Arm's length royalty pricing cannot be reduced to nil by applying a benefit test under transfer pricing rules.

In determining the arm's length price of royalty in an international transaction, the Transfer Pricing Officer's role is confined to Chapter X of the Income-tax Act, 1961 and the prescribed rules. The Officer cannot substitute a nil value by applying a benefit test or by examining commercial expediency, allowability, or deductibility under Section 37, because those considerations fall outside transfer pricing analysis. Where the assessee benchmarked the transaction at entity level under the transactional net margin method and that approach was accepted, a nil royalty adjustment was impermissible. The issue was therefore resolved in favour of the assessee.

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Issues: Whether, in determining the arm's length price of royalty paid in an international transaction, the Transfer Pricing Officer could adopt a nil value and test the allowability of the expenditure by applying the benefit test and the requirements of Section 37 of the Income-tax Act, 1961.

Analysis: The dispute concerned only the determination of arm's length price under the transfer pricing framework. The transaction had been benchmarked by the assessee at entity level under the transactional net margin method, and the Tribunal accepted that approach. The governing principle applied was that the Transfer Pricing Officer's function is confined to determining the arm's length price in the manner prescribed under Chapter X of the Income-tax Act, 1961 and the relevant rules. The Officer cannot sit in judgment over the commercial expediency, allowability, or benefit of the expenditure by importing considerations relevant to Section 37 of the Income-tax Act, 1961. The adjustment based on a nil valuation of royalty was therefore outside the limited transfer pricing jurisdiction.

Conclusion: The question was answered in favour of the assessee. The Transfer Pricing Officer could not determine the arm's length price of the royalty payment at nil by applying a benefit test or examining allowability under Section 37 of the Income-tax Act, 1961.

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