Transfer Pricing

October 2025

Royalty Benchmarking and Its Issues: A Closer Look

Introduction

In the world of intellectual property (IP), licensing and transfer pricing, royalty benchmarking plays a crucial role. It helps determine arm’s length royalty rates for the use of intangible assets such as trademarks, patents, copyrights and know-how. However, while the concept sounds straightforward, implementing an effective royalty benchmarking study presents several challenges. This article explores what royalty benchmarking entails and the key issues that can arise in practice.

What is Royalty Benchmarking?

Royalty benchmarking is the process of identifying and analyzing comparable licensing agreements to determine an appropriate royalty rate for an intangible asset. This is commonly used for:

Transfer pricing compliance between related parties
Valuation of IP in M&A transactions
Tax planning and litigation support
Licensing negotiations

Benchmarking involves analyzing databases of licensing agreements (e.g., RoyaltyStat, RoyaltySource, ktMINE) to identify “comparables” agreements that are similar in terms of industry, geography, assets and terms and then applying a reasoned analysis to arrive at an arm’s length range or a specific rate.

Example: Royalty Benchmarking in a Tech Company

Let take an example of a U.S. based parent company develops proprietary AI-based recommendation software. It licenses the software to its subsidiaries in Europe and Asia for use in localized e-commerce platforms. To comply with OECD transfer pricing guidelines and local tax laws, the company must determine an arm’s length royalty rate for this software license.

Steps in this Case Might Includes:

Searching databases for third-party software license agreements in the AI or SaaS domain.
Screening deals with similar scope, exclusivity and application.
Adjusting for differences in geographic reach or license rights.
Arriving at a royalty rate range (e.g., 3% to 7% of net revenue) depending on the comparables and functions performed by the licensee.

Key Issues in Royalty Benchmarking (with Tech Examples)

Despite a structured approach, several challenges make royalty benchmarking difficult (especially in the tech industry):

Scarcity of Truly Comparable Agreements

Tech licensing deals are often unique. For example:

SaaS models with tiered pricing and freemium options are hard to compare to perpetual software licenses.
Licenses for patented mobile tech may differ significantly from open-source software support deals.

Data Quality and Confidentiality

Many tech licensing agreements are:

Private and not publicly disclosed.
Lacking in detail like performance-based royalties or revenue thresholds.
Redacted to remove key financial terms in databases.

Intangible Asset Complexity

Tech assets often bundle multiple intangibles. A single license may include:

Software
Trademarks
Cloud hosting
Technical support

Valuing the individual components becomes subjective and can lead to transfer pricing disputes.

Rapid Innovation and Obsolescence

The pace of change in tech means:

Older licensing deals may not reflect current market rates.
Valuation of AI tools or blockchain technology can change dramatically in short periods.

Geographic and Regulatory Variance

Some jurisdictions (e.g., India, Brazil) impose specific rules on royalty payments or deductibility. In cross-border tech licensing, companies must navigate:

Withholding taxes
Royalty caps
Restrictions on IP ownership

Table: Benchmarking illustrations

Company	IP Licensed	Example Royalty Range	Notes
U.S. AI firm to EU subsidiary	AI-based recommendation engine	4%–6% of net sales	Adjusted for exclusivity and technical support included
Cloud services provider	SaaS platform	2%–5% of user-based revenue	Freemium model excluded from base
Consumer tech brand	Trademark and branding	1%–3% of sales	Applied to branded hardware only

Note: These are illustrative examples; actual rates depend on facts and circumstances.

Best Practices for Effective Royalty Benchmarking

To mitigate these issues, companies and advisors should consider:

Using multiple data sources and triangulating results
Documenting the rationale behind selection and rejection of comparables
Clearly explaining all adjustments and assumptions
Staying updated with industry trends and regulatory expectations
Engaging experienced professionals with legal, tax and industry knowledge

Some important cases and judicial decisions (in India and abroad) related to royalty benchmarking / reasonable royalty / arm’s‑length royalty

Johnson Controls (India) P. Ltd. vs DCIT (Mumbai, 2020)

Facts: The assessee paid royalty to its Associate Enterprise (AE) 1.5% of net sales for use of trademark and brand. The Transfer Pricing Officer (TPO) rejected the benchmarking using Comparable Uncontrolled Price (CUP) method and determined the Arm’s Length Price (ALP) as NIL.
Significance: Confirms that if the taxpayer has used a valid benchmarking method (CUP), the TPO must respect that unless comparables are truly unavailable or methodology is flawed.

Praxair India Pvt Ltd (Bangalore ITAT, 2021)

Facts: The assessee used an aggregate/TNMM approach for related party transactions including royalty and also provided supplementary benchmarking via CUP method. The TPO rejected aggregation and used an ad hoc rate. The ITAT accepted the taxpayer’s analysis, using CUP for royalty and confirming that benchmarking via external comparables was valid.
Significance: Cases where CUP is accepted for royalty benchmarking, especially when the taxpayer has properly documented and supported comparable licenses

Conclusion

Royalty benchmarking is not just a regulatory requirement, it’s a vital component of strategic IP management, especially for technology-driven businesses. However, identifying the right comparables and applying consistent, defensible methodologies is challenging in a sector characterized by innovation, disruption and global reach.

For tech companies, the stakes are high. Mispricing can result in audits, penalties, reputational risk and even double taxation. Getting the benchmarking right with detailed documentation and sound economic analysis can offer protection and clarity in a complex regulatory landscape.