On 1 February 2010, E.K. and its subsidiary, E. S.A, concluded an agreement on the transfer of E.K.’s trade marks to E. S.A. Following the transfer (on the same day), E.K. concluded with E. S.A. an agreement to grant a licence for the use of the marks in return for payment to the licensor (E. S.A.) of a monthly remuneration. In 2011, E.K. recognised as a deductible expense the royalties paid to E. S.A. According to the tax authorities this resulted in E.K. understating its corporate income tax liability for 2011. According to the tax authorities, E. S.A. did not participate in any way in the creation of revenue, with the result that the profits generated by E.K. were ‘passed on’ in the form of royalties to a related company – E. S.A. The remuneration payable to the legal owner of the trademarks did not take into account the very limited functions performed by that entity in creating the value of the trademarks. The only function performed by E. S.A. in 2011 was to manage the legal protection of the trade marks, for which it would be entitled to a limited remuneration appropriate to its function. After receiving the resulting assessment of additional taxable income, a complaint was then filed by E.K. with the Director of the Tax Chamber which was later dismissed. An appeal was then filed by E.K. with the Administrative Court. Judgement of the Administrative Court. The Administrative Court set aside the Decision of the Tax Chamber and referred the case back to the Tax Chamber. Excerpts “… In the Court’s view, the faulty application of Article 11(1) and (4) of the u.p.d.o.p. affected the manner in which the applicant’s income was estimated and the estimation method adopted by the authorities, based on the erroneous assumption that the transaction analysed by the authorities consisted in the provision of trade mark administration services on behalf of the economic owner of those trade marks. In making that assumption, the authorities applied the net transaction margin method in order to determine the market level of the remuneration payable to the company for its trade mark administration functions. Meanwhile, the applicant provided the tax authority with the data that formed the basis for the calculation of the royalties, as well as the licence agreement. In view of the repetitive nature of such transactions on the market, the applicant used the comparable uncontrolled price method as the correct approach. The Court notes that the estimation of income by the methods indicated in Article 11(2) of the u.p.d.o.p. (comparable uncontrolled price method, reasonable margin method, selling price method) should be considered first, and only when it is not possible to apply these methods, the methods indicated in Article 11(3) of that Act (net transaction margin method, profit sharing method) will be applied. Furthermore, the applicant reasonably pointed out that in the comparability analysis the authorities should have taken into account the fact that intangible assets of significant value (trademarks) were involved in the examined transaction, being the only significant asset analysed by the parties to the examined transaction. As a result, the authorities incorrectly conducted the comparability analysis of the transaction involving the licence for the use of trademarks granted to the applicant by the limited partnership, which prejudges the validity of the allegation of a breach of Article 11(1)-(3) of the u.p.d.o.p. in conjunction with § 3, § 7, § 8, § 10 and § 11 of the MF Regulation. In the opinion of the Court, the basis for the decision in this case was not the provision of Article 11c(4) of the u.p.d.o.p. in the 2019 wording, hence the allegation of violation of this provision contained in the complaint does not merit consideration. In the opinion of the Court, the evidence gathered in the case allowed it to be resolved and, in this respect, the authorities did not fail to comply with Article 122 in conjunction with Article 187 § 1 of the Tax Ordinance. On the other hand, the allegation of a breach of Article 191 of the Tax Ordinance, consisting in the authorities’ faulty assessment of the market nature of the examined legal transactions, is justified. In the context of this allegation, however, it should be stipulated that the reclassification of a legal action by the authorities is not so much the result of a defective assessment of the evidence gathered, but results from the interpretation and manner of application of substantive law provisions adopted by the authorities (Article 11(1) and (4) of the u.p.d.o.p.). As aptly pointed out in the case law, in such a situation the state of facts was not so much established, but adopted by the tax authority. This is because the tax authority determines the factual state not on the basis of established circumstances, but reconstructs it, taking as a directional guideline the taxpayer’s intention to achieve the intended fiscal goal (unauthorised tax benefit). Thus, the state of facts adopted by the tax authorities does not so much result from the evidence gathered in the case, but from the assumption that if the taxpayer was guided only by economic and economic rationale and not by the intention to achieve an unauthorised tax benefit, it is precisely in the way the tax authority wants him to arrange his relations (judgment of the NSA of 8 May 2019, II FSK 2711/18). On the other hand, the consequence of the violation of substantive law is the legitimacy of the allegations of violation of Articles 120 and 121 § 1 of the Tax Ordinance by the authorities. On the other hand, due to the voluminous nature of the complaint, the Court referred to the allegations contained therein and their justification to the extent necessary to conduct a review of the appealed decisions (judgment of the Supreme Administrative Court of 26 May 2017, I FSK 1660/15). When re-examining the case, the authority will take into account the legal assessment presented above as to the interpretation and application, in the ...

K.P. is active in retail sale of computers, peripheral equipment and software. In December 2013 it had transfered valuable trademarks to its subsidiary and in the years following the transfer incurred costs in form of licence fees for using the trademarks. According to the tax authorities the arrangement was commercially irrationel and had therfore been recharacterised. Not satisfied with the assessment an appeal was filed. Judgement of the Provincial Administrative Court. The Court decided in favor of K.P.  According to the Court recharacterization of controlled transactions was not possible under the Polish arm’s length provisions in force until the end of 2018. Click here for English translation Click here for other translation ...

K. S.A. had made an in-kind contribution to a subsidiary (a partnership) in the form of previously created or acquired and depreciated trademark protection rights for individual beer brands. The partnership in return granted K. S.A. a licence to use these trademarks (K. S.A. was the only user of the trademarks). The partnership made depreciations on these intangible assets, which – due to the lack of legal personality of the partnership – were recognised as tax deductible costs directly by K. S.A. According to the tax authorities the role of the partnership was limited to the administration of trademark rights, it was not capable of exercising any rights and obligations arising from the licence agreements. Therefore the prerequisites listed in Article 11(1) of the u.p.d.o.p. were met, allowing K. S.A.’s income to be determined without regard to the conditions arising from those agreements. The assessment issued by the tax authorities was later set aside by the Provincial Administrative Court. An appeal and cross appeal was then filed with the Supreme Administrative Court. Judgement of the Supreme Administrative Court. The Supreme Administrative Court upheld the decisions of the Provincial Administrative Court and dismissed both appeals as neither of them had justified grounds. The Provincial Administrative Court had correctly deduced that Article 11(1) of the u.p.d.o.p. authorises only adjustment of the amount of licence fees, but not the nature of the controlled transactions by recognising that instead of a licence agreement for the use of the rights to trademarks, an agreement was concluded for the provision of services for the administration of these trademarks. Excerpts “The tax authorities, in finding that the applicant had not in fact made an in-kind contribution of trademark rights to the limited partnership, but had merely entrusted that partnership with the duty to administer the marks, referred to Article 11(1) of the u.p.d.o.p. (as expressed in the 2011 consolidated text. ), by virtue of which the tax authorities could determine the taxpayer’s income and the tax due without taking into account the conditions established or imposed as a result of the links between the contracting entities, with the income to be determined by way of an estimate, using the methods described in paragraphs 2 and 3 of Article 11 u.p.d.o.p. However, these are not provisions creating abuse of rights or anti-avoidance clauses, as they only allow for a different determination of transaction (transfer) prices. The notion of ‘transaction price’ is legally defined in Article 3(10) of the I.P.C., which, in the wording relevant to the tax period examined in the case, stipulated that it is the price of the subject of a transaction concluded between related parties. Thus, the essence of the legal institution regulated in Article 11 of the u.p.d.o.p. is not the omission of the legal effects of legal transactions performed by the taxpayer or a different legal definition of those transactions, but the determination of their economic effect expressed in the transaction price, with the omission of the impact of institutional links between counterparties”  “For the same reasons, the parallel plea alleging infringement of Articles 191, 120 and 121(1) of the P.C.P. by annulling the tax authority’s legal rulings on the grounds of a breach of the aforementioned rules of evidence in conjunction with Articles 11(1) and 11(4) of the u.p.d.o.p. and holding that the tax authority did not correct the amount of royalties and the marketability of the transaction, but reclassified the legal relationship on the basis of which the entity incurred the expenditure, is also inappropriate. In fact, the assessment of the Provincial Administrative Court that such a construction of the tax authority’s decision corresponds to the hypothesis of the 2019 standard of Article 11c(4) of the u.p.d.o.p. is correct, but there was no adequate legal basis for applying it to 2012/2013 and based on Article 11(1) and (4) of the u.p.d.o.p. in its then wording. Failure to take into account a transaction undertaken by related parties deemed economically irrational by the tax authority violated, in these circumstances, the provisions constituting the cassation grounds of the plea, as the Provincial Administrative Court reasonably found.” “Contrary to the assumption highlighted in the grounds of the applicant’s cassation appeal, in the individual interpretations issued at its request, the applicant did not obtain confirmation of the legality of the entire optimisation construction, but only of the individual legal and factual actions constituting this construction, presented in isolation from the entire – at that time – planned future event. Such a fragmentation of the description of the future event does not comply with the obligation under Article 14b § 3 of the Code of Civil Procedure to provide an exhaustive account of the actual state of affairs or future event, and therefore – as a consequence – the applicant cannot rely on the legal protection provided under Article 14k § 1 or Article 14m § 1, § 2 (1) and § 3 of the Code of Civil Procedure.” Click here for English translation Click here for other translation ...

“Cosmetics sp. z o.o.” is a Polish distributor of cosmetics. It purchases the goods from a related foreign company. The contract concluded between “Cosmetics sp. z o.o.” and the foreign company contained a provision according to which 3% of the price of the goods purchased was to be paid (in the form of royalties) for the right to use the trademarks for the promotion, advertising and sale of the products. However, the invoices issued by the foreign company for the sale of the goods in question did not show the amount paid for the right to use the trademarks as a separate item. The invoices simply stated the price of the goods purchased. “Cosmetics sp. z o.o. requested an “individual interpretation” from the tax authorities as to whether the royalty payments included in the price of the goods were subject to withholding tax in Poland. According to Cosmetics sp. z o.o., the answer should be no, as the “royalty” element was an ancillary part of the main transaction – the purchase of the goods. The tax authority disagreed. According to the authorities, the payment of royalties for the right to use trademarks was not an ancillary element of the main transaction and its importance was not insignificant. Under the CIT Act and the relevant double tax treaty (DTT), the payment of royalties would be subject to withholding tax. Dismissing an appeal filed by Cosmetics sp. z o.o., the Administrative Court held that there were two separate transactions – one for the acquisition of goods and one for the acquisition of the right to use the trademark. Therefore, the tax authority’s interpretation was correct. Judgement of the Supreme Administrative Court. The Supreme Administrative Court upheld the decision of the Administrative Court and dismissed the appeal of “Cosmetics sp. z o.o.”. According to the court, it was clear from the agreement that the fee consisted of two transactions, one of which was a licence fee (royalty). Therefore, the claim that the tax authority was trying to separate this payment from the payment for the goods was not justified. Excerpt “The issue in dispute in the case is the taxation withholding tax on the amount paid by the Appellant to a foreign entity on account of the right to use trademarks, included in the agreement on the purchase of goods from that entity. Instead, the resolution of the above problem depends on whether the fee for the use of trademarks remains an ancillary element of the main consideration – the purchase of goods – and should then share the tax fate of that consideration, or whether it constitutes a separate element of the contract, which is subject to a separate method of taxation. The author of the cassation appeal argued that the elements comprising the subject matter of the contract and making up the price paid should be qualified together, as a single consideration. In the opinion of the Company’s attorney, a transaction transferring the right to use trademarks should not be treated as generating a licence fee, since the right is related only to the possibility of further resale of goods, and thus “the scope of the licence granted to the Applicant was significantly limited”. In support of the above argumentation, the attorney referred to the opinion of a representative of international tax doctrine, Professor Michelle Markham. Referring to the excerpt from the publication quoted on p. 6 of the cassation complaint concerning the issue analysed in the case, the panel finds that it is not relevant to the case at hand. Firstly, it is clear from the full context of the quoted sentence that these are considerations on the basis of US tax law regulations. Secondly, the quoted passage refers specifically to such contracts, the subject of which are at least two services (including one intangible service) covered by a single price, where it could be unreasonable to try to separate them for tax purposes. However, we do not face such a situation in the case, as the Company’s agreement with the Establishment clearly separates the remuneration for the right to use trademarks in the amount of 3% of the value of the purchased goods – even if the above amount is not specified on the invoices. Above all, however, the Supreme Administrative Court draws attention to the introduction in the agreement of a provision concerning the granting of a paid licence for the use of trademarks within the scope presented in the application, which is of fundamental importance in the case under consideration. Pursuant to Article 155 of the Act of 30 June 2000. – Industrial Property Law (Journal of Laws of 2019, item 2309; hereinafter: ‘p.w.p.’), the right of protection for a trademark suffers a significant limitation as a result of the exhaustion of the right to market the goods. “Pursuant to Article 155(1) p.w.p., the right of protection for a trademark does not extend to acts concerning goods with the trademark, consisting in particular in offering them for sale or further marketing of goods bearing the trademark, if the goods have been placed on the market in the territory of Poland by the authorised entity or with its consent. (…) By the act of placing the marked goods on the market, by the rightsholder or a third party acting with his consent, the rightsholder’s competence to use the trade mark in such a manner as to further distribute the goods is deemed to be exhausted. Therefore, the purchaser – as the owner of the goods – may continue to resell the goods and, in doing so, to advertise using the holder’s mark. Exhaustion, however, covers only one exclusive competence of the right holder, which is the right to put the marked goods on the market, and concerns only normal distribution processes of the marked goods, understood as a whole, which do not threaten the loss of connection with the goods.” (U. PromiÅ„ska, Industrial Property Law, 5th edition, LexisNexis 2011, p. 340). Transferring the above considerations to the grounds ...

(i) Facts. The year 1 facts are the same as in Example 3. In year 2, FP and USSub enter into a separate services agreement that obligates FP to perform incremental marketing activities, not specified in the year 1 license, by advertising AA trademarked athletic gear in selected international sporting events, such as the Olympics and the soccer World Cup. FP’s corporate advertising department develops and coordinates these special promotions. The separate services agreement obligates USSub to pay an amount to FP for the benefit to USSub that may reasonably be anticipated as the result of FP’s incremental activities. The separate services agreement is not a qualified cost sharing arrangement under § 1.482-7T. FP begins to perform the incremental activities in year 2 pursuant to the separate services agreement. (ii) Whether an allocation is warranted with respect to the incremental marketing activities performed by FP under the separate services agreement would be evaluated under § 1.482-9. Under the circumstances, it is reasonable to anticipate that FP’s activities would increase the value of USSub’s license as well as the value of FP’s trademark. Accordingly, the incremental activities by FP may constitute in part a controlled services transaction for which USSub must compensate FP. The analysis of whether an allocation is warranted would include a comparison of the compensation provided for the services with the results obtained under a method pursuant to § 1.482-9, selected and applied in accordance with the best method rule of § 1.482-1(c). (iii) Whether an allocation is appropriate with respect to the royalty under the license agreement would be evaluated under §§ 1.482-1 through 1.482-3, this section, and §§ 1.482-5 and 1.482-6. The comparability analysis would include consideration of all relevant factors, such as the term and geographical exclusivity of USSub’s license, the nature of the intangible property subject to the license, and the marketing activities required to be undertaken by both FP and USSub pursuant to the license. This comparability analysis would take into account that the compensation for the incremental activities performed by FP was provided for in the separate services agreement, rather than embedded in the royalty paid for use of the AA trademark. For illustrations of application of the best method rule, see § 1.482-8, Example 10, Example 11, and Example 12 ...

(i) Facts. The year 1 facts are the same as in Example 3. In year 2, FP and USSub enter into a separate services agreement that obligates USSub to perform certain incremental marketing activities to promote AA trademark athletic gear in the United States, above and beyond the activities specified in the license agreement executed in year 1. In year 2, USSub begins to perform these incremental activities, pursuant to the separate services agreement with FP. (ii) Whether an allocation is warranted with respect to USSub’s incremental marketing activities covered by the separate services agreement would be evaluated under §§ 1.482-1 and 1.482-9, including a comparison of the compensation provided for the services with the results obtained under a method pursuant to § 1.482-9, selected and applied in accordance with the best method rule of § 1.482-1(c). (iii) Whether an allocation is warranted with respect to the royalty under the license agreement is determined under § 1.482-1, and this section through § 1.482-6. The comparability analysis would include consideration of all relevant factors, such as the term and geographical exclusivity of the license, the nature of the intangible property subject to the license, and the nature of the marketing activities required to be undertaken pursuant to the license. The comparability analysis would take into account that the compensation for the incremental activities by USSub is provided for in the separate services agreement, rather than embedded in the royalty paid for use of the AA trademark. For illustrations of application of the best method rule, see § 1.482-8 Examples 10, 11, and 12 ...

(i) Facts. The year 1 facts are the same as in Example 3, with the following exceptions. In year 2, USSub undertakes certain incremental marketing activities in addition to those required by the contractual terms of the license for the AA trademark executed in year 1. The parties do not execute a separate agreement with respect to these incremental marketing activities performed by USSub. The license agreement executed in year 1 is of sufficient duration that it is reasonable to anticipate that USSub will obtain the benefit of its incremental activities, in the form of increased sales or revenues of trademarked products in the U.S. market. (ii) To the extent that it was reasonable to anticipate that USSub’s incremental marketing activities would increase the value only of USSub’s intangible property (that is, USSub’s license to use the AA trademark for a specified term), and not the value of the AA trademark owned by FP, USSub’s incremental activities do not constitute a contribution for which an allocation is warranted under paragraph (f)(4)(i) of this section ...

(i) Facts. FP, a foreign producer of athletic gear, is the registered holder of the AA trademark in the United States and in other countries. In year 1, FP licenses to a newly organized U.S. subsidiary, USSub, the exclusive rights to use certain manufacturing and marketing intangible property to manufacture and market athletic gear in the United States under the AA trademark. The license agreement obligates USSub to pay a royalty based on sales of trademarked merchandise. The license agreement also obligates FP and USSub to perform without separate compensation specified types and levels of marketing activities. In year 1, USSub manufactures and sells athletic gear under the AA trademark in the United States. (ii) The consideration for FP’s and USSub’s respective marketing activities is embedded in the contractual terms of the license for the AA trademark. Accordingly, pursuant to paragraph (f)(4)(i) of this section, ordinarily no separate allocation would be appropriate with respect to the embedded contributions in year 1. See § 1.482-9(m)(4). (iii) Whether an allocation is warranted with respect to the royalty under the license agreement would be analyzed under § 1.482-1, and this section through § 1.482-6. The comparability analysis would include consideration of all relevant factors, such as the term and geographical exclusivity of the license, the nature of the intangible property subject to the license, and the nature of the marketing activities required to be undertaken pursuant to the license. Pursuant to paragraph (f)(4)(i) of this section, the analysis would also take into account the fact that the compensation for the marketing services is embedded in the royalty paid for use of the AA trademark, rather than provided for in a separate services agreement. For illustrations of application of the best method rule, see § 1.482-8 Examples 10, 11, and 12 ...

(i) FP, a foreign corporation, licenses to USS, its U.S. subsidiary, a new air-filtering process that permits manufacturing plants to meet new environmental standards. The license runs for a 10-year period, and the profit derived from the new process is projected to be $15 million per year, for an aggregate profit of $150 million. (ii) The royalty rate for the license is based on a comparable uncontrolled transaction involving a comparable intangible under comparable circumstances. The requirements of paragraphs (f)(2)(ii)(B)(1) through (5) of this section have been met. Specifically, FP and USS have entered into a written agreement that provides for a royalty in each year of the license, the royalty rate is considered arm’s length for the first taxable year in which a substantial royalty was required to be paid, the license limited the use of the process to a specified field, consistent with industry practice, and there are no substantial changes in the functions performed by USS after the license was entered into. (iii) In examining Year 4 of the license, the district director determines that the aggregate actual profits earned by USS through Year 4 are $30 million, less than 80% of the projected profits of $60 million. However, USS establishes to the satisfaction of the district director that the aggregate actual profits from the process are less than 80% of the projected profits in Year 3 because an earthquake severely damaged USS’s manufacturing plant. Because the difference between the projected profits and actual profits was due to an extraordinary event that was beyond the control of USS, and could not reasonably have been anticipated at the time the license was entered into, the requirement under § 1.482-4(f)(2)(ii)(D) has been met, and no adjustment under this section is made ...

(i) The facts are the same as in Example 1, except that Eurodrug’s actual profits earned were much higher than the projected profits, as follows: Profit projections Actual profits Year 1 200 250 Year 2 250 500 Year 3 500 800 Year 4 350 700 Year 5 100 600 Total 1400 2850 (ii) In examining USdrug’s tax return for Year 5, the district director considers the actual profits realized by Eurodrug in Year 5, and all past years. Accordingly, although Years 1 through 4 may be closed under the statute of limitations, for purposes of determining whether an adjustment should be made with respect to the royalty rate in Year 5 with respect to Nosplit, the district director aggregates the actual profits from those years with the profits of Year 5. However, the district director will make an adjustment, if any, only with respect to Year 5 ...

(i) USdrug, a U.S. pharmaceutical company, has developed a new drug, Nosplit, that is useful in treating migraine headaches and produces no significant side effects. A number of other drugs for treating migraine headaches are already on the market, but Nosplit can be expected rapidly to dominate the worldwide market for such treatments and to command a premium price since all other treatments produce side effects. Thus, USdrug projects that extraordinary profits will be derived from Nosplit in the U.S. and European markets. (ii) USdrug licenses its newly established European subsidiary, Eurodrug, the rights to produce and market Nosplit for the European market for 5 years. In setting the royalty rate for this license, USdrug makes projections of the annual sales revenue and the annual profits to be derived from the exploitation of Nosplit by Eurodrug. Based on the projections, a royalty rate of 3.9% is established for the term of the license. (iii) In Year 1, USdrug evaluates the royalty rate it received from Eurodrug. Given the high profit potential of Nosplit, USdrug is unable to locate any uncontrolled transactions dealing with licenses of comparable intangible property. USdrug therefore determines that the comparable uncontrolled transaction method will not provide a reliable measure of an arm’s length royalty. However, applying the comparable profits method to Eurodrug, USdrug determines that a royalty rate of 3.9% will result in Eurodrug earning an arm’s length return for its manufacturing and marketing functions. (iv) In Year 5, the U.S. income tax return for USdrug is examined, and the district director must determine whether the royalty rate between USdrug and Eurodrug is commensurate with the income attributable to Nosplit. In making this determination, the district director considers whether any of the exceptions in § 1.482-4(f)(2)(ii) are applicable. In particular, the district director compares the profit projections attributable to Nosplit made by USdrug against the actual profits realized by Eurodrug. The projected and actual profits are as follows: Profit projections Actual profits Year 1 200 250 Year 2 250 300 Year 3 500 600 Year 4 350 200 Year 5 100 100 Total 1400 1450 (v) The total profits earned through Year 5 were not less than 80% nor more than 120% of the profits that were projected when the license was entered into. If the district director determines that the other requirements of § 1.482-4(f)(2)(ii)(C) were met, no adjustment will be made to the royalty rate between USdrug and Eurodrug for the license of Nosplit ...

(i) USbond is a U.S. company that licenses to its foreign subsidiary, Eurobond, a proprietary process that permits the manufacture of Longbond, a long-lasting industrial adhesive, at a substantially lower cost than otherwise would be possible. Using the proprietary process, Eurobond manufactures Longbond and sells it to related and unrelated parties for the market price of $550 per ton. Under the terms of the license agreement, Eurobond pays USbond a royalty of $100 per ton of Longbond sold. USbond also manufactures and markets Longbond in the United States. (ii) In evaluating whether the consideration paid for the transfer of the proprietary process to Eurobond was arm’s length, the district director may consider, subject to the best method rule of § 1.482-1(c), USbond’s alternative of producing and selling Longbond itself. Reasonably reliable estimates indicate that if USbond directly supplied Longbond to the European market, a selling price of $300 per ton would cover its costs and provide a reasonable profit for its functions, risks and investment of capital associated with the production of Longbond for the European market. Given that the market price of Longbond was $550 per ton, by licensing the proprietary process to Eurobond, USbond forgoes $250 per ton of profit over the profit that would be necessary to compensate it for the functions, risks and investment involved in supplying Longbond to the European market itself. Based on these facts, the district director concludes that a royalty of $100 for the proprietary process is not arm’s length ...

(i) FP, is a foreign company that designs, manufactures and sells industrial equipment. FP has developed proprietary components that are incorporated in its products. These components are important in the operation of FP’s equipment and some of them have distinctive features, but other companies produce similar components and none of these components by itself accounts for a substantial part of the value of FP’s products. (ii) FP licenses its U.S. subsidiary, USSub, exclusive North American rights to use the patented technology for producing component X, a heat exchanger used for cooling operating mechanisms in industrial equipment. Component X incorporates proven technology that makes it somewhat more efficient than the heat exchangers commonly used in industrial equipment. FP also agrees to provide technical support to help adapt component X to USSub’s products and to assist with initial production. Under the terms of the license agreement USSub pays FP a royalty equal to 3 percent of sales of USSub equipment incorporating component X. (iii) FP does not license unrelated parties to use component X, but many similar components are transferred between uncontrolled taxpayers. Consequently, the district director decides to apply the comparable uncontrolled transaction method to evaluate whether the 3 percent royalty for component X is an arm’s length royalty. (iv) The district director uses a database of company documents filed with the Securities and Exchange Commission (SEC) to identify potentially comparable license agreements between uncontrolled taxpayers that are on file with the SEC. The district director identifies 40 license agreements that were entered into in the same year as the controlled transfer or in the prior or following year, and that relate to transfers of technology associated with industrial equipment that has similar applications to USSub’s products. Further review of these uncontrolled agreements indicates that 25 of them involved components that have a similar level of technical sophistication as component X and could be expected to play a similar role in contributing to the total value of the final product. (v) The district director makes a detailed review of the terms of each of the 25 uncontrolled agreements and finds that 15 of them are similar to the controlled agreement in that they all involve – (A) The transfer of exclusive rights for the North American market; (B) Products for which the market could be expected to be of a similar size to the market for the products into which USSub incorporates component X; (C) The transfer of patented technology; (D) Continuing technical support; (E) Access to technical improvements; (F) Technology of a similar age; and (G) A similar duration of the agreement. (vi) Based on these factors and the fact that none of the components to which these license agreements relate accounts for a substantial part of the value of the final products, the district director concludes that these fifteen intangibles have similar profit potential to the component X technology. (vii) The 15 uncontrolled comparables produce the following royalty rates: License Royalty rate (percent) 1 1.0 2 1.0 3 1.25 4 1.25 5 1.5 6 1.5 7 1.75 8 2.0 9 2.0 10 2.0 11 2.25 12 2.5 13 2.5 14 2.75 15 3.0 (viii) Although the uncontrolled comparables are clearly similar to the controlled transaction, it is likely that unidentified material differences exist between the uncontrolled comparables and the controlled transaction. Therefore, an appropriate statistical technique must be used to establish the arm’s length range. In this case the district director uses the interquartile range to determine the arm’s length range. Therefore, the arm’s length range covers royalty rates from 1.25 to 2.5 percent, and an adjustment is warranted to the 3 percent royalty charged in the controlled transfer. The district director determines that the appropriate adjustment corresponds to a reduction in the royalty rate to 2.0 percent, which is the median of the uncontrolled comparables ...

Allocating arm’s length compensation determined under an aggregate analysis – (i) P provides services to S1, which is incorporated in Country A. In connection with those services, P licenses intellectual property to S2, which is incorporated in Country B. S2 sublicenses the intellectual property to S1. (ii) Under paragraph (f)(2)(i)(B) of this section, if an aggregate analysis of the service and license transactions provides the most reliable measure of an arm’s length result, then an aggregate analysis must be performed. Under paragraph (f)(2)(i)(D) of this section, if an allocation of the value that results from such an aggregate analysis is necessary, for example, for purposes of sourcing the services income that P receives from S1 or determining deductible expenses incurred by S1, then the value determined under the aggregate analysis must be allocated using the method that provides the most reliable measure of the services income and deductible expenses ...

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 ...

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 ...

The U.S. Tax Court held in favor of the Commissioner of Internal Revenue, stating that neither Internal Revenue Code §482 nor the regulations thereunder require the Respondent to always determine the separate taxable income of each controlled taxpayer in a consolidated group contemporaneously with the making of the resulting adjustments. The Tax Court further held that §482 and the regulations thereunder allow the Respondent to aggregate one or more related transactions instead of making specific adjustments with respect to each type of transaction ...

B SA Limited was incorporated in South Africa 9 May 1924. C plc is the controlling shareholder of the company. On 24 October 1979 B SA Limited amended paragraph 1 of its memorandum of association by adding the following to it: The corporate name “B SA Limited” is adopted and used by permission of (C) Limited. On withdrawal of that permission B SA Limited will cease to use such name and will immediately change its corporate name and trading name so that neither includes the mark (B) or any trade mark, trade name, name or other mark of ownership belonging to (C) Company Limited, or any other trade mark, trade name, name or other mark of ownership likely to be confused therewith. During 1996 C plc decided that users of its licensed marks and the licensed marketing indicia should be required to pay a royalty. To this end it commissioned an independent company to determine the value of its licensed marks and licensed marketing indicia. This study identified the role played by the brand in the various business segments in which B SA Limited was involved. Based on this information calculation was made in respect of the profit actually generated by each segment which could be attributable to the licensed marks. Consequent upon the above B SA Limited made the following royalty payments during the relevant years of assessment: 1997 1998 1999 : : : R 40.190.000; R 45.150 000; and R 42.519.000. B SA Limited then claimed a deduction of the above amounts in calculating its taxable income in its Income Tax Returns for the years 1997, 1998 and 1999. The Revenue Service issued an assessment disallowing the deduction of the royalties in calculating the taxable income. B SA Limited objected and appealed against the disallowance of the deduction. The Court ruled as follows: The consideration paid in terms of the Trademark Licence Agreement enabled the Respondent to trade in its economic sphere with a valuable brand. The payments made were made with the purpose of maintaining and growing market share. The agreement was crucial as it is the foundation and pre-requisite of any entitlement to conduct the Appellant’s business in the manner and form that it conducts its business. The payments in issue are thus in substance a purchase price for a business which gave a substantial market share in the defined area, similar to a franchise agreement. The payments made to obtain these rights must therefore by its very nature be a capital expense. In the statement of agreed facts it is recorded that the price of (the products in which Appellant trades) are fixed. As a result, the only way that the Appellant can distinguish its products from its competitors is by its brand. Brand is thus the nucleus to secure and guarantee the Appellant a market share. Having regard to what I have said above I am satisfied that the expenditure incurred by the Appellant in paying for the licensed marks and the licensed marketing indicia are expenses which are capital in nature and the Respondent was thus entitled to disallow such expense as it properly did. B SA Limited’s appeal against the assessment was dismissed ...

A subsidiary company, which paid royalties for a licence of a trademark to its parent company, could not deduct part of the sums paid as a temporary increase of the royalties by one point because it could not justify the benefit from the use of the trademark. Click here for translation ...