development: Entities that develop the brand through marketing campaigns, product development, and market research should be appropriately compensated. The development function includes creating brand awareness, establishing brand identity, and building consumer loyalty.
Enhancement: Entities that enhance the brand through innovation, new product launches, and expanded marketing efforts should receive returns. Enhancement activities improve the value of the brand over time.
Maintenance: Entities that maintain the brand through ongoing marketing, advertising, and quality control should be compensated. Maintenance activities preserve the existing value of the brand.
Protection: Entities that protect the brand through trademark registration, enforcement against infringement, and legal protection should be compensated. Protection activities preserve the legal rights and exclusivity of the brand.
Exploitation: Entities that exploit the brand through licensing, franchising, and commercialisation should be compensated. Exploitation activities generate revenue from the intangible.
Valuation Methods for Brand Licensing
Comparable Uncontrolled Price Method
The CUP method compares the royalty rate in the controlled transaction with royalty rates in comparable uncontrolled licensing transactions. This requires identifying comparable licensing agreements between independent parties for similar brands in similar markets.
Profit Split Method
The profit split method may be appropriate where both parties contribute to the development, enhancement, and exploitation of the brand. The profits from the brand are split between the parties based on their relative contributions.
Transactional Net Margin Method
The TNMM may be used for routine brand licensing where the licensor performs relatively routine functions and the brand is a mature, well-established brand. However, for valuable brands with significant intangibles, the TNMM may not be appropriate.
Income Method
The income method values the brand based on the present value of expected future economic benefits. This requires projecting future revenues, applying a royalty rate, and discounting to present value. The income method is often used for brand valuation in transfer pricing.
Documentation Requirements
Rule 84 requires comprehensive documentation for brand licensing transactions. This includes a description of the ownership structure of the assessee enterprise with details of shares or other ownership interest held therein by other enterprises. A profile of the multinational group of which the assessee enterprise is a part must be maintained along with the name, address, legal status and country of tax residence of each of the enterprises comprised in the group.
The documentation must include a broad description of the business of the assessee and the industry in which the assessee operates, and of the business of the associated enterprises with whom the assessee has transacted. The nature and terms including prices of brand licensing transactions entered into with each associated enterprise, details of intangible property transferred or licensed and the quantum and the value of each such transaction must be clearly set out.
A description of the functions performed, risks assumed and assets employed or to be employed by the assessee and by the associated enterprises involved in the brand licensing transaction is essential. This functional analysis must identify who performs the DEMPE functions for the brand intangibles.
The documentation must include a record of the economic and market analyses, forecasts, budgets or any other financial estimates prepared by the assessee which may have a bearing on the brand licensing transactions. A record of uncontrolled transactions taken into account for analysing their comparability with the brand licensing transaction must be documented.
A description of the methods considered for determining the arm's length price, the method selected as the most appropriate method along with explanations as to why such method was so selected, and how such method was applied in each case is required. A record of the actual working carried out for determining the arm's length price must be maintained, including details of the comparable data and financial information used.
Royalty Rate Considerations
Royalty rates for FMCG brands typically range from 1% to 5% of net sales, depending on the strength of the brand, the nature of the products, and the territory. Factors affecting royalty rates include the market position of the brand, the stage of the brand lifecycle, the exclusivity of the licence, the duration of the licence, and the territory covered.
The royalty rate should also consider the functions performed by the licensee, including marketing, distribution, and customer service. Where the licensee performs significant functions that enhance the brand, a lower royalty rate may be appropriate. Conversely, where the licensee's functions are limited and the brand does most of the work, a higher royalty rate may be appropriate.
Withholding Tax Considerations
Royalty payments to non-residents are subject to withholding tax under Section 393(2) of the Income-tax Act, 2025. The rate of withholding tax depends on the nature of the payment and the applicable tax treaty. Under the Act, royalty payments to non-residents are generally subject to withholding tax at the rate of 20% for payments to non-resident companies and 20% for payments to non-resident individuals.
Tax treaties may provide for lower withholding tax rates. For example, under the India-USA tax treaty, royalty rates for copyrights, patents, and similar property may be limited to 10-15%. Under the India-UK tax treaty, royalty rates may be limited to 10%. The beneficial rates under tax treaties are available subject to compliance with limitation of benefits provisions and other conditions.
Secondary Adjustment Requirements
Section 170 requires a secondary adjustment where primary adjustment of one crore rupees or more to the transfer price has been made. Where royalty payments have been adjusted at the time of transfer pricing assessment, the excess money available with the associated enterprise shall be deemed to be an advance made by the assessee to such associated enterprise. This excess money must be repatriated within ninety days from the due date of furnishing of return.
If the excess money is not repatriated within the prescribed time, the assessee may at his option pay additional income-tax at the rate of 18% on such excess money. This tax shall be treated as the final payment of tax in respect of the excess money not repatriated and no further credit thereof shall be claimed by the assessee or by any other person.
Advance Pricing Agreements
FMCG companies with significant brand licensing arrangements should consider obtaining advance pricing agreements (APAs) under Section 168. An APA provides certainty on the arm's length price for a period of up to five years, reducing the risk of disputes and penalties.
The APA process involves a detailed analysis of the brand licensing arrangement, the functions performed, the assets employed, and the risks assumed. The APA team may conduct due diligence, request additional information, and negotiate the terms of the agreement. Once entered into, the APA is binding on the taxpayer and the tax authorities.
Disclaimer: This article provides general information and does not constitute legal advice. For specific guidance on transfer pricing for FMCG group royalty and brand licensing structures, please consult qualified legal and tax professionals.
Need Expert Legal Guidance?
Navigating the complex transfer pricing framework for brand licensing and royalty structures requires experienced legal counsel. At Anuj Desai & Associates, we provide comprehensive advisory services on intangible valuation, DEMPE analysis, advance pricing agreements, and dispute resolution. Contact us for expert guidance on your FMCG brand licensing transfer pricing matters.