Tag: License agreement

Netherlands vs “Tobacco B.V.”, December 2023, North Holland District Court, Case No AWB – 20_4350 (ECLI:NL:RBNHO: 2023:12635)

A Dutch company “Tobacco B.V.” belonging to an internationally operating tobacco group was subjected to (additional assessment) corporate income tax assessments according to taxable amounts of €2,850,670,712 (2013), €2,849,204,122 (2014), €2,933,077,258 (2015) and €3,067,630,743 (2016), and to penalty fines for the year 2014 of €1,614,709, for the year 2015 of €363,205 and for the year 2016 of €125,175,082. In each case, the dispute focuses on whether the fees charged by various group companies for supplies and services can be regarded as business-related. Also in dispute is whether transfer profit should have been recognised in connection with a cessation of business activities. One of the group companies provided factoring services to “Tobacco B.V.”. The factoring fee charged annually for this includes a risk fee to cover the default risk and an annual fee for other services. The court concluded that the risk was actually significantly lower than the risk assumed in determining the risk fee, that the other services were routine in nature and that the factoring fee as a whole should be qualified as impractical. “Tobacco B.V.” has not rebutted the presumption that the disadvantage caused to it by paying the factoring fees was due to the affiliation between it and the service provider. In 2016, a reorganisation took place within the tobacco group in which several agreements concluded between group companies were terminated. The court concluded that there had been a coherent set of legal acts, whereby a Dutch group company transferred its business activities in the field of exporting tobacco products, including the functions carried out therein, the risks assumed therein and the entire profit potential associated therewith, to a group company in the UK. For the adjustment related to the transfer profit, the court relies on the projected cash flows from the business and information known at the time the decision to transfer was taken. The conclusions regarding factoring and the termination of business activities in the Netherlands lead to a deficiency in the tax return for each of the years 2014 to 2016. For these years, “Tobacco B.V.” filed returns to negative taxable amounts. For the years 2014 and 2016, a substantial amount of tax due arises after correction, even if the corrections established by application of reversal and aggravation are disregarded. For the year 2015, the tax due remains zero even after correction. Had the return been followed, this would have resulted in “Tobacco B.V.” being able to achieve, through loss relief, that substantially less tax would be due than the actual tax due. At the time the returns were filed, “Tobacco B.V.” knew that this would result in a substantial amount of tax due not being levied in each of these years and the court did not find a pleading position in this regard. The burden of proof is therefore reversed and aggravated. For the year 2013, this follows from the court’s decision of 17 October 2022, ECLI:NL:RBNHO:2022:8937. To finance their activities, the group companies issued listed bonds under the tobacco group’s so-called EMTN Programme, which were guaranteed by the UK parent company. A subsidiary of “Tobacco B.V.” joined in a tax group paid an annual guarantee fee to the UK parent company for this purpose. The court ruled that: – the guarantee fees are not expenses originating from the subsidiary’s acceptance of liability for debts of an affiliated company; – the EMTN Programme is not a credit arrangement within the meaning of the Umbrella Credit Judgment(ECLI:NL:HR:2013:BW6520); – “Tobacco B.V.” has made it clear that a not-for-profit fee can be determined at which an independent third party would have been willing to accept the same liability on otherwise the same terms and conditions; – “Tobacco B.V.” failed to show that in the years in which the guarantee fees were provided, credit assessments did not have to take implied guarantee into account; – “Tobacco B.V.” failed to show that its subsidiary was not of such strategic importance to the group that its derivative rating did not match the group rating, so that the guarantee fees paid are not at arm’s length due to the effect of implied guarantee in their entirety; – “Tobacco B.V.” did not put forward any contentions that could rebut the objectified presumption of awareness that follows from the size of the adjustments (the entire guarantee fee), that the disadvantage suffered by the plaintiff as a result of the payment of the guarantee fees is due to its affiliation with its parent company. A group company charges the claimant, inter alia, a fee corresponding to a percentage of “Tobacco B.V.”‘s profits (profit split) for activities on behalf of the tobacco group that result in cost savings for “Tobacco B.V.”. The court ruled that “Tobacco B.V.” failed to prove that the group company made a unique contribution to the tobacco group that could justify the agreed profit split. The group company also charges “Tobacco B.V.” a fee equivalent to a 12% mark-up on costs for services relating to the manufacture of cigarettes. The court ruled that, in the context of the reversal and aggravation of the burden of proof, it was not sufficient for “Tobacco B.V.” to refer to the functional analysis, as it was based on the incorrect premise that the group company could be compared to a manufacturer. Finally, since April 2012, “Tobacco B.V.” has been paying the group company a 10% fee on the costs excluding raw materials for the production of cigarettes as toll manufacturer, where previously the basis of this fee also included the costs of raw materials. The court noted that the flow of goods remained the same and that “Tobacco B.V.” remained operationally responsible for the production process. The court ruled that it was up to “Tobacco B.V.” to establish and prove facts from which it follows that it was businesslike to change the basis of remuneration, which it did not do sufficiently. Regarding an adjustment made by the tax authorities in relation to reorganisation costs, the court finds that the adjustment was made in error ...

Italy vs Otis Servizi s.r.l., August 2023, Supreme Court, Sez. 5 Num. 23587 Anno 2023

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 ...

Portugal vs R… Cash & C…, S.A., June 2023, Tribunal Central Administrativo Sul, Case 2579/16.6 BELRS

The tax authorities had issued a notice of assessment which disallowed tax deductions for royalties paid by R…Cash & C…, S.A. to its Polish parent company, O…Mark Sp. Z.o.o. R… Cash & C…, S.A. appealed to the Administrative Court, which later annulled the assessment. The tax authorities then filed an appeal with the Administrative Court of Appeal. Judgement of the Court The Court of Appeal revoked the judgement issued by the administrative court and decided in favour of the tax authorities. Extracts “It is clear from the evidence in the case file that the applicant has succeeded in demonstrating that the agreement to transfer rights is not based on effective competition, in the context of identical operations carried out by independent entities. The studies presented by the challenger do not succeed in overturning this assertion, since, as is clear from the evidence (12), they relate to operations and market segments other than the one at issue in the case. The provision for the payment of royalties for the transfer of the brands, together with the unpaid provision of management and promotion services for the brands in question by the applicant, prove that there has been a situation that deviates from full competition, with the allocation of income in a tax jurisdiction other than the State of source, without any apparent justification. The application of the profit splitting method (Article 9 of Ministerial Order 1446-C/2001 of 21 December 2001) does not deserve censure. Intangible assets are at stake, so invoking the comparability of transactions, in cases such as the present one, does not make it possible to understand the relationships established between the companies involved. It should also be noted that the Polish company receiving the royalties has minimal staff costs, and that brand amortisation costs account for 97.72% of its operating costs. As a result, the obligations arising for the defendant from the licence agreement in question are unjustified. In view of the demonstration of the deviation from the terms of an arm’s length transaction, it can be seen that the taxpayer’s declaratory obligations (articles 13 to 16 of Ministerial Order 1446-C/2001, of 21.12.200) have not been complied with, as there is a lack of elements that would justify the necessary adjustment. Therefore, the correction under examination does not deserve to be repaired and should be confirmed in the legal order. By ruling differently, the judgement under appeal was an error of judgement and should therefore be replaced by a decision dismissing the challenge.” Click here for English translation. Click here for other translation Portugal 2579-16-6 BELRS ORG ...

Portugal vs “N…S.A.”, March 2023, Tribunal Central Administrativo Sul, Case 762/09.0BESNT

The tax authorities had issued a notice of assessment which, among other adjustments, disallowed a bad debt loss and certain costs as tax deductible. In addition, royalties paid to the parent company were adjusted on the basis of the arm’s length principle. N…S.A. appealed to the Administrative Court, which partially annulled the assessment. Both the tax authorities and N…S.A. then appealed to the Administrative Court of Appeal. Judgement of the Court The Administrative Court of Appeal partially upheld the assessment of the tax authorities, but dismissed the appeal in respect of the royalty payments. According to the Court, a transfer pricing adjustment requires a reference to the terms of the comparable transaction between independent entities and a justification of the comparability factors. Extracts from the judgement related to the controlled royalty payment. “2.2.2.2 Regarding the correction for ‘transfer pricing’, the applicant submits that the Judgment erred in annulling the correction in question since the defendant calculated the royalty payable to the mother company in a manner that deviated from similar transactions between independent entities. It censures the fact that the rappel discount was not included in the computation of net sales for the purposes of computing the royalty under review. “[S]ince rappel is a discount resulting from the permanent nature of the contractual relationship between the supplier and the customer, (in the case of the Defendant, set at one year) constituting a reduction in the customer’s pecuniary benefit structurally linked to the volume of goods purchased, it can hardly be argued that it has a temporary nature, in the sense of ‘momentary’ or of ‘short duration'”; “(…) by excluding the rappel of rebates deductible from the gross value of sales, for the purposes of determining the net value of sales pursuant to Clause 32 of the Licence Agreement, the Tribunal a quo erred in fact”; “[that] on the transfer pricing regime, the AT demonstrated, by the reasoning of fact and law contained in the final inspection report that the existence of special relations between the Defendant and SPN led to the establishment of different contractual conditions, in the calculation of the royalties payable, had they been established, between independent persons”. In this regard, it was written in the contested judgment as follows: “(…) // In fact, the exceptions provided for in clause 32 of the Licence Agreement, which have a broad content, allow the framing of the so-called rappel situations, contracted by the Impugnant with its clients for a determined period of time and subject to periodic review, given their temporary nature. // Which means that, as to the form of calculation of the tax basis of the royalties payable to SPN, no violation of the provisions of the Licence Agreement has occurred. // For this reason, one cannot accept the conclusion of the Tax Authority in the inspection report, that such discounts do not fall within the group of those which, as they have a limited timeframe for their validity, should not be considered as a negative component of the sales for the purposes of calculation of the royalties, in accordance with the contract entered into between the Impugnant and SPN. // In addition, the Tax Authority failed to demonstrate in the inspection report to what extent the conditions practiced in the calculation of the royalties payable by the Impugnant to SPN diverge from the conditions that would be practiced by independent entities, not having been observed the provisions of article 77, no. 3, of the General Tax Law (LGT)”. Assessment. The grounds for the correction under examination appear in item “III.1.1.6 Transfer prices: € 780,318.77” of the Inspection Report. The relevant regulatory framework is as follows: i) “In commercial transactions, including, namely, transactions or series of transactions on goods, rights or services, as well as in financial transactions, carried out between a taxable person and any other entity, subject to IRC or not, with which it is in a situation of special relations, substantially identical terms or conditions must be contracted, accepted and practiced to those that would normally be contracted, accepted and practiced between independent entities in comparable transactions”(12). (ii) ‘When the Directorate-General for Taxation makes corrections necessary for the determination of the taxable profit by virtue of special relations with another taxpayer subject to corporation tax or personal income tax, in the determination of the taxable profit of the latter the appropriate adjustments reflecting the corrections made in the determination of the taxable profit of the former shall be made’.) (iii) “The taxable person shall, in determining the terms and conditions that would normally be agreed, accepted or carried out between independent entities, adopt the method or methods that would ensure the highest degree of comparability between his transactions or series of transactions and other transactions that are substantially the same under normal market conditions or in the absence of special relations…”.) (iv) “The most appropriate method for each transaction or series of transactions is that which is capable of providing the best and most reliable estimate of the terms and conditions that would normally be agreed, accepted or practised at arm’s length, the method which is the most appropriate to achieve the highest degree of comparability between the tied and untied transactions and between the entities selected for the comparison, which has the highest quality and the most extensive amount of information available to justify its adequate justification and application, and which involves the smallest number of adjustments to eliminate differences between comparable facts and situations”. (v) ‘Two transactions meet the conditions for comparable transactions if they are substantially the same, meaning that their relevant economic and financial characteristics are identical or sufficiently similar, so that the differences between the transactions or between the undertakings involved in them are not such as to significantly affect the terms and conditions which would prevail in a normal market situation, or, if they do, so that the necessary adjustments can be made to eliminate the material effects of the differences found’ (16). (vi) “In the case of operations ...

US vs Skechers USA Inc., February 2023, Wisconsin Tax Appeals Commission, Nos. 10-I-171 AND 10-I-172

Skechers US Inc. had formed a related party entity, SKII, in 1999 and transferred IP and $18 million in cash to the entity in exchange for 100 percent of the stock. Skechers then licensed the IP back from SKII and claimed a franchise tax deduction for the royalties and also deductions for management fees and interest expenses on the unpaid balance of royalty fees. The Wisconsin tax authorities held that these were sham transaction lacking business purpose and disallowed the deductions. Judgement of the Tax Appeals Commission The Tax Appeals Commission ruled in favor of the tax authorities. Excerpt “(…) The burden of proof is on Petitioner to prove that the Department’s assessment is incorrect by clear and satisfactory evidence. In this case, Petitioner must prove that it had a valid nontax business purpose for entering into the licensing transaction that generated the royalty deductions claimed on its Wisconsin tax returns and that the licensing transaction had economic substance. Both are required. Petitioner did not present persuasive evidence or testimony of either requirement being met. Therefore, the Department’s assessments are upheld. CONCLUSIONS OF LAW Petitioner did not have a valid nontax business purpose for the creation of SKII. Petitioner did not have a valid nontax business purpose for entering into the licensing transactions between Skechers and SKII that generated the royalty deductions claimed on its Wisconsin tax returns. Petitioner’s licensing transactions between Skechers and SKII did not have economic substance. (…)” US vs Skechers Final DO ...

US vs 3M Company And Subsidiaries, February 2023, US Tax Court, 160 T.C. No. 3 (Docket No. 5816-13)

“3M Parent” is the parent company of the 3M Group and owns the Group’s trademarks. Other intellectual property, including patents and unpatented technology, is owned by “3M Sub-parent”, a second-tier wholly owned US subsidiary of 3M Parent. “3M Brazil” has used trademarks owned by 3M US in its business operations. 3M Brazil’s use of these trademarks was governed by three trademark licences entered into by 3M Parent and 3M Brazil in 1998. Each licence covered a separate set of trademarks. Under the terms of the licences, 3M Brazil paid 3M Parent a royalty equal to 1% of its sales of the trademarked products. Some products sold by 3M Brazil were covered by trademarks covered by more than one of the three trademark licences. For such products, 3M Brazil and 3M Parent calculated the trademark royalties using a stacking principle whereby, for example, if a particular product used trademarks covered by all three trademark licences, the royalties would be 3% of the sales of that product. By calculating royalties using this stacking principle, 3M Brazil paid trademark royalties to 3M Parent in 2006. 3M Brazil also used patents and unpatented technology owned by 3M Sub-parent in its operations. 3M Brazil paid no patent royalties and made no technology transfer payments to 3M Sub-parent. There was no patent licence or technology transfer agreement between 3M Sub-parent and 3M Brazil. On its 2006 consolidated federal income tax return, 3M Parent reported as income the trademark royalties paid by 3M Brazil to 3M Parent in 2006. In the notice of deficiency, the IRS determined that the income of the 3M Parent consolidated group under I.R.C. sec. 482 to reflect 3M Brazil’s use of intellectual property owned by 3M Parent and 3M Sub-parent. The increase in income determined in the notice of deficiency represents an arm’s length compensation for the intellectual property used by 3M Brazil. 3M Parent’s position was that the I.R.C. sec. 482 allocation should be the maximum amount 3M Brazil could have paid for the intellectual property in question under Brazilian law, less related expenses. 3M Parent also contended that the entire regulation was invalid because income could not be allocated to a taxpayer that did not receive income and could not legally receive the income. The IRS’s position was that the I.R.C. sec. 482 adjustment does not take into account the effect of the Brazilian statutory restrictions unless certain conditions are met, and that the Brazilian statutory restrictions did not meet those conditions. The blocked income rules in section 1.482-1(h)(2) require, among other things, that the foreign law restriction apply equally to controlled and uncontrolled parties, be publicly announced, and prevent the payment or receipt of an arm’s length amount in any form. Tax Court opinion The US Tax Court agreed with the IRS that 3M’s US income should be increased by royalties from 3M Brazil’s use of its trademarks and other intellectual property – without regard to the legal restrictions on related party royalty payments in Brazil. US vs 3M US TC Feb 2023 ...

Italy vs Dolce & Gabbana S.R.L., November 2022, Supreme Court, Case no 02599/2023

Italien fashion group, Dolce & Gabbana s.r.l. (hereinafter DG s.r.l.), the licensee of the Dolce&Gabbana trademark, entered into a sub-licensing agreement with its subsidiary Dolce&Gabbana Industria (hereinafter DG Industria or Industria) whereby the former granted to the latter the right to produce, distribute and sell products bearing the well-known trademark throughout the world and undertook to carry out promotion and marketing activities in return for royalties. DG s.r.l., in order to carry out promotion and marketing activities in the U.S.A., made use of the company Dolce&Gabbana Usa Inc. (hereinafter DG Usa) with contracts in force since 2002; in particular, on March 16, 2005, it entered into a service agreement whereby DG Usa undertook to provide the aforesaid services in return for an annual fee payable by DG s.r.l.; this consideration is determined on the basis of the costs analytically attributable to the provision of the agreed services in addition to a mark up, i.e. a mark-up, determined in a variable percentage based on the amount of the cost. In order to verify the fairness of the consideration, the parties have provided for the obligation of analytical reporting as well as an amicable settlement procedure through an auditing company. Lastly, DG s.r.l., DG Usa and DG Industria entered into another agreement, supply agreement, whereby DG Industria appointed DG Usa as its distributor for the USA in mono-brand shops, DG Usa committed to DG s.r.l. to adapt the shops to its high quality standards functional to increasing brand awareness, and DG s.r.l. committed to pay a service fee. The service contribution was recognised in relation to the costs exceeding a percentage of the turnover realised through the mono-brand sales outlets. In the course of an audit, the Italian Revenue Agency made the following findings in relation to the tax year 1 April 2004 to 31 March 2005: first, it denied the deductibility from the taxable income for IRES and IRAP purposes of part of the fees paid by DG s.r.l. to DG USA under the service contract and precisely: a) of the costs of certain services (in particular, it recognised the costs for commercial sales, executive consultant, advertising Madison sales, advertising all others and not the others), because, provided that these were generic services, falling within the normal activity of the reseller of goods, remunerated by the resale margin, and that the reimbursable costs were defined generically, without provision of a ceiling, a reporting method and prior approval by DG s.r.l., it pointed out that it could only recognise the costs rendered in the interest >>also of the parent company<<; b) the portion corresponding to the chargeback of the mark-up, referring to Revenue Agency Circular No. 32/80 on intra-group services, where it provides that the mark-up in favour of the service provider is recognisable only where the services constitute the typical activity of the service provider and not for those services rendered by the parent company that have no market value or are attributable to the general management or administrative activity of the parent company; secondly, it denied the deductibility of the consideration paid by DG s.r.l. to DG Usa under the supply agreement, pointing out that the costs to be considered for the purposes of the contribution would be generically identified, there would be no obligation of adequate reporting or prior approval, which would in fact transfer to DG s.r.l. the risk of substantial inefficiencies of DG Usa, a risk that no independent third party would have assumed, and that the party had not adequately demonstrated that the costs corresponded to the normal value of the costs inasmuch as the documentation produced, relating to other fashion groups, concerned persons who were also owners of the mark, directly interested in its development and promotion. DG s.r.l. brought an appeal before the Provincial Tax Commission of Milan, which rejected it. An appeal was then brought before the Regional Tax Commission of Lombardy which was likewise rejected. In particular, the Regional Tax Commission, for what is relevant herein rejected the preliminary objections (failure to contest the recovery by means of a report; insufficiency and contradictory motivation); reconstructed the subject matter of the dispute, pointing out that the Agency had contested some costs of the service agreement, excluding their inherent nature; for the costs deemed inherent, it had recalculated the amount, excluding the mark-up; for the supply agreement, it had re-taxed the costs, excluding their deductibility due to lack of inherent nature in relation to the service agreement, it confirmed that the costs for the excluded services were not inherent, because: a) DG Usa also carried out activities pertaining to the retailer DG Industria, distributor of Dolce&Gabbana branded products in the U.S. and the costs were connected to this marketing activity; b) the correlation deducted by the company between the costs recharged to DG s.r.l. and the revenues that the latter obtains as a result of the royalties paid by DG Industria, because the costs connected to services intended to increase sales are those of the retailer and not of the licensee of the trademark, to which are inherent only the costs intended to increase the prestige of the trademark itself; c) the costs incurred in the interest of both DG s.r.l. and DG Usa is not relevant and the only cost items recognisable in favour of the former are those pertaining exclusively to its relevance; d) for the purpose of proving congruity, the expert’s report by Prof. Lorenzo Pozza and the certification by Mahoney Cohen & company were irrelevant, since they were mere opinions that were not binding on the administration; (e) the mark up was not deductible since the services rendered by DG USA were rendered in the interest of both DG s.r.l., licensee of the mark, and DG Industria, reseller, and it was not possible to take into consideration the actions of the latter in favour of Itierre s.p.a., reseller and therefore different from DG s.r.l.; (f) the recharging of costs to DG s.r.l. was formally obligatory in the antero but largely ...

§ 1.482-4(f)(3)(ii) Example 2.

The facts are the same as in Example 1. As a result of its sales and marketing activities, USSub develops a list of several hundred creditworthy customers that regularly purchase AA trademarked products. Neither the terms of the contract between FP and USSub nor the relevant intellectual property law specify which party owns the customer list. Because USSub has knowledge of the contents of the list, and has practical control over its use and dissemination, USSub is considered the sole owner of the customer list for purposes of this paragraph (f)(3) ...

§ 1.482-4(f)(3)(ii) Example 1.

FP, a foreign corporation, is the registered holder of the AA trademark in the United States. FP licenses to its U.S. subsidiary, USSub, the exclusive rights to manufacture and market products in the United States under the AA trademark. FP is the owner of the trademark pursuant to intellectual property law. USSub is the owner of the license pursuant to the terms of the license, but is not the owner of the trademark. See paragraphs (b)(3) and (4) of this section (defining an intangible as, among other things, a trademark or a license) ...

TPG2022 Chapter VI Annex I example 20

69. Ilcha is organised in country A. The Ilcha group of companies has for many years manufactured and sold Product Q in countries B and C through a wholly owned subsidiary, Company S1, which is organised in country B. Ilcha owns patents related to the design of Product Q and has developed a unique trademark and other marketing intangibles. The patents and trademarks are registered by Ilcha in countries B and C. 70. For sound business reasons, Ilcha determines that the group’s business in countries B and C would be enhanced if those businesses were operated through separate subsidiaries in each country. Ilcha therefore organises in country C a wholly owned subsidiary, Company S2. With regard to the business in country C: Company S1 transfers to Company S2 the tangible manufacturing and marketing assets previously used by Company S1 in country C. Ilcha and Company S1 agree to terminate the agreement granting Company S1 the following rights with relation to Product Q: the right to manufacture and distribute Product Q in country C; the right to use the patents and trademark in carrying out its manufacturing and distribution activities in country C; and, the right to use customer relationships, customer lists, goodwill and other items in country C (hereinafter, “the Rightsâ€). Ilcha enters into new, long-term licence agreements with Company S2 granting it the Rights in country C. The newly formed subsidiary thereafter conducts the Product Q business in country C, while Company S1 continues to conduct the Product Q business in Country B. 71. Assume that over the years of its operation, Company S1 developed substantial business value in country C and an independent enterprise would be willing to pay for that business value in an acquisition. Further assume that, for accounting and business valuation purposes, a portion of such business value would be treated as goodwill in a purchase price allocation conducted with regard to a sale of Company S1’s country C business to an independent party. 72. Under the facts and circumstances of the case, there is value being transferred to Company S2 through the combination of (i) the transfer of part of Company S1’s tangible business assets to Company S2 in country C, and (ii) the surrendering by Company S1 of the Rights and the subsequent granting of the Rights by Ilcha to Company S2. There are three separate transactions: the transfer of part of Company S1’s tangible business assets to Company S2 in country C; the surrendering by Company S1 of its rights under the licence back to Ilcha; and the subsequent granting of a licence by Ilcha to Company S2. For transfer pricing purposes, the prices paid by Ilcha and by Company S2 in connection with these transactions should reflect the value of the business which would include amounts that may be treated as the value of goodwill for accounting purposes ...

TPG2022 Chapter VI Annex I example 18

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 ...

TPG2022 Chapter VI paragraph 6.26

Limited rights in intangibles are commonly transferred by means of a licence or other similar contractual arrangement, whether written, oral or implied. Such licensed rights may be limited as to field of use, term of use, geography or in other ways. Such limited rights in intangibles are themselves intangibles within the meaning of Section A. 1 ...

Russia vs LLC OTIS LIFT, December 2021, Arbitration Court of Moscow, Case â„– Ð40-180523/20-140-3915

The Russian company LLC OTIS LIFT carries out service and maintenance activities for lifts and escalators both under the registered trademarks and designations of Otis and lifts and escalators of other manufacturers. A License Agreement was in force between the Russian subsidiary and its US parent OTIS ELEVATOR COMPANY (NJ) (Licensor). In accordance with the License Agreement, LLC OTIS LIFT should pay to OTIS ELEVATOR COMPANY (NJ) an amount equal to three and a half percent (3.5%) of the net amount invoiced by Otis Lift for Goods and Services as payment for the right to manufacture, promote, sell, install, repair and maintain Goods under the registered trademarks and designations “Otis”. Hence, the License Agreement did not provide for charging royalties from the revenue for the services provided by LLC OTIS LIFT for the maintenance of lift equipment of third-party manufacturers. Following an audit it was established that in violation of the terms and conditions of the license agreement the royalties accrued LLC OTIS LIFT in favour of the Licensor – OTIS ELEVATOR COMPANY (NJ) were calculated and paid from the total amount of all invoices issued to customers for maintenance services and not only from invoices for maintenance of goods under the trademarks. Hence the company overstated its expenses. On that basis an assessment of additional taxable income was issued. This assessment of additional income was brought to court by LLC OTIS. Judgement of the Arbitration Court The court dismissed the complaint of LLC OTIS LIFT and decided in favor of the tax authorities. Excerpts “In support of its conclusion that the expenses for the payment of royalties for the use of the designation “Otis” in the provision of services for maintenance of lifts, escalators under other trademarks and designations are economically justified, the Company provides the following arguments: during the audited period the Company used the trademark “Otis” in its corporate name in all its activities, including the provision of services for maintenance of lift equipment of third party manufacturers; However, the Court considers it necessary to note the following. In view of the fact that royalties represent an equitable payment for the right to use intellectual property, it should be noted that the formula established by the license agreement for calculating the royalty as a percentage of revenue related only to sales and maintenance of Otis-branded goods is economically justified, since Otis Group has designed, developed, improved, maintained, promoted and protected intellectual property related directly to the goods produced. Accordingly, it is reasonable to assume that it is the Otis group that has the most knowledge, the most technology and the most competence to maintain its own equipment. At the same time, there is no reason to believe that the unique knowledge of the Company’s service personnel in the design and maintenance of Otis-branded lift equipment, including from foreign group companies, gives them an unconditional advantage in repairing and servicing equipment of other manufacturers. In the course of additional tax control measures the issue of using the business reputation of the Licensor in the course of rendering services on maintenance of the lift equipment of third-party manufacturers was investigated. In particular, whether potential contractors were guided by the company’s brand, trademark, reputation of the company in the world and other characteristics when choosing the Company as a supplier of maintenance services for lift equipment. The analysis of the documents submitted by the Company’s counterparties does not establish whether the potential counterparties were guided by the company’s brand, trademark and reputation in the world when selecting the Company as a supplier of services for maintenance of lift equipment. In accordance with paragraph 1 of Art. 252 of the Tax Code of the Russian Federation, the taxpayer reduces the income received by the amount of the costs incurred. Expenses are considered to be justified and documented expenses made (incurred) by the taxpayer. Reasonable expenses are economically justified costs, the assessment of which is expressed in monetary form. Therefore, the argument that the Company’s expenses on payment of the license fees for the use of the “Otis” trademark in the course of providing maintenance services for lift equipment of third parties does not comply with the provisions of Article 252 of the Tax Code of the Russian Federation on documentary confirmation and justification of the expenses charged by the taxpayer to expenses. Regarding the fact that the Company’s use of the Licensor’s intangible assets relating to the Otis trademark had a positive effect on the cost of maintenance services for third-party lift equipment, it should be noted that the Company has not provided any evidence of this and (or) calculations of this benefit effect.” “Thus, the Company’s argument that it used OTIS know-how when servicing lift equipment of third party manufacturers rather than the requirements stipulated by the Russian legislation is unfounded. Otis Lift LLC also failed to document that in providing maintenance services for third-party lift equipment, the use of the Licensor’s intangible assets relating to the Otis trademarks gave them a competitive advantage over other manufacturers and service companies engaged in the maintenance of such equipment or had any other positive effect on the cost of services for the maintenance of third-party lift equipment. Since the Company has not provided any evidence of this and (or) calculations of such benefit effect. Thus, there is no objective connection between the incurred expenses on payment of the license fee to OTIS ELEVATOR COMPANY (NJ) and the focus of the Company’s activities on obtaining profit when providing services for repair of lift equipment of third-party manufacturers. Furthermore, the Company’s argument that the tax authority suggests the Company’s gratuitous use of the Licensor’s tangible assets is unfounded and contrary to the facts of the case, as the Inspectorate has not made any claims against the Company in respect of license fees for maintenance of lift equipment (goods) under the registered trademark “OTIS”. On the basis of the above, the applicant’s claims are not subject to satisfaction.” Click here for English translation Click here ...

Indonesia vs P.T. Sanken Indonesia Ltd., December 2021, Supreme Court, Case No. 5291/B/PK/PJK/2020

P.T. Sanken Indonesia Ltd. – an Indonesian subsidiary of Sanken Electric Co., Ltd. Japan – paid royalties to its Japanese parent for use of IP. The royalty payment was calculated based on external sales and therefore did not include sales of products to group companies. The royalty payments were deducted for tax purposes. Following an audit, the tax authorities issued an assessment where deductions for the royalty payments were denied. According to the authorities the license agreement had not been registrered in Indonesia. Furthermore, the royalty payment was found not to have been determined in accordance with the arm’s length principle. P.T. Sanken issued a complaint over the decision with the Tax Court, where the assessment later was set aside. This decision was then appealed to the Supreme Court by the tax authorities. Judgement of the Supreme Court The Supreme Court dismissed the appeal of the tax authorities and upheld the decision of the Tax Court. The OECD Transfer Pricing Guidelines states that to test the existence of transactions to royalty payments on intangible between related parties, four tests/considerations must be performed: a) Willing to pay test (Par 6.14); b) Economic benefit test (Par 6.15); c) Product life cycle considerations (Par 1.50); d) Identify contractual and arrangement for transfer of IP (Par 6.16-6.19 ); To obtain a comparison that is reliable the level of comparability between the transactions must be determined. The degree of comparability must be measured accurately and precisely because it would be “the core” in the accuracy of the results of the selected method . Although the characteristics of products and the provision in the contract on the sale to related parties and independent was comparable, it was not sufficient to justify the conditions of the transactions are  sufficiently comparable; Based on the OECD Guidelines there are five factors of comparability, namely : ( i ) the terms and conditions in the contract ; (ii) FAR analysis ( function , asset and risk ); (iii) the product or service being transacted ; (iv) business strategy ; and (v) economic situation ; In the application of the arm’s length principle, the OECD TP Guidenline provide guidance as follows: 6.23 “In establishing arm’s length pricing in the case of a sale or license of intangible property, it is possible to use the CUP method where the same owner has transferred or licensed comparable intangible property under comparable circumstances to independent enterprises. The amount of consideration charged in comparable trnsaction between independent enterprises in the same industry can also be guide, where this information is available, and a range of pricing may be Appropriate. “That the provisions mentioned in the above , the Panel of Judges Court believes that the payment of royalties can be financed due to meet the requirements that have been set out in the OECD TP Guidenline and have a relationship with 3M ( Getting , Charge and Maintain ) income and therefore on the correction compa ( now Applicant Review Back) in the case a quo not be maintained because it is not in accordance with the provisions of regulatory legislation which applies as stipulated in Article 29, the following explanation of Article 29 paragraph (2) Paragraph Third Act Provisions General and Tata How Taxation in conjunction with Article 4 paragraph (1), Article 6 paragraph (1) and Article 9 paragraph (1) and Article 18 paragraph (3) of Law – Income Tax Law in conjunction with Article 69 paragraph (1) letter e and Article 78 of the Tax Court Law ; Click here for translation putusan_5291_b_pk_pjk_2020 Dec 2021 ...

US vs Coca Cola, October 2021, US Tax Court, T.C. Docket 31183-15

In a November 2020 opinion the US Tax Court agreed with the IRS that Coca-Cola’s US-based income should be increased by $9 billion in a dispute over royalties from its foreign-based licensees. Coca-Cola filed a Motion to Reconsider June 2, 2021 – 196 days after the Tax Court had served its opinion. Judgement of the tax court The Tax Court denied the motion to reconsider. There is a 30-day deadline to move for reconsideration and the court concluded that Coca-Cola was without a valid excuse for the late filing and that the motion would have failed on the merits in any event. 2021_10_26-Order-re-Motion-for-Leave-Coca-Cola-762 ...

The European Commission vs. Nike and the Netherlands, July 2021, European Court of Justice Case No T-648/19

In 2016 the European Commission announced that it had opened an in-depth investigation to examine whether tax rulings (unilateral APA’s) granted by the Netherlands had given Nike an unfair advantage over its competitors, in breach of EU State aid rules. The formal investigation concerned the tax treatment in the Netherlands of two Nike group companies, Nike European Operations Netherlands BV and Converse Netherlands BV. These two operating companies develops, markets and records the sales of Nike and Converse products in Europe, the Middle East and Africa (the EMEA region). Nike European Operations Netherlands BV and Converse Netherlands BV obtained licenses to use intellectual property rights relating to Nike and Converse products in the EMEA region. The two companies obtained the licenses, in return for a tax-deductible royalty payment, from two Nike group entities, which are currently Dutch entities that are “transparent” for tax purposes (i.e., not taxable in the Netherlands). From 2006 to 2015, the Dutch tax authorities issued five tax rulings, two of which are still in force, endorsing a method to calculate the royalty to be paid by Nike European Operations Netherlands and Converse Netherlands for the use of the intellectual property. As a result of these tax rulings, Nike European Operations Netherlands BV and Converse Netherlands BV are only taxed in the Netherlands on a limited operating margin based on sales. The Commission was concerned that the royalty payments endorsed by the rulings may not reflect economic reality. According to the Commission the payments appeared to be higher than what independent companies negotiating on market terms would have agreed. On 26 September 2019 Nike brought the decision to open the investigation to the European General Court claiming the investigation was in breach of fundamental  EU rights, principles of good administration and equal treatment by (1) erring in law in the preliminary assessment of the aid character of the contested measures. (2) not providing sufficient reasons for finding that the contested measures fulfil all elements of State aid, especially why they should be regarded as selective. (3) prematurely opening a formal investigation and providing insufficient reasoning for the existence of State aid where there were no difficulties to continue the preliminary investigation. Judgement of the Court On 14 July 2021 The General Court dismissed the claims brought by Nike. The Court agreed that the intercompany royalties payments as determined in the tax rulings (unilateral APA’s) issued by the Netherlands left the distribution affiliates with less profits than would have occurred at arm’s length. EC vs Nike and NL june 2021 ECJ T 648-19 ...

Indonesia vs P.T. Sanken Indonesia Ltd., December 2020, Supreme Court, Case No. 5291/B/PK/Pjk/2020

P.T. Sanken Indonesia Ltd. – an Indonesian subsidiary of Sanken Electric Co., Ltd. Japan – paid royalties to its Japanese parent for use of IP. The royalty payment was calculated based on external sales and therefore did not include sales of products to group companies. The royalty payments were deducted for tax purposes. Following an audit, the tax authorities issued an assessment where deductions for the royalty payments were denied. According to the authorities the license agreement had not been registrered in Indonesia. Furthermore, the royalty payment was found not to have been determined in accordance with the arm’s length principle. P.T. Sanken issued a complaint over the decision with the Tax Court, where the assessment later was set aside. This decision was then appealed to the Supreme Court by the tax authorities. Judgement of the Supreme Court The Supreme Court dismissed the appeal of the tax authorities and upheld the decision of the Tax Court. The OECD Transfer Pricing Guidelines states that to test the existence of transactions to royalty payments on intangible between related parties, four tests/considerations must be performed: a) Willing to pay test (Par 6.14); b) Economic benefit test (Par 6.15); c) Product life cycle considerations (Par 1.50); d) Identify contractual and arrangement for transfer of IP (Par 6.16-6.19 ); To obtain a comparison that is reliable the level of comparability between the transactions must be determined. The degree of comparability must be measured accurately and precisely because it would be “the core” in the accuracy of the results of the selected method . Although the characteristics of products and the provision in the contract on the sale to related parties and independent was comparable, it was not sufficient to justify the conditions of the transactions are  sufficiently comparable; Based on the OECD Guidelines there are five factors of comparability, namely : ( i ) the terms and conditions in the contract ; (ii) FAR analysis ( function , asset and risk ); (iii) the product or service being transacted ; (iv) business strategy ; and (v) economic situation ; In the application of the arm’s length principle, the OECD TP Guidenline provide guidance as follows: 6.23 “In establishing arm’s length pricing in the case of a sale or license of intangible property, it is possible to use the CUP method where the same owner has transferred or licensed comparable intangible property under comparable circumstances to independent enterprises. The amount of consideration charged in comparable trnsaction between independent enterprises in the same industry can also be guide, where this information is available, and a range of pricing may be Appropriate. “That the provisions mentioned in the above , the Panel of Judges Court believes that the payment of royalties can be financed due to meet the requirements that have been set out in the OECD TP Guidenline and have a relationship with 3M ( Getting , Charge and Maintain ) income and therefore on the correction compa ( now Applicant Review Back) in the case a quo not be maintained because it is not in accordance with the provisions of regulatory legislation which applies as stipulated in Article 29, the following explanation of Article 29 paragraph (2) Paragraph Third Act Provisions General and Tata How Taxation in conjunction with Article 4 paragraph (1), Article 6 paragraph (1) and Article 9 paragraph (1) and Article 18 paragraph (3) of Law – Income Tax Law in conjunction with Article 69 paragraph (1) letter e and Article 78 of the Tax Court Law ; Click here for translation putusan_5291_b_pk_pjk_2020_20210918 ...

US vs Coca Cola, November 2020, US Tax Court, 155 T.C. No. 10

Coca Cola, a U.S. corporation, was the legal owner of the intellectual property (IP) necessary to manufacture, distribute, and sell some of the best-known beverage brands in the world. This IP included trade- marks, product names, logos, patents, secret formulas, and proprietary manufacturing processes. Coca Cola licensed foreign manufacturing affiliates, called “supply points,†to use this IP to produce concentrate that they sold to unrelated bottlers, who produced finished beverages for sale  to distributors and retailers throughout the world. Coca Cola’s contracts with its supply points gave them limited rights to use the IP in performing their manufacturing and distribution functions but gave the supply points no ownership interest in that IP. During 2007-2009 the supply points compensated Coca Cola for use of its IP under a formulary apportionment method to which Coca Cola and IRS had agreed in 1996 when settling Coca Cola’s tax liabilities for 1987-1995. Under that method the supply points were permitted to satisfy their royalty obligations by paying actual royalties or by remitting dividends. During 2007-2009 the supply points remitted to Coca Cola dividends of about $1.8 billion in satisfaction of their royalty obligations. The 1996 agreement did not address the transfer pricing methodology to be used for years after 1995. Upon examination of Coca Cola’s 2007-2009 returns IRS determined that Coca Cola’s methodology did not reflect arm’s-length norms because it over-compensated the supply points and undercompensated Coca Cola for the use of its IP. IRS reallocated income between Coca Cola and the supply points employing a comparable profits method (CPM) that used Coca Cola’s unrelated bottlers as comparable parties. These adjustments increased Coca Cola’s aggregate taxable income for 2007- 2009 by more than $9 billion. The US Tax Court ruled on November 18 that Coca-Cola’s US-based income should be increased by about $9 billion in a dispute over the appropriate royalties owned by its foreign-based licensees for the years from 2007 to 2009. The court reduced the IRS’s adjustment by $1.8 billion because the taxpayer made a valid and timely choice to use an offset treatment when it came to dividends paid by foreign manufacturing affiliates to satisfy royalty obligations. Coca-Cola-US-Tax-Court-Opinion ...

Japan vs. “Metal Plating Corp”, February 2020, Tokyo District Court, Case No 535 of Heisei 27 (2008)

“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 JAP TOKYO 089550_hanrei ...

Finland vs A Group, December 2018, Supreme Administrative Court, Case No. KHO:2018:173

During fiscal years 2006–2008, A-Group had been manufacturing and selling products in the construction industry – insulation and other building components. License fees received by the parent company A OY from the manufacturing companies had been determined by application of the CUP method. The remuneration of the sales companies in the group had been determined by application of the resale price method. The Finnish tax administration, tax tribunal and administrative court all found that the comparable license agreements chosen with regard to determining the intercompany license fees had such differences regarding products, contract terms and market areas that they were incomparable. With regard to the sale of the finished products, they found that the resale price method had not been applied on a sufficiently reliable basis. By reference to the 2010 version of the OECD’s Transfer Pricing Guidelines, they considered the best method for determining the arm’s length remuneration of the group companies was the residual profit split method. The Supreme Administrative Court found that the choice of transfer pricing method constituted the central starting point for the assessment of whether the companies’ tax declarations were to be regarded as incorrect. In this respect special attention should be paid to the version of the OECD Transfer Pricing Guidelines published at the time where the tax return had been submitted. The arm’s length remuneration could be determined by applying the transfer pricing methods used by the companies, and the tax declarations for the years in question were not incorrect in terms of the transfer pricing method applied. The court further noted that the OECD Transfer Pricing Guidelines act as an important source of interpretation. However, in regard to the choice of transfer pricing method, the court did not approve of using guidance provided in the 2010 for fiscal years 2006 – 2008. The later 2010 version of the guidelines contained fundamentally new interpretative recommendations (best method) compared to the 1995 version, where the traditional methods were considered superior to the transactional profit methods, and where the profit split method was reserved to exceptional circumstances. Click here for translation Finland vs taxpayer 2018 HFD ...

US vs Coca Cola, Dec. 2017, US Tax Court, 149 T.C. No. 21

Coca Cola collects royalties from foreign branches and subsidiaries for use of formulas, brand and other intellectual property. Years ago an agreement was entered by Coca Cola and the IRS on these royalty payments to settle an audit of years 1987 to 1995. According to the agreement Coca-Cola licensees in other countries would pay the US parent company royalties using a 10-50-50 formula where 10% of the gross sales revenue is treated as a normal return to the licensee and the rest of the revenue is split evenly between the licensee and the US parent, with the part going to the US parent paid in the form of a royalty. The agreement expired in 1995, but Coca-Cola continued to use the model for transfer pricing in the following years. Coca-Cola and the Mexican tax authorities had agreed on the same formula and Coca-Cola continued to use the pricing-formula in Mexico on the advice of Mexican counsel. In 2015, the IRS made an adjustment related to 2007 – 2009 tax returns stating that Coca-Cola licensees should have paid a higher royalty to the US parent. On that bases the IRS said that too much income had been declared in Coca Cola’s tax returns in Mexico because a higher royalty should have been deducted. The IRS therefore disallowed $43.5 to $50 million in foreign tax credits in each of the three years for taxes that the IRS said Coca-Cola overpaid in Mexico due to failure to deduct the right amount of royalty payments – voluntary tax payments cannot be claimed as a foreign tax credit in the United States. The court sided with Coca-Cola on this question and concluded that the all practical remedies to reduce Mexican taxes had been exhausted and Coca Cola. Foreign tax credits were to be allowed. US vs Coca Cola 2017 ...

Taiwan vs Jat Health Corporation , November 2018, Supreme Administrative Court, Case No 612 of 106

A Taiwanese distributor in the Jat Health Corporation group had deducted amortizations and royalty payments related to distribution rights. These deductions had been partially denied by the Taiwanese tax administration. The case was brought to court. The Supreme Administrative court dismissed the appeal and upheld the assessment. “The Appellant’s business turnover has increased from $868,217 in FY07 to $1,002,570,293 in FY12, with such a high growth rate, and the Appellant has to bear the increase in business tax, which is not an objective comparative analysis and is not sufficient to conclude that the purchase of the disputed supply rights was necessary or reasonable for the operation of the business.” Click here for English Translation 最高行政法院106年判字第612號判決 ...

TPG2017 Chapter VI Annex example 20

69. Ilcha is organised in country A. The Ilcha group of companies has for many years manufactured and sold Product Q in countries B and C through a wholly owned subsidiary, Company S1, which is organised in country B. Ilcha owns patents related to the design of Product Q and has developed a unique trademark and other marketing intangibles. The patents and trademarks are registered by Ilcha in countries B and C. 70. For sound business reasons, Ilcha determines that the group’s business in countries B and C would be enhanced if those businesses were operated through separate subsidiaries in each country. Ilcha therefore organises in country C a wholly owned subsidiary, Company S2. With regard to the business in country C: Company S1 transfers to Company S2 the tangible manufacturing and marketing assets previously used by Company S1 in country C. Ilcha and Company S1 agree to terminate the agreement granting Company S1 the following rights with relation to Product Q: the right to manufacture and distribute Product Q in country C; the right to use the patents and trademark in carrying out its manufacturing and distribution activities in country C; and, the right to use customer relationships, customer lists, goodwill and other items in country C (hereinafter, “the Rightsâ€). Ilcha enters into new, long-term licence agreements with Company S2 granting it the Rights in country C. The newly formed subsidiary thereafter conducts the Product Q business in country C, while Company S1 continues to conduct the Product Q business in Country B. 71. Assume that over the years of its operation, Company S1 developed substantial business value in country C and an independent enterprise would be willing to pay for that business value in an acquisition. Further assume that, for accounting and business valuation purposes, a portion of such business value would be treated as goodwill in a purchase price allocation conducted with regard to a sale of Company S1’s country C business to an independent party. 72. Under the facts and circumstances of the case, there is value being transferred to Company S2 through the combination of (i) the transfer of part of Company S1’s tangible business assets to Company S2 in country C, and (ii) the surrendering by Company S1 of the Rights and the subsequent granting of the Rights by Ilcha to Company S2. There are three separate transactions: the transfer of part of Company S1’s tangible business assets to Company S2 in country C; the surrendering by Company S1 of its rights under the licence back to Ilcha; and the subsequent granting of a licence by Ilcha to Company S2. For transfer pricing purposes, the prices paid by Ilcha and by Company S2 in connection with these transactions should reflect the value of the business which would include amounts that may be treated as the value of goodwill for accounting purposes ...

TPG2017 Chapter VI Annex example 18

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 ...

Luxembourg vs Lux SA, December 2016, Administrative Tribunal Case No 36954

By a trademark license agreement dated August 22, 2008, a group company in Luxembourg granted another group company a non-exclusive right to use and exploit the brands registered in the territory of the Grand Duchy of Luxembourg, Benelux and the European Community for an initial period of ten years, renewable tacitly each time for a period of one year and this against a license fee paid and calculated annually corresponding to 3% of this turnover. By letters of 30 January 2015, the Tax Office informed the company that they intended to refuse to deduct the royalties paid to the company for the years 2010, 2011 and 2010. Click here for translation Lux vs taxpayer 21 dec 2016 36954 ...

Indonesia vs P.T. Sanken Electric Indonesia Ltd, February 2016, Tax Court, Case No. Put.68357/PP/M.IA/15/2016

P.T. Sanken Electric Indonesia Ltd. – an Indonesian subsidiary of Sanken Electric Co., Ltd. Japan – paid royalties to its Japanese parent for use of IP. The royalty payment was calculated based on external sales and therefore did not include sales of products to group companies. The royalty payments were deducted for tax purposes. The tax authorities denied the deduction as the license agreement had not been registrered in Indonesia. Furthermore, the royalty payment was not found to have been determined in accordance with the arm’s length principle. P.T. Sanken Electric Indonesia Ltd appealed the decision of the Tax Court. Judgement of the Tax Court The tax court set aside the assessment and decided in favor of taxpayer. Click here for translation Indonesia PUT 68357-PP-MIA-15-2016 ...

Denmark vs Corp. October 2015, Supreme Court, case nr. SKM2015.659.HR

A Danish production company terminated a 10-year license and distribution agreement with a group distribution company one year prior to expiry of the agreement. The distribution agreement was transferred to another group company and the new distribution company agreed as a successor in interest to pay a “termination fee” to the former distribution company. However, the termination fee was paid by the Danish production company and the amount was depreciated in the tax-return. The Danish company claimed that it was a transfer pricing case and argued that the tax administration could only adjust agreed prices and conditions of the agreement if the requirements for making a transfer pricing correction were met. The Supreme Court stated that the general principles of tax law in the State Tax Act §§ 4-6 also applies to the related companies. Hence, the question was whether the termination fee was held for “acquiring, securing and maintaining the applicant’s income”, cf. the state tax act § 6. The Supreme Court found that payment of the termination fee did not have a sufficient connection to the Danish company’s income acquisition for the payment to be tax deductible. The applicant was therefore not entitled to tax depreciation of the payment. The Supreme Court ruled in favor of the Danish tax administration. Click here for translation Denmark-vs-Corp-October-2015-Supreme-Court-SKM2015-659HR ...

Spain vs. Roche, January 2012, Supreme Court, Case No. 1626/2008

Prior to a business restructuring in 1999, the Spanish subsidiary, Roche Vitaminas S.A., was a full-fledged distributor, involved in manufacturing, importing, and selling the pharmaceutical products in the Spanish and Portuguese markets. In 1999 the Spanish subsidiary and the Swiss parent, Roche Vitamins Europe Ltd., entered into a manufacturing agreement and a distribution agreement. Under the manufacturing agreement, the Spanish subsidiary manufactured products  according to directions and using formulas, know-how, patents, and trademarks from the Swiss parent. These manufacturing activities were remunerated at cost plus 3.3 percent. Under the distribution (agency) agreement, the Spanish subsidiary would “represent, protect and promote†the products. These activities were remunerated at 2 percent of sales. The Spanish subsidiary was now characterized as a contract manufacturer and commission agent and the taxable profits in Spain were much lower than before the business restructuring. The Spanish tax authorities argued that the activities constituted a PE in Spain according to article 5 of DTT between Spain and Switzerland. Therefore, part of the profits should be allocated to the Spanish subsidiary in accordance with article 7 of the DTT. Supreme Court Judgement The Supreme Court held that the restructured Spanish entity created a PE of Roche Vitamins Europe Ltd. in Switzerland. The profits attributed to the PE included not only the manufacturing profits but also profits from the distribution activity performed on behalf of Roche Vitamins Europe Ltd. in Switzerland. Excerpts “The administration is therefore correct in stating that the applicant company operated in Spain by means of a permanent establishment…” “In short, what is laid down in these two paragraphs 1 and 2 of Article 7 of the Spanish-Swiss Convention (in summary form) is that: (a) If a taxpayer acts in a State, of which he is not a resident, through a permanent establishment, then the profits of that taxpayer may be taxed in that State, but only to the extent that such profits are attributable to the said re-establishment. (b) This means that only the profit that the non-resident would have made in that State if he had had a full presence (as a resident), through a separate and distinct company, will be taxable in that State; but, of course, only in respect of the activity carried out by that establishment. The Audiencia Nacional, contrary to this reading of Article 7, establishes that if a non-resident company has a permanent establishment, then it must be taxed in the State in which that establishment is located for all the activities carried out in the territory of that State, even if they are not carried out through the permanent establishment. Contrary to this, and by application of the only possible interpretation of Article 7(1) and (2) (already explained and in accordance with the criteria of the OECD Tax Committee, as we shall see below), a permanent establishment should only be taxed in the State in which it is located on the profit derived from the activity carried out through the permanent establishment.” “…the sales figure must include all sales made by the permanent establishment. We consider that it is established in the file, contrary to the appellant’s submissions, that those sales must include those made to Portuguese customers, since they were made as a result of the promotional and marketing activities of Roche Vitaminas SA and are therefore attributable to it. It is also common ground that the expenses referred to by the appellant have been taken into account, as is stated in the official document dated 12 July 2002. For the rest, we refer to what was established in the settlement agreement dated 23 April 2003, as well as to the full arguments contained in the judgment under appeal.” Click here for english translation Click here for other translation Spain-vs-Roche-Januar-2014-Supreme-Court-case-nr.-1626-2008 ...

US vs Perkin-Elmer Corp. & Subs., September 1993, United States Tax Court, Case No. T.C. Memo. 1993-414

During the years in issue, 1975 through 1981, the worldwide operations of Perkin-Elmer (P-E) and its subsidiaries were organized into five operating groups, each of which was responsible for the research, manufacturing, sales, and servicing of its products. The five product areas were analytical instruments, optical systems, computer systems, flame spray equipment and materials, and military avionics. P-E and PECC entered into a General Licensing Agreement dated as of October 1, 1970, by the terms of which P-E granted PECC an exclusive right to manufacture in Puerto Rico and a nonexclusive right to use and sell worldwide the instruments and accessories to be identified in specific licenses. P-E also agreed to furnish PECC with all design and manufacturing information, including any then still to be developed, associated with any licensed products. PECC agreed to pay royalties on the products based upon the “Net Sales Price”, defined as “the net amount billed and payable for *** [licensed products] excluding import duties, insurance, transportation costs, taxes which are separately billed and normal trade discounts.” In practice, P-E and PECC interpreted this definition to mean the amount PECC billed P-E rather than the amount P-E billed upon resale. The specified term of this agreement was until the expiration of the last license entered into pursuant to the agreement. Following an audit the tax authorities issued an assessment of additional income taxes related to controlled transactions between the above parties. The issues presently before the Tax Court for decision were: [1) Whether the tax authorities’s allocations of gross income to P-E under section 482 were arbitrary, capricious, or unreasonable; (2) whether the prices FE paid for finished products to a wholly owned subsidiary operating in Puerto Rico were arm’s-length amounts; (3) whether the prices the subsidiary paid to P-E for parts that went into the finished products were arm’s-length amounts; (4) whether the royalties the subsidiary paid to P-E on sales of the finished products to P-E were arm’s-length amounts; and (5) for prices or royalties that were not arm’s length, what the arm’s-length amounts are. US vs Perkin-Elmer TCMemo 1993-414 ...

US vs Proctor & Gamble Co, April1992, Court of Appeal (6th Cir.), Case No 961 F.2d 1255

Proctor & Gamble is engaged in the business of manufacturing and marketing of consumer and industrial products. Proctor & Gamble operates through domestic (US) and foreign subsidiaries and affiliates. Proctor & Gamble owned all the stock of Procter & Gamble A.G. (AG), a Swiss corporation. AG was engaged in marketing Proctor & Gamble’s products, generally in countries in which Proctor & Gamble did not have a marketing subsidiary or affiliate. Proctor & Gamble and AG were parties to a License and Service Agreement, known as a package fee agreement, under which AG paid royalties to Proctor & Gamble for the nonexclusive use by AG and its subsidiaries of Proctor & Gamble’s patents, trademarks, tradenames, knowledge, research and assistance in manufacturing, general administration, finance, buying, marketing and distribution. The royalties payable to Proctor & Gamble were based primarily on the net sales of Proctor & Gamble’s products by AG and its subsidiaries. AG entered into agreements similar to package fee agreements with its subsidiaries. In 1967, Proctor & Gamble made preparations to organize a wholly-owned subsidiary in Spain to manufacture and sell its products in that country. Spanish laws in effect at that time closely regulated foreign investment in Spanish companies. The Spanish Law of Monetary Crimes of November 24, 1938, in effect through 1979, regulated payments from Spanish entities to residents of foreign countries. This law required governmental authorization prior to payment of pesetas to residents of foreign countries. Making such payments without governmental authorization constituted a crime. Decree 16/1959 provided that if investment of foreign capital in a Spanish company was deemed economically preferential to Spain, a Spanish company could transfer in pesetas “the benefits obtained by the foreign capital.” Proctor & Gamble requested authorization to organize Proctor & Gamble Espana S.A. (Espana) and to own, either directly or through a wholly-owned subsidiary, 100 percent of the capital stock of Espana. Proctor & Gamble stated that its 100 percent ownership of Espana would allow Espana immediate access to additional foreign investment, and that Proctor & Gamble was in the best position to bear the risk associated with the mass production of consumer products. Proctor & Gamble also indicated that 100 percent ownership would allow Proctor & Gamble to preserve the confidentiality of its technology. As part of its application, Proctor & Gamble estimated annual requirements for pesetas for the first five years of Espana’s existence. Among the items listed was an annual amount of 7,425,000 pesetas for royalty and technical assistance payments. Under Spanish regulations, prior authorization of the Spanish Council of Ministers was required in order for foreign ownership of the capital of a Spanish corporation to exceed fifty percent. The Spanish government approved Proctor & Gamble’s application for 100 percent ownership in Espana by a letter dated January 27, 1968. The letter expressly stated that Espana could not, however, pay any amounts for royalties or technical assistance. For reasons that are unclear in the record, it was determined that AG, rather than Proctor & Gamble, would hold 100 percent interest in Espana. From 1969 through 1979, Espana filed several applications with the Spanish government seeking to increase its capital from the amount originally approved. The first such application was approved in 1970. The letter granting the increase in capital again stated that Espana “will not pay any amount whatsoever in the concept of fees, patents, royalties and/or technical assistance to the investing firm or to any of its affiliates, unless with the approval of the Administration.” All future applications for capital increases that were approved contained the same prohibition. In 1973, the Spanish government issued Decree 2343/1973, which governed technology agreements between Spanish entities and foreign entities. In order to obtain permission to transfer currency abroad under a technology agreement, the agreement had to be recorded with the Spanish Ministry of Industry. Under the rules for recording technology agreements, when a foreign entity assigning the technology held more than 50 percent of the Spanish entity’s capital, a request for registration of a technology agreement was to be looked upon unfavorably. In cases where foreign investment in the Spanish entity was less than 50 percent, authorization for payment of royalties could be obtained. In 1976, the Spanish government issued Decree 3099/1976, which was designed to promote foreign investment. Foreign investment greater than 50 percent of capital in Spanish entities was generally permitted, but was conditioned upon the Spanish company making no payments to the foreign investor, its subsidiaries or its affiliates for the transfer of technology. Espana did not pay a package fee for royalties or technology to AG during the years at issue. Espana received permission on three occasions to pay Proctor & Gamble for specific engineering services contracts. The Spanish Foreign Investments Office clarified that payment for these contracts was not within the general prohibition against royalties and technical assistance payments. Espana never sought formal relief from the Spanish government from the prohibition against package fees. In 1985, consistent with its membership in the European Economic Community, in Decree 1042/1985 Spain liberalized its system of authorization of foreign investment. In light of these changes, Espana filed an application for removal of the prohibition against royalty payments. This application was approved, as was Espana’s application to pay package fees retroactive to July 1, 1987. Espana first paid a dividend to AG during the fiscal year ended June 30, 1987. The Commissioner determined that a royalty of two percent of Espana’s net sales should be allocated to AG as royalty payments under section 482 for 1978 and 1979 in order to reflect AG’s income. The Commissioner increased AG’s income by $1,232,653 in 1978 and by $1,795,005 in 1979 and issued Proctor & Gamble a notice of deficiency.1 Proctor & Gamble filed a petition in the Tax Court seeking review of the deficiencies. The Tax Court held that the Commissioner’s allocation of income was unwarranted and that there was no deficiency. The court concluded that allocation of income under section 482 was not proper in this case because Spanish ...

US vs BAUSCH & LOMB INC, May 1991, United States Court of Appeals, No. 1428, Docket 89-4156.

BAUSCH & LOMB Inc (B&L Inc) and its subsidiaries were engaged in the manufacture, marketing and sale of soft contact lenses and related products in the United States and abroad. B&L Ireland was organized on February 1, 1980, under the laws of the Republic of Ireland as a third tier, wholly owned subsidiary of petitioner. B&L Ireland was organized for valid business reasons and to take advantage of certain tax and other incentives offered by the Republic of Ireland. Pursuant to an agreement dated January 1, 1981, petitioner granted to B&L Ireland a nonexclusive license to use its patented and unpatented manufacturing technology to manufacture soft contact lenses in Ireland and a nonexclusive license to use certain of its trademarks in the sale of soft contact lenses produced through use of the licensed technology worldwide. In return, B&L Ireland agreed to pay B&L Inc. a royalty equal to five percent of sales. In 1981 and 1982, B&L Ireland engaged in the manufacture and sale of soft contact lenses in the Republic of Ireland. All of B&L Ireland’s sales were made either to B&L Inc or certain of B&L Inc’s wholly owned foreign sales affiliates at a price of $7.50 per lens. The tax authorities determined that the $7.50 sales price did not constitute an arm’s-length consideration for the soft contact lenses sold by B&L Ireland to B&L Inc. Furthermore the authorities determined that, the royalty contained in the January 1, 1981 license agreement did not constitute an arm’s-length consideration for the use by B&L Ireland of B&L Inc’s intangibles. Opinion of the Tax Court A. Determination of Arm’s-Length Prices Between B&L Inc and B&L Ireland for Soft Contact Lenses “… The market price for any product will be equal to the price at which the least efficient producer whose production is necessary to satisfy demand is willing to sell. During 1981 and 1982, the lathing methods were still the predominant production technologies employed in the soft contact lens industry. American Hydron, an affiliate of NPDC and a strong competitor in the contact lens market, was able to produce 466,348 and 762, 379 soft contact lenses using the lathing method in 1981 and 1982, for $6.18 and $6.46 per unit, respectively. It is questionable whether any of B&L Ireland’s competitors, save B&L, could profitably have sold soft contact lenses during the period in issue for less than the $7.50 charged by B&L Ireland. The fact that B&L Ireland could, through its possession of superior production technology, undercut the market and sell at a lower price is irrelevant. Petitioners have shown that the $7.50 they paid for lenses was a ‘market price‘ and have thus ‘earned the right to be free from a section 482 reallocation.‘ United States Steel Corp. v. Commissioner, supra at 947. Finally, respondent argues that B&L COULD HAVE produced the contact lenses purchased from B&L Ireland itself at lesser cost. However, B&L DID NOT produce the lenses itself. The mere power to determine who in a controlled group will earn income cannot justify a section 482 allocation of the income from the entity who actually earned the income. Bush Hog Mfg. Co. v. Commissioner, 42 T.C. 713, 725 (1964); Polak’s Frutal Works, Inc. v. Commissioner, 21 T.C. 953, 976 (1954). B&L Ireland was the entity which actually produced the contact lenses. Respondent is limited to determining how the sales to B&L by B&L Ireland would have been priced had the parties been unrelated and negotiating at arm’s length. We have determined that the $7.50 charged was a market price. We thus conclude that respondent abused his discretion and acted arbitrarily and unreasonably in reallocating income between B&L and B&L Ireland based on use of a transfer price for contact lenses other than the $7.50 per lens actually used. When conditions for use of the comparable uncontrolled price method are present, use of that method to determine an arm’s-length price is mandated. Sec. 1.482-2(e)(1)(ii), Income Tax Regs. Therefore, we need not consider petitioner’s alternative position — that application of the resale price method supports the arm’s-length nature of the $7.50 transfer price. We note, however, that application of such method lends further support to the arm’s-length nature of B&L Ireland’s $7.50 sales price. Uncontrolled purchases and resales by American Optical, Southern, Bailey-Smith, and Mid-South indicate gross profit percentages of between 22 and 40 percent were common among soft contact lens distributors. This is confirmed by the testimony of Thomas Sloan, president of Southern, who testified that he tried to purchase lenses from manufacturers at prices which allowed Southern to maintain a reasonable profit margin of between 25 and 40 percent. Applying a 40- percent gross margin to B&L’s average realized price of $16.74 and $15.25 for domestic sales in 1981 and 1982, respectively, indicates a lens cost of $10.04 and $9.15, respectively — well above the $7.50 received by B&L Ireland for its lenses and also above the $8.12 cost to B&L when freight and duty are added.” B. Determination of Arm’s-Length Royalty Payable by B&L Ireland for use of B&L’s Intangibles “… Obviously, no independent party would enter into an agreement for the license of intangibles under circumstances in which the royalty charged would preclude any reasonable expectation of earning a profit through use of the intangibles. We therefore find respondent’s section 482 allocation with respect to the royalty to be arbitrary, capricious and unreasonable. Our rejection of the royalty rate advocated by respondent does not, however, require that we accept that proposed by petitioners. G.D. Searle v. Commissioner, 88 T.C. at 367. Both Dr. Arons and Dr. Plotkin testified that in their opinion a royalty of five percent of the transfer price charged for the contact lenses sold by B&L Ireland was inadequate as arm’s-length consideration. On brief, petitioners recalculated the royalty due from B&L Ireland based on five percent of the average realized price (ARP) of Irish-produced lenses, arriving at royalties of $1,072,522 and $3,050,028 for 1981 and 1982, respectively. This translates to a royalty of ...

US vs Proctor & Gamble, September 1990, US Tax Court, Opinion No. 16521-84.

Proctor & Gamble is an US corporation engaged in the business of manufacturing and marketing of consumer and industrial products. Proctor & Gamble operates through domestic and foreign subsidiaries and affiliates. Proctor & Gamble owned all the stock of Procter & Gamble A.G. (AG), a Swiss corporation. AG was engaged in marketing Proctor & Gamble’s products, generally in countries in which Proctor & Gamble did not have a marketing subsidiary or affiliate. Proctor & Gamble and AG were parties to a License and Service Agreement, known as a package fee agreement, under which AG paid royalties to Proctor & Gamble for the nonexclusive use by AG and its subsidiaries of Proctor & Gamble’s patents, trademarks, tradenames, knowledge, research and assistance in manufacturing, general administration, finance, buying, marketing and distribution. The royalties payable to Proctor & Gamble were based primarily on the net sales of Proctor & Gamble’s products by AG and its subsidiaries. AG entered into agreements similar to package fee agreements with its subsidiaries. In 1967, Proctor & Gamble made preparations to organize a wholly-owned subsidiary in Spain to manufacture and sell its products in that country. Spanish laws in effect at that time closely regulated foreign investment in Spanish companies. The Spanish Law of Monetary Crimes of November 24, 1938, in effect through 1979, regulated payments from Spanish entities to residents of foreign countries. This law required governmental authorization prior to payment of pesetas to residents of foreign countries. Making such payments without governmental authorization constituted a crime. Decree 16/1959 provided that if investment of foreign capital in a Spanish company was deemed economically preferential to Spain, a Spanish company could transfer in pesetas “the benefits obtained by the foreign capital.” Proctor & Gamble requested authorization to organize Proctor & Gamble Espana S.A. (Espana) and to own, either directly or through a wholly-owned subsidiary, 100 percent of the capital stock of Espana. Proctor & Gamble stated that its 100 percent ownership of Espana would allow Espana immediate access to additional foreign investment, and that Proctor & Gamble was in the best position to bear the risk associated with the mass production of consumer products. Proctor & Gamble also indicated that 100 percent ownership would allow Proctor & Gamble to preserve the confidentiality of its technology. As part of its application, Proctor & Gamble estimated annual requirements for pesetas for the first five years of Espana’s existence. Among the items listed was an annual amount of 7,425,000 pesetas for royalty and technical assistance payments. Under Spanish regulations, prior authorization of the Spanish Council of Ministers was required in order for foreign ownership of the capital of a Spanish corporation to exceed fifty percent. The Spanish government approved Proctor & Gamble’s application for 100 percent ownership in Espana by a letter dated January 27, 1968. The letter expressly stated that Espana could not, however, pay any amounts for royalties or technical assistance. For reasons that are unclear in the record, it was determined that AG, rather than Proctor & Gamble, would hold 100 percent interest in Espana. From 1969 through 1979, Espana filed several applications with the Spanish government seeking to increase its capital from the amount originally approved. The first such application was approved in 1970. The letter granting the increase in capital again stated that Espana “will not pay any amount whatsoever in the concept of fees, patents, royalties and/or technical assistance to the investing firm or to any of its affiliates, unless with the approval of the Administration.” All future applications for capital increases that were approved contained the same prohibition. In 1973, the Spanish government issued Decree 2343/1973, which governed technology agreements between Spanish entities and foreign entities. In order to obtain permission to transfer currency abroad under a technology agreement, the agreement had to be recorded with the Spanish Ministry of Industry. Under the rules for recording technology agreements, when a foreign entity assigning the technology held more than 50 percent of the Spanish entity’s capital, a request for registration of a technology agreement was to be looked upon unfavorably. In cases where foreign investment in the Spanish entity was less than 50 percent, authorization for payment of royalties could be obtained. In 1976, the Spanish government issued Decree 3099/1976, which was designed to promote foreign investment. Foreign investment greater than 50 percent of capital in Spanish entities was generally permitted, but was conditioned upon the Spanish company making no payments to the foreign investor, its subsidiaries or its affiliates for the transfer of technology. Espana did not pay a package fee for royalties or technology to AG during the years at issue. Espana received permission on three occasions to pay Proctor & Gamble for specific engineering services contracts. The Spanish Foreign Investments Office clarified that payment for these contracts was not within the general prohibition against royalties and technical assistance payments. Espana never sought formal relief from the Spanish government from the prohibition against package fees. In 1985, consistent with its membership in the European Economic Community, in Decree 1042/1985 Spain liberalized its system of authorization of foreign investment. In light of these changes, Espana filed an application for removal of the prohibition against royalty payments. This application was approved, as was Espana’s application to pay package fees retroactive to July 1, 1987. Espana first paid a dividend to AG during the fiscal year ended June 30, 1987. The Commissioner determined that a royalty of two percent of Espana’s net sales should be allocated to AG as royalty payments under section 482 for 1978 and 1979 in order to reflect AG’s income. The Commissioner increased AG’s income by $1,232,653 in 1978 and by $1,795,005 in 1979 and issued Proctor & Gamble a notice of deficiency.1 Proctor & Gamble filed a petition in the Tax Court seeking review of the deficiencies. Decision of the Tax Court The Tax Court held that the Commissioner’s allocation of income was unwarranted and that there was no deficiency. The court concluded that allocation of income under section 482 was ...

France vs. Caterpillar, October 1989, CE No 65009

In Caterpillar, a 5% royalty was found to be an arm’s-length rate for the manufacturing and assembling operations. The court did not accept that there should be different rates for the two different activities. Excerpt from the Judgement “…According to the administration, the rate of the royalty paid by the company “Caterpillar France” is admissible only when it applies to the selling price of equipment entirely manufactured by the company, but not when it affects the gross margin made on equipment that the company has only assembled, since the assembly operations make less use of the technology and know-how acquired by the American company than the machining operations themselves; that, however, the details provided and the documents produced in this respect by the company do not make it possible to make such a distinction between the operations that successively contribute to the production of the finished products; that the uniform rate of the fee cannot, in the circumstances of the case, be regarded as excessive; that, consequently, the Minister is not justified in maintaining that the Administrative Court was wrong to hold that, as regards the tax years 1969 to 1972, the company ‘Caterpillar France’ provided proof that, contrary to what the departmental commission considered, the amount of the royalty paid by it to the company ‘Caterpillar Tractor’ was justified in the light of the rights granted and the services rendered, that, as regards the tax years 1973 to 1976, the administration did not establish that the royalty could have constituted a means of transferring profits, and that, for all these years, the disputed increases could not find a legal basis in the provisions of Article 57 of the General Tax Code;” Click here for English translation Click here for other translation France vs Caterpillar Oct 1989 CE No 65009 ...

US vs BAUSCH & LOMB INC, March 1989, US Tax Court Docket No 3394-86

BAUSCH & LOMB Inc (B&L Inc) and its subsidiaries were engaged in the manufacture, marketing and sale of soft contact lenses and related products in the United States and abroad. B&L Ireland was organized on February 1, 1980, under the laws of the Republic of Ireland as a third tier, wholly owned subsidiary of petitioner. B&L Ireland was organized for valid business reasons and to take advantage of certain tax and other incentives offered by the Republic of Ireland. Pursuant to an agreement dated January 1, 1981, petitioner granted to B&L Ireland a nonexclusive license to use its patented and unpatented manufacturing technology to manufacture soft contact lenses in Ireland and a nonexclusive license to use certain of its trademarks in the sale of soft contact lenses produced through use of the licensed technology worldwide. In return, B&L Ireland agreed to pay B&L Inc. a royalty equal to five percent of sales. In 1981 and 1982, B&L Ireland engaged in the manufacture and sale of soft contact lenses in the Republic of Ireland. All of B&L Ireland’s sales were made either to B&L Inc or certain of B&L Inc’s wholly owned foreign sales affiliates at a price of $7.50 per lens. The tax authorities determined that the $7.50 sales price did not constitute an arm’s-length consideration for the soft contact lenses sold by B&L Ireland to B&L Inc. Furthermore the authorities determined that, the royalty contained in the January 1, 1981 license agreement did not constitute an arm’s-length consideration for the use by B&L Ireland of B&L Inc’s intangibles. Opinion of the Tax Court A. Determination of Arm’s-Length Prices Between B&L Inc and B&L Ireland for Soft Contact Lenses “… The market price for any product will be equal to the price at which the least efficient producer whose production is necessary to satisfy demand is willing to sell. During 1981 and 1982, the lathing methods were still the predominant production technologies employed in the soft contact lens industry. American Hydron, an affiliate of NPDC and a strong competitor in the contact lens market, was able to produce 466,348 and 762, 379 soft contact lenses using the lathing method in 1981 and 1982, for $6.18 and $6.46 per unit, respectively. It is questionable whether any of B&L Ireland’s competitors, save B&L, could profitably have sold soft contact lenses during the period in issue for less than the $7.50 charged by B&L Ireland. The fact that B&L Ireland could, through its possession of superior production technology, undercut the market and sell at a lower price is irrelevant. Petitioners have shown that the $7.50 they paid for lenses was a ‘market price‘ and have thus ‘earned the right to be free from a section 482 reallocation.‘ United States Steel Corp. v. Commissioner, supra at 947. Finally, respondent argues that B&L COULD HAVE produced the contact lenses purchased from B&L Ireland itself at lesser cost. However, B&L DID NOT produce the lenses itself. The mere power to determine who in a controlled group will earn income cannot justify a section 482 allocation of the income from the entity who actually earned the income. Bush Hog Mfg. Co. v. Commissioner, 42 T.C. 713, 725 (1964); Polak’s Frutal Works, Inc. v. Commissioner, 21 T.C. 953, 976 (1954). B&L Ireland was the entity which actually produced the contact lenses. Respondent is limited to determining how the sales to B&L by B&L Ireland would have been priced had the parties been unrelated and negotiating at arm’s length. We have determined that the $7.50 charged was a market price. We thus conclude that respondent abused his discretion and acted arbitrarily and unreasonably in reallocating income between B&L and B&L Ireland based on use of a transfer price for contact lenses other than the $7.50 per lens actually used. When conditions for use of the comparable uncontrolled price method are present, use of that method to determine an arm’s-length price is mandated. Sec. 1.482-2(e)(1)(ii), Income Tax Regs. Therefore, we need not consider petitioner’s alternative position — that application of the resale price method supports the arm’s-length nature of the $7.50 transfer price. We note, however, that application of such method lends further support to the arm’s-length nature of B&L Ireland’s $7.50 sales price. Uncontrolled purchases and resales by American Optical, Southern, Bailey-Smith, and Mid-South indicate gross profit percentages of between 22 and 40 percent were common among soft contact lens distributors. This is confirmed by the testimony of Thomas Sloan, president of Southern, who testified that he tried to purchase lenses from manufacturers at prices which allowed Southern to maintain a reasonable profit margin of between 25 and 40 percent. Applying a 40- percent gross margin to B&L’s average realized price of $16.74 and $15.25 for domestic sales in 1981 and 1982, respectively, indicates a lens cost of $10.04 and $9.15, respectively — well above the $7.50 received by B&L Ireland for its lenses and also above the $8.12 cost to B&L when freight and duty are added. B. Determination of Arm’s-Length Royalty Payable by B&L Ireland for use of B&L’s Intangibles “… Obviously, no independent party would enter into an agreement for the license of intangibles under circumstances in which the royalty charged would preclude any reasonable expectation of earning a profit through use of the intangibles. We therefore find respondent’s section 482 allocation with respect to the royalty to be arbitrary, capricious and unreasonable. Our rejection of the royalty rate advocated by respondent does not, however, require that we accept that proposed by petitioners. G.D. Searle v. Commissioner, 88 T.C. at 367. Both Dr. Arons and Dr. Plotkin testified that in their opinion a royalty of five percent of the transfer price charged for the contact lenses sold by B&L Ireland was inadequate as arm’s-length consideration. On brief, petitioners recalculated the royalty due from B&L Ireland based on five percent of the average realized price (ARP) of Irish-produced lenses, arriving at royalties of $1,072,522 and $3,050,028 for 1981 and 1982, respectively. This translates to a royalty of ...

TPG1979 Chapter III Paragraph 137

Because of the considerations set out above, it is necessary, in seeking to arrive at the arm’s length price for the right to use a trademark or trade name, to approach this matter rather differently in some respects from the way in which the problem would be approached in the case of a patent royalty or other similar intangible. However, as with transfers of technology, the essential question here is what benefit is transferred. In answering this question, it is necessary to assess all the obligations implied by the licensing agreement and the likely costs to be incurred or saved by both parties. The costs incurred by the licensee under the licence contract will affect the amount of any trademark royalty which he is required to pay. In arriving at the arm’s length price, it may be possible to use the comparable uncontrolled price method if a trademark or trademarks with similar effects are licensed to unrelated enterprises, though as with patent royalties there may be little useful evidence available for this kind of comparison (moreover the impact and the value of a trademark in one market will not necessarily be the same as in another): it will not be very useful to refer to the costs of developing the trademark as a foundation for this calculation since these will not normally be relevant, whereas it may well be relevant to have regard to the costs of maintaining the value of the trademark, including the costs of advertising and quality control; some help may be found, if adequate evidence is available, by comparing the volume of sales and the prices chargeable and profits realised for trademarked goods with those for similar goods which do not carry the trademark ...

TPG1979 Chapter III Paragraph 135

Between associated enterprises more complicated contracts and wide-ranging arrangements are common. There may be different forms of cross-licensing agreements and affiliates may agree on joining a licence pool. ” Package deals ” seem to be widely used by MNEs. The arrangement in a multinational enterprise may be that all members are entitled to use, normally for a consideration, the trademarks, trade names, patents and other intangible property developed by any member of the group ...

TPG1979 Chapter III Paragraph 134

Technical assistance provided by the licensor would be one example where trademark licensing is closely linked to other transactions between the same parties. In other cases, the owner of the trade mark may sell finished or semi-finished products to the licensee. Also, a manufacturing enterprise may be allowed to use a patent for the pro duction and a trademark for the marketing of certain goods. All embracing licensing contracts and similar arrangements are quite often found in practice ...

TPG1979 Chapter III Paragraph 133

What is provided by the owner of a trademark is not limited to measures to ensure the legal validity of the mark which is licensed, and to taking care that it is properly used and protecting it against infringements by other parties. The licensing of a trademark is nearly always coupled with efforts by the licensor to keep the image of the product up-to-date and with a strict control of the quality of the product or its components or of the processing, manufacturing and storage conditions of the products to be sold under the trademark licensed. If a licensor wants to secure that the products made and sold or the services rendered under the licensed trademark meet his quality standards, this will lead almost automatically to a certain degree of technical guidance. On the other hand, the licensee would often be expected to co-operate in promoting the trademark for the common benefit and to take account of trends in consumer attitudes. Because co-operation between licensee and licensor is a feature of trademark licensing, it will therefore affect the nature and amount of payments made under the relevant contracts ...

TPG1979 Chapter III Paragraph 132

Various kinds of licence contracts are concluded in practice. There are two main categories: first, the licensee could be a dealer who is allowed to use the trademark in selling products manufactured by the licensor and owner of the trademark; secondly, the owner of a trademark could license a trademark to an enterprise which will use the sign for goods that it produces itself or buys from other sources. The terms and conditions of licence agreements may vary to a considerable extent ...

TPG1979 Chapter III Paragraph 131

It seems to be generally recognised nowadays that a trade mark may be sold or otherwise transferred by one person to another. It is also admitted, in principle, that the owner of a trademark may allow another person to use his trademark under certain conditions. Trademark licensing has become a common practice, particularly in international trade ...

TPG1979 Chapter III Paragraph 130

A trade name (often the name of an enterprise) may have the same force of penetration as a trademark and may indeed be registered in some specific form as a trademark. The names of certain multinational enterprises in pharmaceutical or electronic industries, for example, have an excellent sales promotion value, and they may be used for the marketing of a variety of goods or services. The names of well-known persons, designers, sportsmen, actors, people working in show business, etc., may also be used as trade names and trademarks, and they have often been very successful marketing instruments ...