The Revenue raised an additional assessment on gain received from the transfer of technical know-how by Keysight Technologies to Agilent Technologies International for the amount of RM821,615,000.00 being income under section 4(f) of the Income Tax Act 1967 (ITA 1967) together with the penalty under section 113(2) ITA 1967. The Revenue contended that subsection 91(3) of the ITA 1967 provided that the Revenue may issue an assessment after the expiration of the time period of 5 years on grounds of fraud or willful default or negligence. The findings of negligence on the part of Keysight Technologies include failure to support the claim that the gain from the transfer of technical knowhow (i.e. the marketing and manufacturing intangibles) by Keysight Technologies to Agilent Technologies International was an outright sale and failure to furnish the document and information as requested by the Revenue in the audit letter on the valuation of the marketing and manufacturing intangibles. The Revenue found that there was no proof of outright sale of the technical know-how as the Intellectual Property (IP) Agreement and Manufacturing Services (MS) Agreement showed no evidence that the legal rights had been transferred to ATIS since the agreements merely stated of the transfer of beneficial rights. Further, facts have shown that the technical know-how was still used by Keysight Technologies in a similar manner prior to and post the IP Agreement and MS Agreement. Instead, the gain of RM821,615,000.00 million was proven to represent the future income that would have been received by Keysight Technologies for the years 2008-2015 should Keysight Technologies continue to carry out its function as a full-fledged manufacturing company of which the function had subsequently changed to being a contract manufacturing company due to the group’s global restructuring exercise. As such, the gain was taxed as other income under section 4(f) ITA 1967. Keysight Technologies argued that the Revenue was time-barred under section 91(1) ITA 1967 from issuing the Notice of Additional Assessment for YA 2008. Keysight Technologies also argued that the sale of marketing and manufacturing intangibles by Keysight Technologies to Agilent Technologies International was capital in nature and therefore should not subject to tax under section 4(f) ITA 1967. The “badges of trade test” would be applicable in determining whether the income was revenue or capital in nature. Judgment The Court of Appeal overturned the SCIT and the High Court dicisions and allowed Keysight Technologies’ appeal. The Court of Appeal affirmed the application of the “badges of trade” test as argued by Keysight Technologies in determining whether the income was capital or revenue in nature and the test was not confined to disposal of land. The “Badges of Trade test” considers several factors; Subject matter of the transaction, Period of ownership, Frequency of transactions, Alteration of property to render it more saleable, Methods employed in disposing of property, Circumstances responsible for sale. The Court of Appeal held that Keysight Technologies was not in the business of buy and sell of IP and the IP was not its stock in trade. No special effort had been made by Keysight Technologies to attract purchasers. The transfer of technical know-how was due to global restructuring of the group of the company. The Court of Appeal further held that there had been an actual sale by way of agreement. The title to technical know-how was not registrable due to protection of confidential information. The outright sale test thus was not a proper test and the valuation report as requested by the Revenue was irrelevant. There was no failure on the part of Keysight Technologies to adduce valuation report as it was not requested during audit. Thus, there was no negligence and hence the additional assessment was time-barred. Keysight Technologies’ appeal was allowed with cost of RM20,000 to be paid by the Revenue to Keysight Technologies. Click here for translation ...

A sales, marketing and management service agreement entered into in 1993 between Asian Hotels Limited and Hyatt International-Southwest Asia Limited had been replaced by various separate agreements – a Strategic Oversight Services Agreements, a Technical Services Agreement, a Hotel Operation Agreement with Hyatt India, and trademark license agreements pursuant to which Asian Hotels Limited was permitted to use Hyatt’s trademark in connection with the hotel’s operation. In 2012, the tax authorities issued assessment orders for FY 2009-2010 to FY 2017-2018, qualifying a portion of the service payments received by Hyatt as royalty and finding that Hyatt had a PE in India. Hyatt appealed the assessment orders to the Income Tax Appellate Tribunal, which later upheld the order of the tax authorities. Aggrieved with the decision, Hyatt filed appeals before the High Court. Judgement of the High Court The High Court set aside in part and upheld in part the decision of the Tribunal. The court set aside the decision of the Tribunal in regards of qualifying the service payments as royalty. The court found that the strategic and incentive fee received by Hyatt International was not a consideration for the use of or the right to use any process or for information of commercial or scientific experience. Instead, these fees were in consideration of the services as set out in SOSA. The fact that the extensive services rendered by Hyatt in terms of the agreement also included access to written knowledge, processes, and commercial information in furtherance of the services could not lead to the conclusion that the fee was royalty as defined under Article 12 of the DTAA. The court upheld the findings of the Tribunal that Hyatt had a permanent establishment in India. According to the court “It is apparent from the plain reading of the SOSA that the Assessee exercised control in respect of all activities at the Hotel, inter alia, by framing the policies to be followed by the Hotel in respect of each and every activity, and by further exercising apposite control to ensure that the said policies are duly implemented. The assessee’s affiliate (Hyatt India) was placed in control of the hotel’s day-to-day operations in terms of the HOSA. This further ensured that the policies and the diktats by the Assessee in regard to the operations of the Hotel were duly implemented without recourse to the Owner. As noted above, the assessee had the discretion to send its employees at its will without concurrence of either Hyatt India or the Owner. This clearly indicates that the Assessee exercised control over the premises of the Hotel for the purposes of its business. Thus, the condition that a fixed place (Hotel Premises) was at the disposal of the Assessee for carrying on its business, was duly satisfied. There is also little doubt that the Assessee had carried out its business activities through the Hotel premises. Admittedly, the Assessee also performed an oversight function in respect of the Hotel. This function was also carried out, at least partially if not entirely, at the Hotel premises.” The Court also confirmed the direction of the Tribunal asking Hyatt to submit the working regarding apportionment of revenue, losses etc. on a financial year basis so that profit attributable to the PE can be determined judicially. According to the High Court profits attributable to a PE are required to be determined considering the permanent establishment as an independent taxable entity, and prima facie taxpayers would be liable to pay tax in India due to profits earned by the permanent establishment notwithstanding the losses suffered in the other jurisdictions. This matter was to be decided later by a larger bench of the Court ...

Maersk Oil and Gas A/S (later TotalEnergies EP Danmark A/S) continued to make operating losses, although the group’s combined oil and gas operations were highly profitable. Following an audit of Maersk Oil, the tax authorities considered that three items did not comply with the arm’s length principle. Maersk Oil incurred all the expenses for preliminary studies of where oil and gas could be found, but the results of these investigations and discoveries were handed over to the newly established subsidiaries free of charge. Licence agreements were signed with Qatar and Algeria for oil extraction. These agreements were entered into with the subsidiaries as contracting parties, but it was Maersk Oil that guaranteed that the subsidiaries could fulfil their obligations and committed to make the required technology and know-how available. Expert assistance (time writing) was provided to the subsidiaries, but these services were remunerated at cost with no profit to Maersk Oil. An assessment was issued where additional taxable income was determined on an aggregated basis as a share of profits from the activities – corresponding to a royalty of approximately 1,7 % of the turnover in the two subsidiaries. In 2018, the Tax Court upheld the decision and Maersk Oil and Gas A/S subsequently appealed to the High Court. In 2022, the High Court held that the subsidiaries in Algeria and Qatar owned the licences for oil extraction, both formally and in fact. In this regard, there was therefore no transaction. Furthermore the explorations studies in question were not completed until the 1990s and Maersk Oil and Gas A/S had not incurred any costs for the subsequent phases of the oil extraction. These studies therefore did not constitute controlled transactions. The Court therefore found no basis for an annual remuneration in the form of royalties or profit shares from the subsidiaries in Algeria and Qatar. On the other hand, the Regional Court found that Maersk Oil and Gas A/S’ so-called performance guarantees for the subsidiaries in Algeria and Qatar were controlled transactions and should therefore be priced at arm’s length. In addition, the Court found that technical and administrative assistance (so-called time writing) to the subsidiaries in Algeria and Qatar at cost was not in line with what could have been obtained if the transactions had been concluded between independent parties. These transactions should therefore also be priced at arm’s length. The High Court referred the cases back to the tax authorities for reconsideration. An appeal was then filed by the tax authorities with the Supreme Court. Judgement of the Supreme Court The Supreme Court decided in favour of the tax authorities and upheld the original assessment. The court stated that the preliminary exploration phases in connection with oil exploration and performance guarantees and the related know-how had an economic value for the subsidiaries, for which an independent party would require ongoing payment in the form of profit share, royalty or the like. They therefore constituted controlled transactions. Furthermore, the court stated that Maersk Oil and Gas A/S’ delivery of timewriting at cost price was outside the scope of what could have been achieved if the agreement had been entered into at arm’s length. Finally, the transactions were considered to be so closely related that they had to be assessed and priced on an aggregated basis and Maersk Oil and Gas A/S had not provided any basis for overturning the tax authorities’ assessment. Click here for English translation Click here for other translation ...

Following an audit of Otis Servizi s.r.l. for FY 2007, 2008 and 2009 an assessment of additional taxable income was issued by the Italian tax authorities. The first part of the assessment related to interest received by OTIS in relation to the contract called “Cash management service for Group Treasury” (hereinafter “Cash Pooling Contract”) signed on 20 March 2001 between OTIS and the company United Technologies Intercompany Lending Ireland Limited (hereinafter “UTILI”) based in Ireland (hereinafter “Cash Pooling Relief”). In particular, the tax authorities reclassified the Cash Pooling Agreement as a financing contract and recalculated the rate of the interest income received by OTIS to be between 5.1 and 6.5 per cent (instead of the rate applied by the Company, which ranged between 3.5 and 4.8 per cent); The second part of the assessment related to of the royalty paid by OTIS to the American company Otis Elevator Company in relation to the “Licence Agreement relating to trademarks and company names” and the “Agreement for technical assistance and licence to use technical data, know-how and patents” signed on 1 January 2004 (hereinafter referred to as the “Royalty Relief”). In particular, the tax authorities had deemed the royalty agreed upon in the aforesaid contracts equal to 3.5% of the turnover as not congruous, recalculating it at 2% and disallowing its deductibility to the extent of the difference between the aforesaid rates. Not satisfied with the assessment an appeal was filed by OTIS. The Regional Tax Commission upheld the assessments and an appeal was then filed with the Supreme Court. Judgement of the Supreme Court The Court decided in favour of OTIS, set aside the assessment and refered the case back to the Regional Tax Commission in a different composition. Excerpt related to interest received by OTIS under the cash pooling contract “In the present case, the Agenzia delle Entrate redetermined the rate of the interest income received by the OTIS in relation to the contract between the same and UTILI (cash pooling contract) concerning the establishment of a current account relationship for the unitary management of the group treasury. UTILI, as pooler or group treasurer, had entered into a bank account agreement with a credit institution in its own name, but on behalf of the group companies. At the same time, OTIS had mandated that bank to carry out the various tasks in order to fully implement the cash pooling agreement. Under this contract, all participating companies undertook to transfer their bank account balances (assets or liabilities) daily to the pooling company, crediting or debiting these balances to the pool account. As a result of this transfer, the individual current account balances of each participating company are zeroed out (‘zero balance cash pooling’). Notwithstanding the fact that the tax authorities do not dispute that this is a case relating to “zero balance cash pooling” (a circumstance that is, moreover, confirmed by the documents attached to the appeal), it should be noted that the same practice documentation of the Revenue Agency leads to the exclusion that, in the hypothesis in question, the cause of the transaction can be assimilated to a loan. In particular, in Circular 21/E of 3 June 2015, it is stated (p. 32) that “with reference to the sums moved within the group on the basis of cash pooling contracts in the form of the so-called zero balance system, it is considered that a financing transaction cannot be configured, pursuant to Article 10 of the ACE Decree. This is because the characteristics of the contract – which provides for the daily zeroing of the asset and liability balances of the group companies and their automatic transfer to the centralised account of the parent company, with no obligation to repay the sums thus transferred and with accrual of interest income or expense exclusively on that account – do not allow the actual possibility of disposing of the sums in question in order to carry out potentially elusive transactions’. These conclusions are confirmed in the answer to Interpretation No. 396 of 29 July 2022 (p. 5) where it is specified that ‘cash pooling contracts in the form of the so-called zero balance stipulated between group companies are characterised by reciprocal credits and debits of sums of money that originate from the daily transfer of the bank balance of the subsidiary/subsidiary to the parent company. As a result of this contract, the balance of the bank account held by the subsidiary/subsidiary will always be zero, since it is always transferred to the parent company. The absence of the obligation to repay the remittances receivable, the reciprocity of those remittances and the fact that the balance of the current account is uncollectible and unavailable until the account is closed combine to qualify the negotiated agreement as having characteristics that are not attributable to a loan of money in the relationship between the companies of the group’. That being so, the reasoning of the judgment under appeal falls below the constitutional minimum in so far as the CTR qualified the cash pooling relationship as a loan on the basis of the mere assertion that “the obligation to repay each other by the closing date of the account is not found in the case”. In so doing, the Regional Commission identified a generic financing contract function in the cash pooling without distinguishing between “notional cash pooling” and “zero balance cash pooling”, instead excluding, on the basis of the same documentation of practice of the Tax Administration, that in the second case (“zero balance”), a loan contract can be configured. The reasoning of the contested decision does not therefore make the basis of the decision discernible, because it contains arguments objectively incapable of making known the reasoning followed by the judge in forming his own conviction, since it cannot be left to the interpreter to supplement it with the most varied, hypothetical conjectures” (Sez. U. no. 22232 of 2016), the trial judge having failed to indicate in a congruous manner the elements from which he drew ...

Institute of International Research España S.L. belongs to the international group Informa Group Brand, of which Informa PLC, a company listed on the London Stock Exchange, is the parent company. In 2006 it had entered into a licence agreement (“for the use of the Licensed Property, Copyright, Additional Property Derived Alwork, the Mark and Name of the Licensor for the sale of Research and Dissemination Services”) under which it paid 6.5% of its gross turnover to a related party in the Netherlands – Institute of International Research BV. Furthermore, in 2007 it also entered into a “Central Support Services Agreement” with its parent Informa PLC according to which it paid cost + 5% for centralised support services: management, finance, accounting, legal, financial, fiscal, audit, human resources, IT, insurance, consultancy and special services. Following an audit, the tax authorities issued assessments of additional income for the FY 2007 and 2008 in which deductions of the licence payments and cost of intra-group services had been disallowed. Not satisfied with the assessment, Institute of International Research España S.L. filed an appeal. Judgement of the Audiencia Nacional The Court decided in favor of Institute of International Research España S.L. and annulled the assessment issued by the tax authorities. Excerpts “The paid nature of the assignment of the use of the trademark in a case such as the one at hand is something that, in the opinion of the Chamber, does not offer special interpretative difficulties. We refer, for example, to the Resolution of the Central Economic-Administrative Court of 3 October 2013 (R.G.: 2296/2012), in which the presumption of onerousness contained in art. 12. 2 of Royal Legislative Decree 5/2004, of 5 March, approving the revised text of the Non-Resident Income Tax Law, to a case of assignment of the use of certain trademarks made in the framework of a complex services contract by a non-resident entity to an entity resident in Spain and in which the reviewing body declared that: “the importance of the trademark is such (and more so the ones we are now dealing with) that it would be difficult to understand in the opinion of the Inspectorate a purely “instrumental” transfer of use of the same and much less free of charge, as the claimant claims”. The differences found by the contested decision, between the case analysed in that decision and the case at issue here, do not affect the above statement. As the complaint states in this respect, ‘it is clear that this rejection of the entire cost of the use of the trademark and the other items included in the licence agreement is not market-based because the IIR group would simply not allow any third party to benefit from using its trademark to provide services without any consideration in return’. Finally, the fact that the appellant did not pay any amount for the assignment of the use of the trademark to the trademark proprietor until the licence agreement does not justify that it should not have paid it, referring on this point to what has just been reasoned. Nor can the signing of the licence agreement be considered sufficient proof, in the manner of the precise and direct link according to the rules of the human standard of proof of presumptions (art. 386.1 of Law 1/2000, of 7 January, on Civil Procedure), that by that circumstance alone it should be ruled out outright that the licence agreement has not brought any benefit or advantage to IIR España or improved its position and prestige with respect to the previous situation.” “It remains, finally, to examine the effective accreditation (or not) of the reality of these complementary services related to the assignment of the use of the trademark. Following the reasoning of the contested decision, in general terms, there would be four reasons why the justification of the reality of those services cannot be admitted. First, the invoices issued by IIR BV refer to the services provided by the parent company in a very generic manner, which makes it impossible to know the benefit or utility received in each case by the Spanish company. Moreover, the way in which these services are valued -simply referring to the turnover of the subsidiaries- does not take into account any rational criteria. Secondly, IIR España has not substantiated the nature of the alleged services received from its Dutch parent company and their differentiation from management support costs. Thirdly, IIR Spain had already been using the brand name ‘IIR’ since its acquisition by the group in 1987 without it being established that it paid a fee for this. Lastly, the Transfer Pricing Report does not serve as evidence of the nature of the costs and their valuation.” “In the Chamber’s view, we are faced with a question of proof. The tax authorities have not considered the reality of the complementary services to be proven (but not the transfer of the use of the trademark, as explained above) and the plaintiff considers that this evidentiary assessment is erroneous in light of the documents submitted to the proceedings. The Board’s assessment of the evidence adduced by the appellant (both in administrative proceedings and in the application) is favourable to the appellant’s arguments, i.e. that it is sufficient evidence to prove the reality of the ancillary services arising from the licence agreement.” “In the light of this documentation, we consider that the reality of the services ancillary to the assignment of the use of the trademark deriving from the licence agreement is sufficiently justified. It is true that, as the Administration basically states in its response, the intensity or completeness of the different services provided in relation to what is set out in the licence agreement can be discussed, but this debate is not exactly the same as the one we are dealing with here, which consists of deciding whether the additional services in question were actually provided or not. In the Board’s view, the documentary evidence cited above proves that they were and that the licence agreement ...

Medtronic had used the comparable uncontrolled transactions (CUT) method to determine the arm’s length royalty rates received from its manufacturing subsidiary in Puerto Rico for use of IP under an inter-group license agreement. The tax authorities found that Medtronic left too much profit in Puerto Rico. Using a “modified CPM” the IRS concluded that at arm’s length 90 percent of Medtronic’s “devices and leads” profit should have been allocated to the US parent and only 10 percent to the operations in Puerto Rico. Medtronic brought the case to the Tax Court. The Tax Court applied its own analysis and concluded that the Pacesetter agreement was the best CUT to calculate the arm’s length result for license payments. This decision from the Tax Court was then appealed by the IRS to the Court of Appeals. In 2018, the Court of Appeal found that the Tax Court’s factual findings had been insufficient. The Court of Appeals stated taht: “The Tax Court determined that the Pacesetter agreement was an appropriate comparable uncontrolled transaction (CUT) because it involved similar intangible property and had similar circumstances regarding licensing. We conclude that the Tax Court’s factual findings are insufficient to enable us to conduct an evaluation of that determination.” The Tax Court did not provide (1) sufficient detail as to whether the circumstances between Siemens Pacesetter, Inc. (Pacesetter), and Medtronic US were comparable to the licensing agreement between Medtronic US and Medtronic Puerto Rico (MPROC) and whether the Pacesetter agreement was one created in the ordinary course of business; (2) an analysis of the degree of comparability of the Pacesetter agreement’s contractual terms and those of the MPROC’s licensing agreement; (3) an evaluation of how the different treatment of intangibles affected the comparability of the Pacesetter agreement and the MPROC licensing agreement; and (4) the amount of risk and product liability expense that should be allocated between Medtronic US and MPROC. According to the Court of Appeal these findings were “… essential to its review of the Tax Court’s determination that the Pacesetter agreement was a CUT, as well as necessary to its determination whether the Tax Court applied the best transfer pricing method for calculating an arm’s length result or whether it made proper adjustments under its chosen method“. Hence, the case was remanded to the Tax Court for further considerations. Opinion of the US Tax Court Following the re-trial, the Tax Court concluded that the taxpayer did not meet its burden to show that its allocation under the CUT method and its proposed unspecified method satisfied the arm’s length standard. “Increasing the wholesale royalty rate to 48.8% results in an overall profit split of 68.72% to Medtronic US/Med USA and 31.28% profit split to MPROC and a R&D profits split of 62.34% to Medtronic US and 37.66% to MPROC. The resulting profit split reflects the importance of the patents as well as the role played by MPROC. The profit split is more reasonable than the profit split of 56.8% to Medtronic US/Med USA and 43.2% to MPROC resulting from petitioner’s unspecified method with a 50–50 allocation. According to respondent’s expert Becker, MPROC had incurred costs of 14.8% of retail prices. The evidence does not support a profit split which allocates 43.2% of the profits to MPROC when it has only 14.8% of the operating cost.” “We conclude that wholesale royalty rate is 48.8% for both leads and devices, and the royalty rate is the same for both years in issue. According to the regulations an unspecified method will not be applied unless it provides the most reliable measure of an arm’s-length result under the principles of the best method rule. Treas. Reg. § 1.482-4(d). Under the best method rule, the arm’s-length result of a controlled transaction must be determined under the method that, under the facts and circumstances, provides the most reliable method of getting an arm’s-length result. Id. § 1.482-1(c)(1). We have concluded previously that petitioner’s CUT method, petitioner’s proposed unspecified method, the Court’s adjusted CUT method in Medtronic I, respondent’s CPM, and respondent’s modified CPM do not result in an arm’s-length royalty rate and are not the best method. Only petitioner suggested a new method, its proposed unspecified method; however, for reasons previously explained, that method needed adjustment for the result to be arm’s length. “Our adjustments consider that the MPROC licenses are valuable and earn higher profits than the licenses covered by the Pacesetter agreement. We also looked at the ROA in the Heimert analysis and from the evidence cannot determine what the proper ROA should be. The criticisms each party had of the other’s methods were factored into our adjustment. Respondent’s expert Becker testified that you may not like the logic of a method but ultimately the answer is fine. Because neither petitioner’s proposed CUT method nor respondent’s modified CPM was the best method, our goal was to find the right answer. The facts in this case are unique because of the complexity of the devices and leads, and we believe that our adjustment is necessary for us to bridge the gap between the parties’ methods. A wholesale royalty rate of 48.8% for both devices significantly bridges the gap between the parties. Petitioner’s expert witness Putnam proposed a CUT which resulted in a blended wholesale royalty rate of 21.8%; whereas respondent’s expert Heimert’s original CPM analysis resulted in a blended wholesale royalty rate of 67.7%. In Medtronic I we concluded that the blended wholesale royalty rate was 38%, and after further trial, we conclude that the wholesale royalty rate is 48.8%, which we believe is the right answer.” Click here for other translation ...

Keysight Technologies Malaysia Sdn Bhd (KTM) was incorporated in 1998 and active as a full-fledged manufacturer of various microwave devices and test instruments in which capacity it had also developed valuable intangibles. In 2008, KTM was converted into a contract manufacturer under an agreement with Agilent Technologies International s.a.r.l. and at the same time KLM purportedly transferred its intangibles to Agilent Technologies. KTM received an amount of RM 821 million which it reported as non-taxable gains form sale of intangibles in its tax return. Following an audit the tax authorities issued a notice of assessment for FY 2008 where the sum of RM 821 million had been considered revenue in nature and thus taxable under Section 4(f) of the ITA. This resulted in a claim of RM 311 million together with a 45% penalty. According to the tax authorities the transfer of technical knowhow was not actually a sale as KTM was still using the technical knowhow in its manufacturing activities. The proceeds were related to the conversion of KLM from a full-fledged manufacturer to a contract manufacturer, which had resulted in a reduction in taxable profits. “The gain on the transfer of technical knowhow was for the payment on the loss of income since it was related to the change of the Appellant’s function from a full-fledged manufacturer to a contract manufacturer which resulted in a reduction of profit margin of the Appellant after the change of the function.” KTM filed an appeal against the assessment in which it stated that proceeds from the sale of know-how were not revenue in nature and therefore not taxable under the ITA. KLM also appealed against the penalty imposed under Section 113(2) of the ITA. The appeal was dismissed by the Special Commissioners of Income Tax, and an appeal was then filed by KTM with the High Court. Judgement of the High Court The High Court Judge dismissed KTM’s appeal and upheld the decision of the Special Commissioners of Income Tax. According to the High Court KTM had “failed to support the claim that the gain from the transfer of technical knowhow (i.e. the marketing and manufacturing intangibles) by KTM to Agilent Technologies International totalling of RM821,615,000.00 is an outright sale.”. There were no documents showing that the IP rights had been registered in the name of Agilent Technologies International s.a.r.l. Hence the proceeds was considered revenue in nature and taxable under Section 4(f) of the Income Tax Act 1967(“ITA”). Click here for translation ...

101. Company A is the Parent company of an MNE group with operations in country S. Company B is a member of the MNE group with operations in country T, and Company C is also a member of the MNE group with operations in country U. For valid business reasons the MNE group decides to centralise all of its intangibles related to business conducted outside of country S in a single location. Accordingly, intangibles owned by Company B are sold to Company C for a lump sum, including patents, trademarks, know-how, and customer relationships. At the same time, Company C retains Company B to act as a contract manufacturer of products previously produced and sold by Company B on a full-risk basis. Company C has the personnel and resources required to manage the acquired lines of business, including the further development of intangibles necessary to the Company B business. 102. The MNE group is unable to identify comparable uncontrolled transactions that can be used in a transfer pricing analysis of the arm’s length price to be paid by Company C to Company B. Based on a detailed comparability and functional analysis, the MNE group concludes that the most appropriate transfer pricing method involves the application of valuation techniques to determine the value of the transferred intangibles. In conducting its valuation, the MNE group is unable to reliably segregate particular cash flows associated with all of the specific intangibles. 103. Under these circumstances, in determining the arm’s length compensation to be paid by Company C for the intangibles sold by Company B, it may be appropriate to value the transferred intangibles in the aggregate rather than to attempt a valuation on an asset by asset basis. This would particularly be the case if there is a significant difference between the sum of the best available estimates of the value of individually identified intangibles and other assets when valued separately and the value of the business as a whole ...

97. Company A is the Parent of an MNE group with operations in country X. Company A owns patents, trademarks and know-how with regard to several products produced and sold by the MNE group. Company B is a wholly owned subsidiary of Company A. All of Company B’s operations are conducted in country Y. Company B also owns patents, trademarks and know-how related to Product M. 98. For sound business reasons related to the coordination of the group’s patent protection and anti-counterfeiting activities, the MNE group decides to centralise ownership of its patents in Company A. Accordingly, Company B sells the Product M patents to Company A for a lump-sum price. Company A assumes responsibility to perform all ongoing functions and it assumes all risks related to the Product M patents following the sale. Based on a detailed comparability and functional analysis, the MNE group concludes that it is not able to identify any comparable uncontrolled transactions that can be used to determine the arm’s length price. Company A and Company B reasonably conclude that the application of valuation techniques represents the most appropriate transfer pricing method to use in determining whether the agreed price is consistent with arm’s length dealings. 99. Valuation personnel apply a valuation method that directly values property and patents to arrive at an after-tax net present value for the Product M patent of 80. The analysis is based on royalty rates, discount rates and useful lives typical in the industry in which Product M competes. However, there are material differences between Product M and the relevant patent rights related to Product M, and those typical in the industry. The royalty arrangements used in the analysis would therefore not satisfy the comparability standards required for a CUP method analysis. The valuation seeks to make adjustments for these differences. 100. In conducting its analysis, Company A also conducts a discounted cash flow based analysis of the Product M business in its entirety. That analysis, based on valuation parameters typically used by Company A in evaluating potential acquisitions, suggests that the entire Product M business has a net present value of 100. The 20 difference between the 100 valuation of the entire Product M business and the 80 valuation of the patent on its own appears to be inadequate to reflect the net present value of routine functional returns for functions performed by Company B and to recognise any value for the trademarks and know-how retained by Company B. Under these circumstances further review of the reliability of the 80 value ascribed to the patent would be called for ...

86. Zhu is a company engaged in software development consulting. In the past Zhu has developed software supporting ATM transactions for client Bank A. In the process of doing so, Zhu created and retained an interest in proprietary copyrighted software code that is potentially suitable for use by other similarly situated banking clients, albeit with some revision and customisation. 87. Assume that Company S, an associated enterprise of Zhu, enters into a separate agreement to develop software supporting ATM operations for another bank, Bank B. Zhu agrees to support its associated enterprise by providing employees who worked on the Bank A engagement to work on Company S’s Bank B engagement. Those employees have access to software designs and know-how developed in the Bank A engagement, including proprietary software code. That code and the services of the Zhu employees are utilised by Company S in executing its Bank B engagement. Ultimately, Bank B is provided by Company S with a software system for managing its ATM network, including the necessary licence to utilise the software developed in the project. Portions of the proprietary code developed by Zhu in its Bank A engagement are embedded in the software provided by Company S to Bank B. The code developed in the Bank A engagement and embedded in the Bank B software would be sufficiently extensive to justify a claim of copyright infringement if copied on an unauthorised basis by a third party. 88. A transfer pricing analysis of these transactions should recognise that Company S received two benefits from Zhu which require compensation. First, it received services from the Zhu employees that were made available to work on the Bank B engagement. Second, it received rights in Zhu’s proprietary software which was utilised as the foundation for the software system delivered to Bank B. The compensation to be paid by Company S to Zhu should include compensation for both the services and the rights in the software ...

67. Company P, a resident of country A conducts a retailing business, operating several department stores in country A. Over the years, Company P has developed special know-how and a unique marketing concept for the operation of its department stores. It is assumed that the know-how and unique marketing concept constitute intangibles within the meaning of Section A of Chapter VI. After years of successfully conducting business in country A, Company P establishes a new subsidiary, Company S, in country B. Company S opens and operates new department stores in country B, obtaining profit margins substantially higher than those of otherwise comparable retailers in country B. 68. A detailed functional analysis reveals that Company S uses in its operations in country B, the same know-how and unique marketing concept as the ones used by Company P in its operations in country A. Under these circumstances, the conduct of the parties reveals that a transaction has taken place consisting in the transfer from Company P to Company S of the right to use the know-how and unique marketing concept. Under comparable circumstances, independent parties would have concluded a license agreement granting Company S the right to use in country B, the know-how and unique marketing concept developed by Company P. Accordingly, one possible remedy available to the tax administration is a transfer pricing adjustment imputing a royalty payment from Company S to Company P for the use of these intangibles ...

64. Primarni is organised in and conducts business in country A. Company S is an associated enterprise of Primarni. Company S is organised in and does business in country B. Primarni develops a patented invention and manufacturing know-how related to Product X. It obtains valid patents in all countries relevant to this example. Primarni and Company S enter into a written licence agreement pursuant to which Primarni grants Company S the right to use the Product X patents and know-how to manufacture and sell Product X in country B, while Primarni retains the patent and know-how rights to Product X throughout Asia, Africa, and in country A. 65. Assume Company S uses the patents and know-how to manufacture Product X in country B. It sells Product X to both independent and associated customers in country B. Additionally, it sells Product X to associated distribution entities based throughout Asia and Africa. The distribution entities resell the units of Product X to customers throughout Asia and Africa. Primarni does not exercise its retained patent rights for Asia and Africa to prevent the sale of Product X by Company S to the distribution entities operating in Asia and Africa. 66. Under these circumstances, the conduct of the parties suggests that the transaction between Primarni and Company S is actually a licence of the Product X patents and know-how for country B, plus Asia and Africa. In a transfer pricing analysis of the transactions between Company S and Primarni, Company S’s licence should be treated as extending to Asia and Africa, and should not be limited to country B, based on the conduct of the parties. The royalty rate should be recalculated to take into account the total projected sales by Company S in all territories including those to the Asian and African entities ...

Know-how and trade secrets are proprietary information or knowledge that assist or improve a commercial activity, but that are not registered for protection in the manner of a patent or trademark. Know-how and trade secrets generally consist of undisclosed information of an industrial, commercial or scientific nature arising from previous experience, which has practical application in the operation of an enterprise. Know-how and trade secrets may relate to manufacturing, marketing, research and development, or any other commercial activity. The value of know-how and trade secrets is often dependent on the ability of the enterprise to preserve the confidentiality of the know-how or trade secret. In certain industries the disclosure of information necessary to obtain patent protection could assist competitors in developing alternative solutions. Accordingly, an enterprise may, for sound business reasons, choose not to register patentable know-how, which may nonetheless contribute substantially to the success of the enterprise. The confidential nature of know-how and trade secrets may be protected to some degree by (i) unfair competition or similar laws, (ii) employment contracts, and (iii) economic and technological barriers to competition. Know-how and trade secrets are intangibles within the meaning of Section A. 1 ...

It should be noted, however, that in some situations, the transfer or secondment of one or more employees may, depending on the facts and circumstances, result in the transfer of valuable know-how or other intangibles from one associated enterprise to another. For example, an employee of Company A seconded to Company B may have knowledge of a secret formula owned by Company A and may make that secret formula available to Company B for use in its commercial operations. Similarly, employees of Company A seconded to Company B to assist with a factory start-up may make Company A manufacturing know-how available to Company B for use in its commercial operations. Where such a provision of know-how or other intangibles results from the transfer or secondment of employees, it should be separately analysed under the provisions of Chapter VI and an appropriate price should be paid for the right to use the intangibles ...

Differences in the specific characteristics of property or services often account, at least in part, for differences in their value in the open market. Therefore, comparisons of these features may be useful in delineating the transaction and in determining the comparability of controlled and uncontrolled transactions. Characteristics that may be important to consider include the following: in the case of transfers of tangible property, the physical features of the property, its quality and reliability, and the availability and volume of supply; in the case of the provision of services, the nature and extent of the services; and in the case of intangible property, the form of transaction (e.g. licensing or sale), the type of property (e.g. patent, trademark, or know-how), the duration and degree of protection, and the anticipated benefits from the use of the property. For further discussion of some of the specific features of intangibles that may prove important in a comparability analysis involving transfers of intangibles or rights in intangibles, see Section D.2.1 of Chapter VI ...

Where no written terms exist, the actual transaction would need to be deduced from the evidence of actual conduct provided by identifying the economically relevant characteristics of the transaction. In some circumstances the actual outcome of commercial or financial relations may not have been identified as a transaction by the MNE, but nevertheless may result in a transfer of material value, the terms of which would need to be deduced from the conduct of the parties. For example, technical assistance may have been granted, synergies may have been created through deliberate concerted action (as discussed in Section D.8), or know-how may have been provided through seconded employees or otherwise. These relations may not have been recognised by the MNE, may not be reflected in the pricing of other connected transactions, may not have been formalised in written contracts, and may not appear as entries in the accounting systems. Where the transaction has not been formalised, all aspects would need to be deduced from available evidence of the conduct of the parties, including what functions are actually performed, what assets are actually used, and what risks are actually assumed by each of the parties ...

Bluestar Silicones France (BSF), now Elkem Silicones France SAS (ESF), produces silicones and various products that it sells to other companies belonging to the Bluestar Silicones International group. The company was audited for the financial years 2007 – 2008 and an assessment was issued. According to the tax authorities, the selling prices of the silicone products had been below the arm’s length price and the company had refrained from invoicing of management exepences and cost of secondment of employees . In the course of the proceedings agreement had been reached on the pricing of products. Hence, in dispute before the court was the issue of lacking invoicing of management exepences and cost of secondment of employees for the benefit of the Chinese and Brazilian subsidiaries of the Group. According to the company there had been no hidden transfer of profits; its method of constructing the group’s prices has not changed and compliance with the arm’s length principle has been demonstrated by a study by the firm Taj using the transactional net margin method and the criticisms of its prices are unfounded. The results must be analyzed in the context of heavy investments made by the Bluestar Silicones International sub-group, 80% of which it financed, and which are at the root of the heavy losses recorded in the sub-group’s first fiscal years for the years 2007 to 2009. Furthermore, the business tax adjustments was considered unjustified by the company since, the transfer prices charged did not constitute transfers of profits; Decision of the Court No charge of management fees from Brazil and Hong Kong: “Under these conditions, the administration was justified in considering that BSF’s renunciation to invoice management fees to the Chinese and Brazilian companies of the Bluestar Silicones International group constituted an abnormal act of management. It was thus entitled to correct the company’s profit and also to correct the company’s added value for the determination of its business tax.” No charge of cost of provision of employees in China: “While BSF claims that it derived a direct benefit from the provision of these three expatriates through the development of sales by the Chinese subsidiary, it does not establish this, even though it has been shown that the project manager and the two technicians worked at the Jiangxi site, which was acquiring the technology needed to manufacture products similar to those previously purchased by the Chinese subsidiary from BSF and therefore potentially competing with it. The impossibility of charging such fees due to Chinese legislation has also not been demonstrated, nor has any compensation resulting from insufficient transfer pricing. Under these conditions, the applicant company does not demonstrate that the advantage granted to the Chinese company had sufficient consideration in the interest of its operations and, consequently, was justified by normal management of its own interests.” Additional withholding tax and business tax However, the Court did find that the company was “entitled to argue that the Montreuil Administrative Court wrongly refused to discharge it from the additional withholding tax contributions charged to it for the financial year ended in 2007 and the additional business tax contributions for the year 2007 resulting from the correction made by the tax authorities of its transfer prices practiced with the company BSI Hong Kong.” Click here for English Translation Click here for other translation ...

A-Contract Manufacturer LDA is an entity residing in Portugal, whose main activity is contract manufacturing of coffee machines and irons, as well as spare parts, tools etc. on behalf of its German parent B A.G. Following an audit, the tax authorities found that the results of A-Contract Manufacturer LDA had not been at arm’s length. An assessment of additional income was issued where the adjustment had been determined based on a benchmark study and use of statistical tools – interquartile range and median. Not satisfied with the assessment A-Contract Manufacturer LDA brought the case to the CAAD, a Portuguese arbitration tribunal. Decision of CAAD The CAAD decided in favour of the tax authorities and upheld the assessment. Excerpt “In sum, regarding the first claim of the Claimant that the arm’s length principle was violated, it appears that the Defendant did nothing more than, in compliance with the duty imposed by art. In short, as to the first claim of violation of the arm’s length principle, it appears that the Claimant, in compliance with the duty imposed by article 3 of Ministerial Order no. 1446-C/2001, of 21 December, and in the exercise of a margin of technical discretion resulting from that precept, carried out calculations that are fully based on the OECD guidelines, after concluding that “the operating result generated [by the Claimant] was lower than it would have been had those transactions been carried out between independent entities” (point 1.4 of the RIT). The mere invocation of its nature as a “contract manufacturer” is not a reason to preclude the application of the arm’s length principle to the special relations between the Claimant and the corporate Group of which it forms part, and even less to conceive any exceptional regime vis-à-vis the rule of application of the OECD Guidelines and the national rules that define those guidelines. As to the Claimant’s second allegation that the arm’s length principle was violated, consisting in the argument that the median value used by the Defendant was highly inflated, this is a mere divergence of quantifications and calculations between the Claimant and the Defendant, and not a doubt that, as the Claimant claims, could lead to the application of art. 100 of the CPPT – since the conclusions of the RIT do not show any such doubt, besides the fact that there is no evidence of any error in the calculations made by the AT that led to the results shown in the RIT. Moreover – and this is the most relevant point – even with lower medians and interquartile ranges such as those proposed by the Claimant, the margins presented by the Claimant are well below these medians, and outside these ranges, with all the consequences that we have seen must result.” Click here for English translation. Click here for other translation ...

The tax authority conducted an inspection of Groklin-Carpathians LLC, which revealed that the company had failed to file a controlled transactions report for 2015. On this basis, the tax authority issued a documentation penalty notice to the company. Groklin-Carpathians LLC appealed the decision, which was upheld by both the District Court and the Court of Appeal. The tax authorities then appealed to the Supreme Court. Judgement of the Supreme Court The Supreme Court dismissed the appeal. “Taking into account the circumstances of this case, as well as the officially expressed position of the fiscal authority on the procedure for determining the transaction as a controlled one, the panel of judges agrees with the conclusions of the courts of previous instances that the plaintiff has no statutory obligation to reflect the return of intangible assets in the TP Report, since such transactions do not in any way affect the increase or decrease of the plaintiff’s taxable object, which in turn indicates that the challenged tax notice is unfounded.” Click here for English translation Click here for other translation ...

The question in this case was whether royalty payments from a loss making Danish subsidiary Adecco A/S (H1 A/S in the decision) to its Swiss parent company Adecco SA (G1 SA in the decision – an international provider of temporary and permanent employment services active throughout the entire range of sectors in Europe, the Americas, the Middle East and Asia – for use of trademarks and trade names, knowhow, international network intangibles, and business concept were deductible expenses for tax purposes or not. In  2013, the Danish tax authorities (SKAT) had amended Adecco A/S’s taxable income for the years 2006-2009 by a total of DKK 82 million. Adecco A/S submitted that the company’s royalty payments were operating expenses deductible under section 6 (a) of the State Tax Act and that it was entitled to tax deductions for royalty payments of 1.5% of the company’s turnover in the first half of 2006 and 2% up to and including 2009, as these prices were in line with what would have been agreed if the transactions had been concluded between independent parties and thus compliant  with the requirement in section 2 of the Tax Assessment Act (- the arm’s length principle). In particular, Adecco A/S claimed that the company had lifted its burden of proof that the basic conditions for deductions pursuant to section 6 (a) of the State Tax Act were met, and the royalty payments thus deductible to the extent claimed. According to section 6 (a) of the State Tax Act expenses incurred during the year to acquire, secure and maintain income are deductible for tax purposes. There must be a direct and immediate link between the expenditure incurred and the acquisition of income. The company hereby stated that it was not disputed that the costs were actually incurred and that it was evident that the royalty payment was in the nature of operating costs, since the company received significant economic value for the payments. The High Court ruled in favor of the Danish tax authorities and concluded as follows: “Despite the fact that, as mentioned above, there is evidence to suggest that H1 A/S’s payment of royalties for the use of the H1 A/S trademark is a deductible operating expense, the national court finds, in particular, that H1 A/S operates in a national Danish market, where price is by far the most important competitive parameter, that the company has for a very long period largely only deficit, that it is an agreement on payment to the company’s ultimate parent company – which must be assumed to have its own purpose of being represented on the Danish market – and that royalty payments must be regarded as a standard condition determined by G1 SA independent of the market in which the Danish company is working, as well as the information on the marketing costs incurred in the Danish company and in the Swiss company compared with the failure to respond to the relevant provocations that H1 A/S has not lifted the burden of proof that the payments of royalties to the group-affiliated company G1 SA, constitutes a deductible operating expense, cf. section 6 (a) of the State Tax Act. 4.5 and par. 4.6, the national court finds that the company’s royalty payment cannot otherwise be regarded as a deductible operating expense.” Adecco appealed the decision to the Supreme Court. The Supreme Court overturned the decision of the High Court and ruled in favor of Adecco. The Supreme Court held that the royalty payments had the nature of deductible operating costs. The Supreme Court also found that Adecco A/S’s transfer pricing documentation for the income years in question was not insufficient to such an extent that it could be considered equal to lack of documentation. The company’s income could therefore not be determined on a discretionary basis by the tax authorities. Finally, the Supreme Court did not consider that a royalty rate of 2% was not at arm’s length, or that Adecco A/S’s marketing in Denmark of the Adecco brand provided a basis for deducting in the royalty payment a compensation for a marketing of the global brand. Click here for translation ...

“Metal Plating Corp” is engaged in manufacturing and selling plating chemicals and had entered into a series of controlled transactions with foreign group companies granting licenses to use intangibles (know-how related to technology and sales) – and provided technical support services by sending over technical experts. The company had used a CUP method to price these transactions based on “internal comparables”. The tax authorities found that the amount of the consideration paid to “Metal Plating Corp” for the licenses and services had not been at arm’s length and issued an assessment where the residual profit split method was applied to determine the taxable profit for the fiscal years FY 2007-2012. “Metal Plating Corp” on its side held that it was inappropriate to use a residual profit split method and that there were errors in the calculations performed by the tax authorities. Judgement of the Court The Court dismissed the appeal of “Metal Plating Corp” and affirmed the assessment made by the Japanese tax authority. On the company’s use of the CUP method the Court concluded that there were significant differences between the controlled transactions and the selected “comparable” transactions in terms of licences, services and the circumstances under which the transactions were took place. Therefore the CUP method was not the most appropriate method to price the controlled transactions. The Court recognised that “Metal Plating Corp” had intangible assets created by its research and development activities. The Court also recognised that the subsidiaries had created intangible assets by penetrating regional markets and cultivating and maintaining customer relationships. The Court found the transactions should be aggregated and that the price should be determined for the full packaged deal – not separately for each transaction. Click here for English Translation Click here for other translation ...

The question in this case was whether royalty payments from a loss making Danish subsidiary Adecco A/S (H1 A/S in the decision) to its Swiss parent company Adecco SA (G1 SA in the decision – an international provider of temporary and permanent employment services active throughout the entire range of sectors in Europe, the Americas, the Middle East and Asia – for use of trademarks and trade names, knowhow, international network intangibles, and business concept were deductible expenses for tax purposes or not. In  2013, the Danish tax authorities (SKAT) had amended Adecco A/S’s taxable income for the years 2006-2009 by a total of DKK 82 million. “Section 2 of the Tax Assessment Act. Paragraph 1 states that, when calculating the taxable income, group affiliates must apply prices and terms for commercial or economic transactions in accordance with what could have been agreed if the transactions had been concluded between independent parties. SKAT does not consider it in accordance with section 2 of the Tax Assessment Act that during the period 2006 to 2009, H1 A/S had to pay royalty to G1 SA for the right to use trademark, “know-how intangibles” and “ international network intangibles ”. An independent third party, in accordance with OECD Guidelines 6.14, would not have agreed on payment of royalties in a situation where there is a clear discrepancy between the payment and the value of licensee’s business. During the period 2006 to 2009, H1 A/S did not make a profit from the use of the licensed intangible assets. Furthermore, an independent third party would not have accepted an increase in the royalty rate in 2006, where the circumstances and market conditions in Denmark meant that higher profits could not be generated. H1 A/S has also incurred considerable sales and marketing costs at its own expense and risk. Sales and marketing costs may be considered extraordinary because the costs are considered to be disproportionate to expected future earnings. This assessment takes into account the licensing agreement, which states in Article 8.2 that the termination period is only 3 months, and Article 8.6, which states that H1 A/S will not receive compensation for goodwill built up during the contract period if the contract is terminated. H1 A/S has built and maintained the brand as well as built up “brand value” on the Danish market. The company has contributed to value of intangible assets that they do not own. In SKAT’s opinion, an independent third party would not incur such expenses without some form of compensation or reduction in the royalty payment, cf. OECD Guidelines 6.36 – 6.38. If H1 A/S was not associated with the trademark owners, H1 A/S would, in SKAT’s opinion, have considered other alternatives such as terminating, renegotiating or entering into more profitable licensing agreements, cf. OECD Guidelines 1.34-1.35. A renegotiation is precisely a possibility in this situation, as Article 8.2 of the license agreement states that the agreement for both parties can be terminated at three months’ notice. The control of the group has resulted in H1 A/S maintaining unfavorable agreements, not negotiating better terms and not seeking better alternatives. In addition, SKAT finds that the continuing losses realized by the company are also due to the Group’s interest in being represented on the Danish market. In order for the Group to service the global customers that are essential to the Group’s strategy, it is important to be represented in Denmark in order to be able to offer contracts in all the countries where the customer has branches. Such a safeguard of the Group’s interest would require an independent third party to be paid, and the company must therefore also be remunerated accordingly, especially when the proportion of global customers in Denmark is significantly lower than in the other Nordic countries.“ Adecco A/S submitted that the company’s royalty payments were operating expenses deductible under section 6 (a) of the State Tax Act and that it was entitled to tax deductions for royalty payments of 1.5% of the company’s turnover in the first half of 2006 and 2% up to and including 2009, as these prices were in line with what would have been agreed if the transactions had been concluded between independent parties and thus compliant  with the requirement in section 2 of the Tax Assessment Act (- the arm’s length principle) . In particular, Adecco A/S claimed that the company had lifted its burden of proof that the basic conditions for deductions pursuant to section 6 (a) of the State Tax Act were met, and the royalty payments thus deductible to the extent claimed. According to section 6 (a) of the State Tax Act expenses incurred during the year to acquire, secure and maintain income are deductible for tax purposes. There must be a direct and immediate link between the expenditure incurred and the acquisition of income. The company hereby stated that it was not disputed that the costs were actually incurred and that it was evident that the royalty payment was in the nature of operating costs, since the company received significant economic value for the payments. The High Court ruled in favor of the Danish tax authorities and concluded as follows: “Despite the fact that, as mentioned above, there is evidence to suggest that H1 A/S’s payment of royalties for the use of the H1 A/S trademark is a deductible operating expense, the national court finds, in particular, that H1 A/S operates in a national Danish market, where price is by far the most important competitive parameter, that the company has for a very long period largely only deficit, that it is an agreement on payment to the company’s ultimate parent company – which must be assumed to have its own purpose of being represented on the Danish market – and that royalty payments must be regarded as a standard condition determined by G1 SA independent of the market in which the Danish company is working, as well as the information on the marketing costs incurred in the Danish company and in the Swiss company compared with the failure to respond to ...

ST Dupont is a French luxury manufacturer of lighters, pens and leather goods. It is majority-owned by the Dutch company, D&D International, which is wholly-owned by Broad Gain Investments Ltd, based in Hong Kong. ST Dupont is the sole shareholder of distribution subsidiaries located abroad, in particular ST Dupont Marketing, based in Hong Kong. Following an audit, an adjustment was issued for FY 2009, 2010 and 2011 where the tax administration considered that the prices at which ST Dupont sold its products to ST Dupont Marketing (Hong Kong) were lower than the arm’s length prices, that royalty rates had not been at arm’s length. Furthermore adjustments had been made to losses carried forward. Not satisfied with the adjustment ST Dupont filed an appeal with the Paris administrative Court. Judgement of the Administrative Court The Court set aside the tax assessment in regards to license payments and resulting adjustments to loss carry forward but upheld in regards of pricing of the products sold to ST Dupont Marketing (Hong Kong). Click here for English translation Click here for other translation ...

In this case the IRS was of the opinion, that Medtronic erred in allocating the profit earned from its devises and leads between its businesses located in the United States and its device manufacturer in Puerto Rico. To determine the arm’s length price for Medtronic’s intercompany licensing agreements the comparable profits method was therefor applied by the IRS, rather than the comparable uncontrolled transaction (CUT) used by Medtronic. Medtronic brought the case to the Tax Court. The Tax Court applied its own valuation analysis and concluded that the Pacesetter agreement was the best CUT to calculate the arm’s length result for intangible property. This decision from the Tax Court was then appealed by the IRS to the Court of Appeals. The Court of Appeal found that the Tax Court’s factual findings were insufficient to enable the Court to conduct an evaluation of Tax Court’s determination. Specifically, the Tax Court failed to: address whether the circumstances of the Pacesetter settlement was comparable to the licensing agreements in this case, the degree of comparability of the contractual terms between the two situations, how the different treatment of intangibles affected the two agreements and the amount of risk and product liability expenses that should be allocated. Thus, the case has been remanded for further consideration ...

C Uyemura & Co, Ltd. is engaged in the business of manufacturing and selling plating chemicals and had entered into a series of controlled transactions with foreign group companies granting licenses to use intangibles (know-how related to technology and sales) – and provided technical support services by sending over technical experts. The company had used a CUP method to price these transactions based on “internal comparables”. The tax authorities found that the amount of the consideration paid to C Uyemura & Co, Ltd for the licenses and services had not been at arm’s length and issued an assessment where the residual profit split method was applied to determine the taxable profit for the fiscal years 2000 – 2004. C Uyemura & Co, Ltd disapproved of the assessment. The company held that it was inappropriate to use a residual profit split method and that there were errors in the calculations performed by the tax authorities. Judgement of the Court The Court dismissed the appeal of C Uyemura & Co, Ltd. and affirmed the assessment made by the Japanese tax authority. On company’s use of the CUP method the Court concluded that there were significant differences between the controlled transactions and the selected “comparable” transactions in terms of licences, services and circumstances in which the transactions were took place. Therefore the CUP method was not the best method to price the controlled transactions. The Court recognised that C Uyemura & Co, Ltd had intangible assets created by its research and development activities. The Court also recognised that the Taiwanese, Malaysian and Singaporean subsidiaries had created intangible assets by penetrating regional markets and cultivating and maintaining customer relationships. The Court found the transactions should be aggregated and that the price should be determined for the full packaged deal – not separately for each transaction. Click here for English translation ...

86. Zhu is a company engaged in software development consulting. In the past Zhu has developed software supporting ATM transactions for client Bank A. In the process of doing so, Zhu created and retained an interest in proprietary copyrighted software code that is potentially suitable for use by other similarly situated banking clients, albeit with some revision and customisation. 87. Assume that Company S, an associated enterprise of Zhu, enters into a separate agreement to develop software supporting ATM operations for another bank, Bank B. Zhu agrees to support its associated enterprise by providing employees who worked on the Bank A engagement to work on Company S’s Bank B engagement. Those employees have access to software designs and know-how developed in the Bank A engagement, including proprietary software code. That code and the services of the Zhu employees are utilised by Company S in executing its Bank B engagement. Ultimately, Bank B is provided by Company S with a software system for managing its ATM network, including the necessary licence to utilise the software developed in the project. Portions of the proprietary code developed by Zhu in its Bank A engagement are embedded in the software provided by Company S to Bank B. The code developed in the Bank A engagement and embedded in the Bank B software would be sufficiently extensive to justify a claim of copyright infringement if copied on an unauthorised basis by a third party. 88. A transfer pricing analysis of these transactions should recognise that Company S received two benefits from Zhu which require compensation. First, it received services from the Zhu employees that were made available to work on the Bank B engagement. Second, it received rights in Zhu’s proprietary software which was utilised as the foundation for the software system delivered to Bank B. The compensation to be paid by Company S to Zhu should include compensation for both the services and the rights in the software ...

Know-how and trade secrets are proprietary information or knowledge that assist or improve a commercial activity, but that are not registered for protection in the manner of a patent or trademark. Know-how and trade secrets generally consist of undisclosed information of an industrial, commercial or scientific nature arising from previous experience, which has practical application in the operation of an enterprise. Know-how and trade secrets may relate to manufacturing, marketing, research and development, or any other commercial activity. The value of know-how and trade secrets is often dependent on the ability of the enterprise to preserve the confidentiality of the know-how or trade secret. In certain industries the disclosure of information necessary to obtain patent protection could assist competitors in developing alternative solutions. Accordingly, an enterprise may, for sound business reasons, choose not to register patentable know-how, which may nonetheless contribute substantially to the success of the enterprise. The confidential nature of know-how and trade secrets may be protected to some degree by (i) unfair competition or similar laws, (ii) employment contracts, and (iii) economic and technological barriers to competition. Know-how and trade secrets are intangibles within the meaning of Section A. 1 ...

It should be noted, however, that in some situations, the transfer or secondment of one or more employees may, depending on the facts and circumstances, result in the transfer of valuable know-how or other intangibles from one associated enterprise to another. For example, an employee of Company A seconded to Company B may have knowledge of a secret formula owned by Company A and may make that secret formula available to Company B for use in its commercial operations. Similarly, employees of Company A seconded to Company B to assist with a factory start-up may make Company A manufacturing know-how available to Company B for use in its commercial operations. Where such a provision of know-how or other intangibles results from the transfer or secondment of employees, it should be separately analysed under the provisions of Chapter VI and an appropriate price should be paid for the right to use the intangibles ...

Differences in the specific characteristics of property or services often account, at least in part, for differences in their value in the open market. Therefore, comparisons of these features may be useful in delineating the transaction and in determining the comparability of controlled and uncontrolled transactions. Characteristics that may be important to consider include the following: in the case of transfers of tangible property, the physical features of the property, its quality and reliability, and the availability and volume of supply; in the case of the provision of services, the nature and extent of the services; and in the case of intangible property, the form of transaction (e.g. licensing or sale), the type of property (e.g. patent, trademark, or know-how), the duration and degree of protection, and the anticipated benefits from the use of the property. For further discussion of some of the specific features of intangibles that may prove important in a comparability analysis involving transfers of intangibles or rights in intangibles, see Section D.2.1 of Chapter VI ...

Where no written terms exist, the actual transaction would need to be deduced from the evidence of actual conduct provided by identifying the economically relevant characteristics of the transaction. In some circumstances the actual outcome of commercial or financial relations may not have been identified as a transaction by the MNE, but nevertheless may result in a transfer of material value, the terms of which would need to be deduced from the conduct of the parties. For example, technical assistance may have been granted, synergies may have been created through deliberate concerted action (as discussed in Section D.8), or know-how may have been provided through seconded employees or otherwise. These relations may not have been recognised by the MNE, may not be reflected in the pricing of other connected transactions, may not have been formalised in written contracts, and may not appear as entries in the accounting systems. Where the transaction has not been formalised, all aspects would need to be deduced from available evidence of the conduct of the parties, including what functions are actually performed, what assets are actually used, and what risks are actually assumed by each of the parties ...

The IRS argued that Medtronic Inc failed to accurately account for the value of trade secrets and other intangibles owned by Medtronic Inc and used by Medtronic’s Puerto Rico manufacturing subsidiary in 2005 and 2006 when determening the royalty payments from the subsidiary. In 2016 the United States Tax Court found in favor of Medtronic, sustaining the use of the CUT method to analyze royalty payments. The Court also found that adjustments to the CUT were required. These included additional adjustments not initially applied by Medtronic Inc for know-how, profit potential and scope of product. The decision from the United States Tax Court has been appealed by the IRS in 2017 ...

In this case the Italien tax administration concluded that transactions between an Italien company an a German sister company had been priced lower than the “normal value” of similar transactions. Judgement of the Supreme Court The Supreme Court ruled partly in favor of the GE Transportation Systems S.p.A. and partly in favour of the tax authorities. The case was remanded to the lower court for further considerations. In relation to intercompany transactions the court found that GE Transportation Systems S.p.A. had only limited risk and that the German company owned the intellectual property. In relation to transactions with independent companies, GE Transportation Systems S.p.A. assumed the risks of the transaction and had the rights to manufacture and sell the products. These differences justified different price and led to the transactions not being comparable. The Court concluded that the limited risk – contract manufacturing – transactions with the German parent could not be compared with the full-fledged manufacturing activities. In regards to the limited risk transactions, the court also stated that the Italien contract manufacturer is in a weaker bargaining position compared to a full-fledged manufacturer that owns the relevant intangibles. Excerpt “Since the case cannot be decided on the merits, it must be referred to the Regional Administrative Court of Tuscany in another composition, which will re-examine the accepted grounds and, therefore, in accordance with the above-mentioned principles, will decide on the merits and settle the costs of the present proceedings.” Click here for English translation Click here for other translation ...

A AB purchased manufacturing services of its subsidiary B AS, which had its headquarters in Estonia. The internal pricing of services had since July 2004 been under the net margin method. The price data beside B AS’s realized expenses also included half of the so-called location-savings. On taxation of A AB approved as deductible expenditure only B AS’s actual expenses plus a calculated profit margin. The Supreme Administrative Court stated that A AB in Finland did not have such manufacturing as B AS was conducted in Estonia during the tax year. B AS’s production of the products differed substantially from A ABs former manufacturing in Finland, where A AB had manufactured the products by hand. Most of the new working methods and stages developed in Estonia had never been used in Finland. Hence the situation was not comparable to the location savings by moving the activities as described in the OECD report, and the pricing of would not be judged on the basis of the principles according to the OECD report in such situations. The base price was not included, the calculated benefits for A AB of the subsidiary’s manufacturing costs being lower than the estimated costs that the company would have had if it had manufactured products in Finland. The market-based internal price for contract manufacturing could be determined by using the net margin method so that it was based on comparable companies’ profit margins. In assessing which companies were comparable, in addition to other factors would be taken into account that B AS had its business in a country where costs were low and therefore had the opportunity for a larger margin than companies in countries where costs were higher. In determining the profit margin had to take account of A ABs and B AS’s supposed negotiating power in the event that they had been independent company. B AS was not the holders of intellectual property rights or particularly high-class know-how or technology that would have formed the basis for a high profit margin. Within the company, however, were developed manufacturing processes so that it was suitable for large scale production, and B AS had acquired significant expertise in the production. It was therefore reasonable to expect a higher profit margin for the B AS than comparable companies in the A AB’s documentation. Click here for translation ...

This case concerns the sale of extended warranties to third-party customers of Dixons, a large retail chain in the UK selling white goods and home electrical products. The DSG group captive (re)insurer in the Isle of Man (DISL) insured these extended warranties for DSG’s UK customers. Until 1997 this was structured via a third-party insurer (Cornhill) that reinsured 95% on to DISL. From 1997 onwards the warranties were offered as service contracts that were 100% insured by DISL. The dispute concerned the level of sales commissions and profit commissions received by DSG. The Tax Tribunal rejected the taxpayer’s contentions that the transfer pricing legislation did not apply to the particular series of transactions (under ICTA 88 Section 770 and Schedule 28AA) – essentially the phrases ‘facility’ (Section 770) and ‘provision’ (Schedule 28AA) were interpreted broadly so that there was something to price between DSG and DISL, despite the insertion of a third party and the absence of a recognised transaction between DSG and the other parties involved. The Tax Tribunal also rejected potentially comparable contracts that the taxpayer had used to benchmark sales commissions on similar contracts on the basis that the commission rate depended on profitability, which itself depended on the different level of loss ratios expected in relation to the products covered. A much more robust looking comparable provider of extended warranty cover offered as a benchmark for the market return on capital of DISL was also rejected owing to its differing relative bargaining power compared to DISL. This third-party re-insurer was considered to be a powerful brand providing extended ‘off-the-shelf’ warranty cover through disparate distributors – the tribunal noted that DSG had a strong brand, powerful point of sales advantage through access to customers in their shops and could easily have sourced the basic insurance provided by DISL elsewhere. The overall finding of the Tax Tribunal was that, to the extent that ‘super profits’ were available, these should be distributed between the parties according to the ability of each party to protect itself from normal competitive forces and each party’s bargaining power. The Tax Tribunal noted in this context that DISL was entirely reliant on DSG for its business. According to the facts of this case, the super profits were deemed to arise because of DSG’s point-of-sale advantage as the largest retailer of domestic electrical goods in the UK and also DSG’s past claims data. DISL was considered to possess only routine actuarial know-how and adequate capital, both of which DSG could find for itself. As a result, the tribunal thought that a profit-split approach was the most appropriate, whereby DISL was entitled to a market return on capital, with residual profit over and above this amount being returned to DSG via a profit commission. This decision offers valuable insights into consideration of the level of comparability demanded to support the use of comparable uncontrolled prices; Selection of the appropriate ‘tested party’ in seeking to benchmark a transaction; The importance of bargaining power; Approval of profit split as the most appropriate methodology; That a captive insurer that is underwriting ‘simple’ risks, particularly where the loss ratios are relatively stable and predictable, and that does not possess significant intangibles or other negotiating power, should not expect to earn more than a market return to its economic capital ...

In this case a pharmaceutical company in the US, Eli Lilly & Co, transferred valuable pharmaceutical patents and manufacturing know-how to its subsidiary in Puerto Rico. The IRS argued that the transaction should be disregarded (substance over form) and claimed that all of the income from the transferred intangibles should be allocated to the U.S. parent. The Judgment from the Tax Court: “Respondent’s argument, that petitioner, having originally developed the patents and know-how, is forever required to report the income from those intangibles, is without merit. Respondent ignores the fact that petitioner, as developer and owner of the intangible property, was free to and did transfer the property to the Puerto Ricanaffiliate in 1966.” The Court of Appeals altered the judgement from the Tax Court. According to the Court of Appeals, the parent company had received an arm’s length consideration for the transfer of intangibles in the form of stock in the subsidiary. Hence, the Court disallowed the allocation of the intangibles’ income to the U.S. parent ...