P and S are controlled taxpayers. P licenses a proprietary process to S for S’s use in manufacturing product X. Using its sales and marketing employees, S sells product X to related and unrelated customers outside the United States. If the license between P and S has economic substance, the Commissioner ordinarily will not restructure the taxpayer’s transaction to treat P as if it had elected to exploit directly the manufacturing process. However, because P could have directly exploited the manufacturing process and manufactured product X itself, this realistic alternative may be taken into account under § 1.482-4(d) in determining the arm’s length consideration for the controlled transaction. For examples of such an analysis, see Examples 7 and 8 in paragraph (f)(2)(i)(E) of this section and the Example in § 1.482-4(d)(2) ...

In this case royalty payments from Sona Okegawa Precision Forgings Ltd. – a contract manufacturer in India – had been disallowed by the tax authorities. The tax authorities “had analyzed this transaction and observed that assessee manufactured the goods and sold those goods to the AE. These goods are specific goods which have been produced for the associate enterprises. The technology has been received from the AE for producing these goods, therefore, the assessee has to be construed as a contract manufacturer for these products. The payment of royalty in the case of a contract manufacturer to the AE is not justified as per OECD guidelines.” Judgement The appeal of the tax authorities was dismissed “…The first aspect is whether the royalty paid by the assessee @ 3% is excessive and not computed at arm’s length price. We find that the assessee has placed on record copy of the letter dated 30.4.1993 written by the RBI, Exchange Control Department to M/s. Sona Steering System Ltd. wherein royalty @ 3% on domestic sales subject to taxes for a period of five years was allowed to be paid. There are similar other correspondence which have been placed on the paper book. Similarly, on page 51 of the paper book, a press note issued in 2003 issued by the Government of India, Ministry of Commerce & Industries, Department of Industrial Policy and Promotion has been placed. In this press release, royalty payment at 8% on export and 5% on domestic sales has been referred as a reasonable payment for processing the cases for approval. Thus, learned TPO failed to bring any material on the record which can suggests that payment of royalty @ 3% was excessive, one and not at arm’s length price. The other aspect is whether assessee has made the sales to the A.E at arm’s length price or not? This issue has not been considered by the learned TPO in detail. He was unable to collect any material indicating that sales price charges by the assessee was not at arm’s length. In a way, he accepted that sales made by the assessee to Assessing Officer are on arm’s length. Learned First Appellate Authority has considered this aspect also in the finding extracted above. Learned TPO further not brought any material indicating the fact that assessee is a contract manufacturer. He only draws inference in this regard. In assessment year 2004-05, ITAT has considered this aspect and has upheld the order of the Learned CIT(Appeals) deleting such addition. Thus, after taking into consideration the facts and circumstances and the findings of the Learned CIT(Appeals) extracted supra, we do not find any merit in this appeal. It is dismissed.” ...

Sunstrand licenced technology to its Singapore-based subsidiary, SunPac. The United States Tax Court ruled that the amounts paid by Sunstrand to SunPac did not constitute and arm’s-length consideration under Section 482, but also that the IRS overstepped its authority in calculating taxable net income. The Court also eliminated interest penalties imposed by the IRS ...