Avon Cosmetics s.r.o. paid 6% of its net sales in royalties/licences for the use of intangible assets to a Group company in Ireland. The Irish company in turn was contractually obliged to pay 5.68% of Avon Cosmetics s.r.o.’s net sales as royalties to its US parent company. In the opinion of the tax authorities, the beneficial owner of the royalties was not the Irish company but the US parent and therefore the royalty payments were not exempt from withholding tax. An assessment of additional withholding tax was therefore issued. Decision of the Supreme Administrative Court The Supreme Administrative Court upheld the decision of the tax authorities and found that the US parent company was the beneficial owner of the royalties. Excerpt in English “[32] The interpretation of the concept of beneficial owner, including in the context of the OECD Model Tax Treaty relied on by the complainant, was dealt with by the Municipal court in the judgment referred to in N Luxembourg 1 and Others, which, although it dealt with preliminary questions relating to the exemption of interest from income tax, its conclusions can be applied without further ado to royalties, given the similarity of the legislation. In that judgment, the CJEU stated: “The concept of ‘beneficial owner of interest’ within the meaning of the Directive must therefore be interpreted as referring to the entity which actually benefits from the interest paid to it. Article 1(4) of the same directive supports this reference to economic reality by specifying that a company of a Member State is to be regarded as the beneficial owner of interest or royalties only if it receives them for itself and not for another person as an intermediary, such as an agent, trustee or principal. [paragraph 88] … It is clear from the development of the OECD Model Tax Treaty and the related commentaries, as described in paragraphs 4 to 6 of this judgment, that the concept of ‘beneficial owner’ excludes conduit companies and cannot be understood in a narrow and technical sense, but in a sense which makes it possible to avoid double taxation and prevent tax avoidance and evasion. [… Article 1(1) of Directive 2003/49, read in conjunction with Article 1(4) of that directive, must be interpreted as meaning that the exemption from any tax on interest provided for therein is reserved only to the beneficial owners of such interest, that is to say, to the entities which actually benefit economically from that interest and are therefore entitled to determine freely how it is used. [paragraph 122]’. [33] The Supreme Administrative Court reached similar conclusions in its judgment of 12 November 2019, no. 10 Afs 140/2018-32. In doing so, it also relied on the commentary to Article 12(4.3) of the OECD Model Tax Treaty cited by the complainant. In that judgment, the Supreme Administrative Court concluded that “the recipient of the (sub)royalties is the beneficial owner of the royalties only if it can use and enjoy them without restriction and is not obliged by law or contract to pass the payments on to another person”. In the present case, the Supreme Administrative Court finds no reason to depart from those conclusions in any way. [34] The answer to the question whether the complainant meets the statutory conditions for the exemption of royalty income from income tax therefore depends on an assessment of whether the complainant is the beneficial owner of the royalties, i.e. whether it actually benefits economically from them, is free to determine how they are used and is not obliged by law or contract to pass the payments on to another person. [35] At this point, the Supreme Administrative Court recalls that the administrative proceedings concerned the applicant’s application for a decision granting an exemption from the royalty income paid exclusively by ACS. The complainant attached to that application an extract from the commercial register, according to which she is the sole shareholder of ACS. In support of its application, the complainant attached a trademark and trade name use agreement dated 9 October 1993 between API and ACS, under which ACS, as licensee, is obliged to pay, as remuneration for the licensed rights (trademarks, trade names, copyrights and patents of AVON), a royalty of 6 % of the net sales of products, in US dollars, within 30 days of the last day of each calendar quarter of the term of the agreement. The Complainant also submitted a license agreement dated June 30, 2016, which it entered into with API and AIO as licensors. By this agreement, the Complainant licensed the use and exercise of API’s proprietary rights (API’s rights relating to technical information, patent rights and commercial rights – trademarks, industrial designs, trade names, copyrights) and the right to receive royalties under the current license agreements (including the aforementioned agreement with ACS) and agreed to pay a royalty of 5.68% of its and its sublicensees’ net sales, in U.S. dollars, within 60 days of the last day of each calendar quarter of the term of this agreement. These findings of fact were made by both the defendant and the municipal court. [36] It follows from the foregoing that the plaintiff, by entering into the agreement with API and AIO, acquired both the authority and the obligation to collect royalties from ACS, while contractually obligating itself to pay royalties to AIO for the same licensed rights. Thus, within 30 days of the end of each calendar quarter, the Complainant collects royalties from ACS at the rate of 6% of its net sales, and if it receives payment from ACS only on the last day, it then has 30 days to pay AIO royalties including an amount equal to 5.68% of ACS’s net sales. The complainant therefore pays 94.6667% of the royalties it collects from ACS to AIO. In essence, this is a contractual obligation to pass on the vast majority of the royalty payment received to another party. [37] The Supreme Administrative Court agrees with the Municipal court and the defendant that the ...

Due to the economic situation of automotive suppliers in Germany in 2006, “Cutting Tech GMBH” established a subsidiary (CB) in Bosnien-Herzegovina which going forward functioned as a contract manufacturer. CB did not develop the products itself, but manufactured them according to specifications provided by “Cutting Tech GMBH”. The majority of “Cutting Tech GMBH”‘s sales articles were subject to multi-stage production, which could include various combinations of production processes. In particular, “Cutting Tech GMBH” was no longer competitive in the labour-intensive manufacturing processes (cut-off grinding, turning, milling) due to the high wage level in Germany. Good contribution margins from the high-tech processes (adiabatic cutting, double face grinding) increasingly had to subsidise the losses of the labour-intensive processes. Individual production stages, however, could not be outsourced to external producers for reasons of certification and secrecy. In addition, if the production had been outsourced, there would have been a great danger that a third company would have siphoned off “Cutting Tech GMBH”‘s know-how and then taken over the business with “Cutting Tech GMBH”‘s customer. This could have led to large losses in turnover for “Cutting Tech GMBH”. Furthermore, some of the labour-intensive work also had to cover one or more finishing stages of the high-tech processes, so that this business was also at risk if it was outsourced. For these reasons, the decision was made to outsource the labour-intensive production processes to Bosnia-Herzegovina in order to become profitable again and to remain competitive in the future. There, there were German-speaking staff with the necessary expertise, low customs duties and a low exchange rate risk. CB functioned as a contract manufacturer with the processes of production, quality assurance and a small administrative unit. Cost advantages existed not only in personnel costs, but also in electricity costs. CB prevented the plaintiff’s good earnings from the high-tech processes in Germany from having to continue to be used to subsidise the low-tech processes. “Cutting Tech GMBH” supplied CB with the material needed for production. The deliveries were processed as sales of materials. “Cutting Tech GMBH” received as purchase prices its cost prices without offsetting profit mark-ups or handling fees/commissions. The material was purchased and supplied to CB by “Cutting Tech GMBH”, which was able to obtain more favourable purchase prices than CB due to the quantities it purchased. The work commissioned by “Cutting Tech GMBH” was carried out by CB with the purchased material and its personnel. CB then sold the products to “Cutting Tech GMBH”. In part, they were delivered directly by CB to the end customers, in part the products were further processed by “Cutting Tech GMBH” or by third-party companies. “Cutting Tech GMBH” determined the transfer prices for the products it purchased using a “contribution margin calculation”. Until 2012, “Cutting Tech GMBH” purchased all products manufactured by CB in Bosnia and Herzegovina. From 2013 onwards, CB generated its own sales with the external company P. This was a former customer of “Cutting Tech GMBH”. Since “Cutting Tech GMBH” could not offer competitive prices to the customer P in the case of production in Germany, CB took over the latter’s orders and supplied P with the products it manufactured in accordance with the contracts concluded. CB did not have its own distribution in the years in dispute. The tax audit of FY 2011 – 2013 The auditor assumed that the transfer of functions and risks to CB in 2007/2008 basically fulfilled the facts of a transfer of functions. However, since only a routine function had been transferred, “Cutting Tech GMBH” had rightly carried out the transfer of functions without paying any special remuneration. Due to CB’s limited exposure to risks, the auditor considered that the cost-plus method should be used for transfer pricing. In adjusting the transfer prices, the auditor assumed a mark-up rate of 12%. The material invoiced by “Cutting Tech GMBH” and the scrap proceeds was not included in the cost basis used in the assessment. For 2013, the auditor took into account that the customer P had agreed contracts exclusively with CB and reduced the costs by the costs of the products sold to P. Furthermore, the auditor took the legal view that the entire audit period should be considered uniformly. Therefore, it was appropriate to deduct an amount of €64,897 in 2011, which had been calculated in favour of “Cutting Tech GMBH” in 2010 and not taken into account in the tax assessment notices, in order to correct the error. The auditor did not consider it justified to determine the transfer prices for “Cutting Tech GMBH”‘s purchases of goods by means of a so-called contribution margin calculation. Based on the functional and risk analysis, the auditor concluded that CB was a contract manufacturer. On the grounds that this profit of CB was remuneration for a routine function, the auditor refrained from recognising a vGA because of the transfer of client P from the applicant to CB. However, he stated that according to arm’s length royalty rates, values between 1% and 3% could be recognised as royalty “according to general practical experience.” “Cutting Tech GMBH” filed an appeal against the assessment in 2015 and in November 2019 the Tax Court parcially allowed the appeal of “Cutting Tech GMBH” and adjusted the assessment issued by the tax authorities. An appeal and cross appeal against the decision of the Tax Court was then filed with the Federal Tax Court (BFH). Judgement of the BFH The Federal Tax Court overturned the decision of the Tax Court and referred the case back to the Tax Court for another hearing and decision. “The appeals of the plaintiff and the FA are well-founded. They lead to the previous decision being set aside and the matter being referred back to the Fiscal Court for a different hearing and decision (§ 126 Para. 3 Sentence 1 No. 2 FGO). The arm’s length comparison carried out by the lower court to determine the transfer prices for the acquisition of processed products from C by the Plaintiff is not free of legal ...

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

YOLT Services s.r.o. is active in distribution of TV programmes and paid royalties/license for use of these programmes to its parent company in Romania and subsidiaries in Hungary and Slovakia. These companies were contractually obliged to pay royalties received on to the producers of the programmes. According to the tax authorites, the beneficial owners of the royalties were not the group companies, but rather the producers of the programmes. On that basis the royalty payments were not excempt from withholding taxes. An assessment of additional taxes was issued where withholding taxes had been calculated as 15% of the royalties paid by YOLT services. Judgement of the Regional Court The court upheld the decision of the tax authorities in regards of the producers – and not the group companies – beeing the beneficial owners of the royalties. But the court referred the case back to the to the tax authorities in regards of the withholding tax percentages applied, as these followed from the Double Tax Treaties entered with the relevant jurisdictions of the producers. Excerpt “It follows from the above that the mere forwarding of royalties through an intermediary entity does not imply the impossibility of applying the FTAA concluded by the Czech Republic with the country of tax residence of the beneficial owner of the income. Provided that other conditions are met, the tax authorities may not only apply the international treaty to the matter covered by the treaty, but are obliged to apply such treaty (Article 37 of the Tax Code in the relevant wording; see also the judgment of the Supreme Administrative Court of 25 May 2013, No. 9 Afs 38/2012-40).” Click here for English Translation Click here for other translation ...

The tax authorities had issued a notice of assessment in which royalty payments had been adjusted on the basis of the arm’s length principle. “I_ 3.1.8 – 9,027,469.67 euros – Transfer prices – Royalties After verifying all documentation submitted by dependent companies F…Hipermercados, SA and P…Distribuição Alimentar, SA, at the request of the Tax Administration during external inspections of a general scope carried out on the books of each of the said companies, relative to royalty costs paid by them to a Swiss entity – J… -, it was possible to conclude that the costs in question derived respectively from a contract for the use of the F. . to that entity for a period of no less than 30 years and of a usage contract of the trademark P… to the same Swiss entity, for a period of no less than 30 years, with F…and P…continuing to deduct from their income, charges directly related with the management, promotion and development of the trademarks assigned by them, as well as bearing all the inherent risks. Due to the fact that F…and P.. have assigned their brands, by means of an operation that could not be carried out between independent entities, and continue to bear the costs associated with the management and development of these brands, as well as all the inherent risks, additionally bearing a royalty for the use of an asset that in practice continues to be theirs, a positive adjustment is made to the taxable profit of the subsidiary F.. Hipermercados, SA, to the amount of 4,116,392.00 euros and to a positive adjustment of the taxable profit of the subsidiary P… – Distribuição Alimentar, SA, to the amount of 4,911,077.67 euros (cf. item 111-1.8 of this document).” An appeal was filed by the company and the assessment was later annulled in the Tax Court. The tax authorities then filed an appeal with the Administrative Court of Appeal claiming that the decision of the Tax Court should be annulled due to lack of reasoning. Judgement of the Court The Administrative Court of Appeal upheld the appeal brought by tax authorities and declared the nullity of the judgment appealed against for failure to specify the factual grounds of the decision. The case was remanded to the Court of First Instance for a new decision to be issued therein, including the grounds of fact, proven and unproven, as well as an analysis of the evidence produced. Extracts from the judgement “Having examined the case-file, it can be seen that some of the listed witnesses were questioned (cf. minutes on pages 9036 and 9043) and that, with regard to the remaining witnesses, use was made of the witness evidence provided in another case (nº 137/08), which involved the same RIT and the same corrections, but with regard to the 2003 financial year (cf. order on pages 8997). It is also noted, from the content of the minutes of the examination of the witnesses in the present case-file, that they replied as to the matter contained in points 130 to 169 and 716 to 719 of the legal document. And, as to the evidence used in case nº 137/08, the witnesses therein responded as to the matter identified in the request on pages 8994 of the records. However, a careful reading of the contested decision shows that the evidence contains no reference to the statements of the witnesses examined. It is not even mentioned that the witnesses were questioned, nor is there any reference to the reasons for not taking their statements into consideration. In addition to the above, there is the circumstance that the sentence mentions, in the assessment of the law, that the Impugner joined to the file various documents relating to the expenses under analysis, which it claims support the effectuation of the expenses in question. However, the list of evidence does not make any reference to these documents and the facts on which they are based. The sentence further mentions that the documentation was corroborated by testimonial evidence. Further on, the sentence mentions that the inquired witnesses demonstrated to have knowledge of the way the Impugner operates, having highlighted some specific statements. Moreover, also in the assessment of the law, the sentence bases its understanding on documents whose existence was not proven, such as, among others, the trademark assignment contract, the Licence Agreement and the study that establishes the comparison with independent entities. The vicissitudes described above lead this Court to conclude that, in effect, the sentence appealed against suffers from the nullity found against it.” “With this appeal, the appellant claims that this Court should decide on the validity of the request formulated by her but, in order for this to happen, it is essential that the decision appealed against should state the reasons why it was decided not to take into account the testimonial evidence produced on the same matter that is now considered relevant. The CPC has the power to change the factual decision made by the “a quo” court provided that the prerequisites set out in Article 712(1) of the CPC (now 662) are met, and it is therefore incumbent on the CPC to re-examine the evidence on which the contested decision which is the object of the controversy was based, as well as to assess, of its own motion, other evidential elements which have served as a basis for the decision on the disputed factual points? Going back to what we have been saying above about the extent of the appellate court’s powers of cognition on the matter of fact, we note that these do not imply a new trial of fact, since, on the one hand, this possibility of cognition is confined to the points of fact that the appellant considers to have been incorrectly judged and provided that he meets the requirements set out in Article 690-A nos. 1 and 2 of the Civil Procedure Code. On the other hand, the control of fact, on appeal, based on the recording and/or transcription ...

Universal Pictures International Spain SL is a distributor of films on the Spanish Market. It distributes films both from related parties (Universal Pictures) and from unrelated parties. Following an audit, the Spanish tax authorities issued an assessment where the remuneration received for distribution of films from related parties had been compared to the remuneration received from distribution of films from unrelated parties and where the pricing of the controlled transactions had been adjusted accordingly . Not satisfied with the assessment of additional income a complaint was filed by Universal Pictures International Spain SL. Judgement of the Court The Court predominantly held in favor of Universal Pictures International Spain SL. The distribution activities performed in regards of films from related parties were limited risk whereas the activities performed in regards of distribution of films from unrelated parties were fully fledged. Hence the pricing of the controlled and uncontrolled transactions was not comparable. However, the comparables in the benchmark analysis on which Universal Pictures International Spain SL had based the pricing of controlled transactions was not all considered sufficiently comparable by the court and on that basis the case was referred back for reconsideration. Click here for English translation Click here for other translation ...

(i) USpharm, a U.S. pharmaceutical company, develops a new drug Z that is a safe and effective treatment for the disease zeezee. USpharm has obtained patents covering drug Z in the United States and in various foreign countries. USpharm has also obtained the regulatory authorizations necessary to market drug Z in the United States and in foreign countries. (ii) USpharm licenses its subsidiary in country X, Xpharm, to produce and sell drug Z in country X. At the same time, it licenses an unrelated company, Ydrug, to produce and sell drug Z in country Y, a neighboring country. Prior to licensing the drug, USpharm had obtained patent protection and regulatory approvals in both countries and both countries provide similar protection for intellectual property rights. Country X and country Y are similar countries in terms of population, per capita income and the incidence of disease zeezee. Consequently, drug Z is expected to sell in similar quantities and at similar prices in both countries. In addition, costs of producing and marketing drug Z in each country are expected to be approximately the same. (iii) USpharm and Xpharm establish terms for the license of drug Z that are identical in every material respect, including royalty rate, to the terms established between USpharm and Ydrug. In this case the district director determines that the royalty rate established in the Ydrug license agreement is a reliable measure of the arm’s length royalty rate for the Xpharm license agreement ...

Aggregation of interrelated licensing, manufacturing, and selling activities. P enters into a license agreement with S1 that permits S1 to use a proprietary manufacturing process and to sell the output from this process throughout a specified region. S1 uses the manufacturing process and sells its output to S2, which in turn resells the output to uncontrolled parties in the specified region. In evaluating whether the royalty paid by S1 to P is an arm’s length amount, it may be appropriate to evaluate the royalty in combination with the transfer prices charged by S1 to S2 and the aggregate profits earned by S1 and S2 from the use of the manufacturing process and the sale to uncontrolled parties of the products produced by S1 ...

As part of a multinational tax integrity package aimed to address the tax avoidance practices of multinational enterprises (MNEs) and improve transparency through better public reporting of MNEs’ tax information, the Australian Treasury issued a Consultation Paper in August 2022. This paper seeks to consult on the implementation of proposals to: amend Australia’s existing thin capitalisation rules to limit interest deductions for MNEs in line with the Organisation for Economic Cooperation and Development (OECD)’s recommended approach under Action 4 of the Base Erosion and Profit Shifting (BEPS) program (Part 1); introduce a new rule limiting MNEs’ ability to claim tax deductions for payments relating to intangibles and royalties that lead to insufficient tax paid (Part 2); and ensure enhanced tax transparency by MNEs (Part 3), through measures such as public reporting of certain tax information on a country‑by‑country basis; mandatory reporting of material tax risks to shareholders; and requiring tenderers for Australian government contracts to disclose their country of tax domicile. The changes contemplated seek to target activities deliberately designed to minimise tax, while also considering the need to attract and retain foreign capital and investment in Australia, limit potential additional compliance cost considerations for business, and continue to support genuine commercial activity ...

On 16 June 2022 McDonald’s France entered into an settlement agreement according to which it will pay €1.245 billion in back taxes and fines to the French tax authorities. The settlement agreement resulted from investigations carried out by the French tax authorities in regards to abnormally high royalties transferred from McDonald’s France to McDonald’s Luxembourg following an intra group restructuring in 2009. McDonald’s France doubled its royalty payments from 5% to 10% of restaurant turnover, and instead of paying these royalties to McDonald’s HQ in the United States, going forward they paid them to a Swiss PE of a group company in Luxembourg, which was not taxable of the amounts. During the investigations it was discovered that McDonald’s royalty fees could vary substantially from one McDonald’s branch to the next without any justification other than tax savings for the group. This conclusion was further supported by statements of the managers of the various subsidiaries as well as documentation seized which showed that the 100% increase in the royalty rate was mainly explained by a higher profitability of McDonald’s in France and a corresponding increase in taxes due. The investigations led the French tax authorities to question the overall economic substance of the IP company in Luxembourg and the contractual arrangements setup by the McDonald’s group. After being presented with the findings of the investigations and charged with tax fraud etc. McDonald’s was offered a public interest settlement agreement (CJIP) under Article 41-1-2 of the French Code of Criminal Procedure. The final settlement agreement between McDonald’s and the French authorities was announced in a press release from the Financial Public Prosecutor (English translation below). On 16 June 2022, the President of the Paris Judicial Court validated the judicial public interest agreement (CJIP) concluded on 31 May 2022 by the Financial Public Prosecutor (PRF) and the companies MC DONALD’S FRANCE, MC DONALD’S SYSTEM OF FRANCE LLC and MCD LUXEMBOURG REAL ESTATE S.A.R.L pursuant to Article 41-1-2 of the Criminal Procedure Code. under Article 41-1-2 of the Code of Criminal Procedure. Under the terms of the CJIP, MC DONALD’S FRANCE, MC DONALD’S SYSTEM OF FRANCE LLC and MCD LUXEMBOURG REAL ESTATE S.A.R.L, undertake to pay the French Treasury a public interest fine totalling 508,482,964 euros. Several French companies of the MC DONALD’S group have also signed a global settlement with the tax authorities, putting an end to the administrative litigation. The sum of the duties and penalties due under the overall settlement and the public interest fine provided for under the CJIP amounts to a total of EUR 1,245,624,269. Subject to the payment of the public interest fine, the validation of the CJIP extinguishes the public prosecution against the signatory companies. This agreement follows a preliminary investigation initiated by the PNF on 4 January 2016 after the filing of a complaint by the works council of MC DONALD’S OUEST PARISIEN. Opened in particular on the charge of tax fraud, the investigation had been entrusted to the Central Office for Combating Corruption and Financial and Fiscal Offences (OCLCIFF). This is the 10ᵉ CJIP signed by the national financial prosecutor’s office. The Financial Public Prosecutor Jean-François Bohnert Validated Settlement Agreement of 16 June 2022 English translation of the Validated Settelment Agreement Preliminary Settlement Agreement of 31 May 2022 with statement of facts and resulting taxes and fines English translation of the Preliminary Settlement Agreement of 31 May 2022 ...

By judgment of 22 May 2020, the Administrative Court set aside a tax assessment in which CBS International Netherlands B.V. had been denied reimbursement of withholding tax in the amount of BGN 156 830,27 related to royalties and license payments. An appeal was filed by the tax authorities with the Supreme Administrative Court. In the appeal the tax authorities held that the beneficial owner of the licence and royalty payments was not CBS International Netherlands B.V. but instead CBS CORPORATION, a company incorporated and domiciled in New York, USA. According to the tax authorities the main function of CBS International Netherlands B.V. was that of an intermediary between the end customers and the beneficial owner. This was further supported by the transfer pricing documentation, according to which the US company that bears the risk of the development activity, the market risk is borne equally by the two companies, and the only risks borne by the Dutch company are the currency, operational and credit risks, which in turn are not directly related to the development activity. Judgement of the Supreme Administrative Court The court upheld the decision of the court of first instance and decided in favour of CBS International Netherlands B.V. Excerpt “The activity from which the income is derived is that of granting rights under underlying television licence contracts. Corresponding to this activity is the risk identified in the transfer pricing documentation – development risk, market risk, currency risk, operational risk, credit risk. Neither CBS International Netherlands B.V. nor the Administration have alleged that the Dutch company was involved in the creation of the rights from the grant of which the income arose. Nor did the tax authorities deny that company’s right to grant the Bulgarian company the use of the copyright objects in return for consideration constituting the income on which the withholding tax was levied. To the contrary, there would be an assertion that there was no basis for the exchange of property and, accordingly, no object of taxation. “CBS International Netherlands B.V. is not a company for the purpose of channelisation of income under section 136A(2) of the ITA. It has not been shown to be controlled by a person not entitled to the same type or amount of relief on direct receipt of income. Control of CBS International Netherlands B.V. is exercised by another Dutch company which is within the personal scope of the Netherlands DTT. There are no sources of information that control is exercised by the ultimate parent company, CBS Corporation, based in New York, USA. The trial court was correct in finding that C.B.S. International Netherlands B.V. had assets, capital, and its own specialized personnel, and a comparison of the 2016 and 2017 C.B.S. figures showed that the company’s employees, offices, and profits were increasing, and therefore it was not a company that did not have assets, capital, and personnel consistent with its business. The existence of control over the use of the rights from which the income was earned is indicated by the content of the underlying contracts, which provide for penalties for non-performance and Fox Networks’ obligation to submit monthly reports. Insofar as the grounds under Article 136 of the VAT Code for the application of the Netherlands DTT are met, CBS International Netherlands B.V. is also entitled to the relief under Article 12(1) of the Netherlands DTT. 1 of the Royalty Income Tax Treaty in its country of residence. There is therefore also a right to a refund of the withholding tax under Art. 195 para. In concluding that the refusal to refund the tax withheld and paid by the contested APV was unlawful, the first instance court made a correct decision which should be upheld.” Click here for English Translation Click here for other translation ...

Synamedia Ltd. provides open end-to-end digital technology services to digital pay television platform operators. The company has expertise in the area of providing conditional access system, interactive systems and other software solutions as well as integration and support services for digital pay TV networks. For FY 2014-15 the company filed a tax return with nil income. The case was selected for a transfer pricing audit. The tax authorities in India accepted the arm’s length pricing determined by Synamedia, but some of the intra-group licence payments for software were considered subject to withholding taxes in India. Hence an assessment was issued. An appeal was filed by the company. Judgement of the Tax Appellate Tribunal The Tribunal decided in favor of Synamedia Ltd. and set aside the assessment. After analyzing the terms of the agreement the Tribunal concluded that the terms of agreement in the present case are similar to those considered by the Indian Supreme Court in the case of Engineering Analysis Centre of Excellence. Excerpt “The terms of the licence in the present case does not grant any proprietory interest on the licencee and there is no parting of any copy right in favour of the licencee. It is non-exclusive non-tranferrable licence merely enabling the use of the copy righted product and does not create any interest in copy right and therefore the payment for such licence would not be in the nature of royalty as defined in DTAA. We therefore hold that the sum in question cannot be brought to tax as royalty.” “Technical and commercial proposal given by the Assessee along with the STB provides technical specifications for the engineering of the relevant systems. That by itself cannot be the basis to conclude that there has been use of any copyright or that technical services have been provided. This is like providing a technical and user manual describing the system and does not imply granting of any copyright rights or transferring technical knowledge. The software is only licensed for use without granting any license.” ...

92. Osnovni is the parent company of an MNE Group engaged in the development and sale of software products. Osnovni acquires 100% of the equity interests in Company S, a publicly traded company organised in the same country as Osnovni, for a price equal to 160. At the time of the acquisition, Company S shares had an aggregate trading value of 100. Competitive bidders for the Company S business offered amounts ranging from 120 to 130 for Company S. 93. Company S had only a nominal amount of fixed assets at the time of the acquisition. Its value consisted primarily of rights in developed and partially developed intangibles related to software products and its skilled workforce. The purchase price allocation performed for accounting purposes by Osnovni allocated 10 to tangible assets, 60 to intangibles, and 90 to goodwill. Osnovni justified the 160 purchase price in presentations to its Board of Directors by reference to the complementary nature of the existing products of the Osnovni group and the products and potential products of Company S. 94. Company T is a wholly owned subsidiary of Osnovni. Osnovni has traditionally licensed exclusive rights in all of its intangibles related to the European and Asian markets to Company T. For purposes of this example it is assumed that all arrangements related to the historic licences of European and Asian rights to Company T prior to the acquisition of Company S are arm’s length. 95. Immediately following the acquisition of Company S, Osnovni liquidates Company S, and thereafter grants an exclusive and perpetual licence to Company T for intangible rights related to the Company S products in European and Asian markets. 96. In determining an arm’s length price for the Company S intangibles licensed to Company T under the foregoing arrangements, the premium over the original trading value of the Company S shares included in the acquisition price should be considered. To the extent that premium reflects the complementary nature of Osnovni group products with the acquired products in the European and Asian markets licensed to Company T, Company T should pay an amount for the transferred Company S intangibles and rights in intangibles that reflects an appropriate share of the purchase price premium. To the extent the purchase price premium is attributable exclusively to product complementarities outside of Company T’s markets, the purchase price premium should not be taken into account in determining the arm’s length price paid by Company T for Company S intangibles related to Company T’s geographic market. The value attributed to intangibles in the purchase price allocation performed for accounting purposes is not determinative for transfer pricing purposes ...

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

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

49. Shuyona is the parent company of an MNE group. Shuyona is organised in and operates exclusively in country X. The Shuyona group is involved in the production and sale of consumer goods. In order to maintain and, if possible, improve its market position, ongoing research is carried out by the Shuyona group to improve existing products and develop new products. The Shuyona group maintains two R&D centres, one operated by Shuyona in country X, and the other operated by Company S, a subsidiary of Shuyona, operating in country Y. 50. The Shuyona group sells two lines of products. All R&D with respect to product line A is conducted by Shuyona. All R&D with respect to product line B is conducted by the R&D centre operated by Company S. Company S also functions as the regional headquarters of the Shuyona group in North America and has global responsibility for the operation of the business relating to product line B. However, all patents developed through Company S research efforts are registered by Shuyona. Shuyona makes no or only a nominal payment to Company S in relation to the patentable inventions developed by the Company S R&D centre. 51. The Shuyona and Company S R&D centres operate autonomously. Each bears its own operating costs. Under the general policy direction of Shuyona senior management, the Company S R&D centre develops its own research programmes, establishes its own budgets, makes determinations as to when R&D projects should be terminated or modified, and hires its own R&D staff. The Company S R&D centre reports to the product line B management team in Company S, and does not report to the Shuyona R&D centre. Joint meetings between the Shuyona and Company S R&D teams are sometimes held to discuss research methods and common issues. 52. The transfer pricing analysis of this fact pattern would begin by recognising that Shuyona is the legal owner/registrant of intangibles developed by Company S. Unlike the situation in Example 14, however, Shuyona neither performs nor exercises control over the research functions carried out by Company S, including the important functions related to management, design, budgeting and funding that research. Accordingly, Shuyona’s legal ownership of the intangibles does not entitle it to retain or be attributed any income related to the product line B intangibles. Tax administrations could arrive at an appropriate transfer pricing outcome by recognising Shuyona’s legal ownership of the intangibles but by noting that, because of the contributions of Company S in the form of functions, assets, and risks, appropriate compensation to Company S for its contributions could be ensured by confirming that Company S should make no royalty or other payment to Shuyona for the right to use any successfully developed Company S intangibles, so that the future income derived from the exploitation of those intangibles by Company S would be allocated to Company S and not to Shuyona. 53. If Shuyona exploits the product line B intangibles by itself, Shuyona should provide appropriate compensation to Company S for its functions performed, assets used and risks assumed related to intangible development. In determining the appropriate level of compensation for Company S, the fact that Company S performs all of the important functions related to intangible development would likely make it inappropriate to treat Company S as the tested party in an R&D service arrangement ...

42. The facts in this example are the same as those set out in Example 10 with the following additions: At the end of Year 3, Primair stops manufacturing watches and contracts with a third party to manufacture them on its behalf. As a result, Company S will import unbranded watches directly from the manufacturer and undertake secondary processing to apply the R name and logo and package the watches before sale to the final customer. It will then sell and distribute the watches in the manner described in Example 10. As a consequence, at the beginning of Year 4, Primair and Company S renegotiate their earlier agreement and enter into a new long term licensing agreement. The new agreement, to start at the beginning of Year 4, is for five years, with Company S having an option for a further five years. Under the new agreement, Company S is granted the exclusive right within country Y to process, market and distribute watches bearing the R trademark in consideration for its agreement to pay a royalty to Primair based on the gross sales of all such watches. Company S receives no compensation from Primair in respect of the renegotiation of the original marketing and distribution agreement. It is assumed for purposes of this example that the purchase price Company S pays for the watches from the beginning of Year 4 is arm’s length and that no consideration with respect to the R name is embedded in that price. 43. In connection with a tax audit conducted by country Y tax administrations in Year 6, it is determined, based on a proper functional analysis, that the level of marketing expenses Company S incurred during Years 1 through 3 far exceeded those incurred by independent marketers and distributors with similar long term marketing and distribution agreements. It is also determined that the level and intensity of marketing activity undertaken by Company S exceeded that of independent marketers and distributors, and that the relatively greater activity has been successful in expanding volumes and/or increasing the Primair group’s overall margins from sales in country Y. Given the extent of the market development activities undertaken by Company S, including its strategic control over such activities, it is evident from the comparability and functional analysis that Company S has assumed significantly greater costs and assumed greater risks than comparable independent enterprises. There is also evidence that the individual entity profit margins realised by Company S are significantly lower than the profit margins of comparable independent marketers and distributors during the corresponding years of similar long-term marketing and distribution arrangements. 44. The country Y audit also identifies that in Years 4 and 5, Company S bears the costs and associated risks of its marketing activities under the new long-term licensing arrangement with Primair, and because of the long-term nature of the agreement, Company S may have an opportunity to benefit (or suffer a loss) from its activities. However, Company S has undertaken market development activities and incurred marketing expenditure far beyond what comparable independent licensees with similar long-term licensing agreements undertake and incur for their own benefit, resulting in significantly lower anticipated profit margins for Company S than those of comparable enterprises. 45. Based on these facts, Company S should be compensated with an additional return for the market development functions it performs, the assets it uses and the risks it assumes. For Years 1 through 3, the possible bases for such an adjustment would be as described in Example 10. For Years 4 and 5 the bases for an adjustment would be similar, except that the adjustment could reduce the royalty payments from Company S to Primair, rather than the purchase price of the watches. Depending on the facts and circumstances, consideration could also be given to whether Company S should have received compensation in connection with the renegotiation of the arrangement at the end of Year 3 in accordance with the guidance in Part II of Chapter IX ...

39. The facts in this example are the same as in Example 9 with the following additions: By the end of Year 3, the R brand is successfully established in the country Y market and Primair and Company S renegotiate their earlier agreement and enter into a new long-term licensing agreement. The new agreement, which is to commence at the beginning of Year 4, is for five years with Company S having an option for a further five years. Under this agreement, Company S agrees to pay a royalty to Primair based on the gross sales of all watches bearing the R trademark. In all other respects, the new agreement has the same terms and conditions as in the previous arrangement between the parties. There is no adjustment made to the price payable by Company S for the branded watches as a result of the introduction of the royalty. Company S’s sales of R brand watches in Years 4 and 5 are consistent with earlier budget forecasts. However, the introduction of the royalty from the beginning of year 4 results in Company S’s profit margins declining substantially. 40. Assume that there is no evidence that independent marketers/distributors of similar branded products have agreed to pay royalties under similar arrangements. Company S’s level of marketing expenditure and activity, from Year 4 on, is consistent with that of independent enterprises. 41. For transfer pricing purposes, it would not generally be expected that a royalty would be paid in arm’s length transactions where a marketing and distribution entity obtains no rights for transfer pricing purposes in trademarks and similar intangibles other than the right to use such intangibles in distributing a branded product supplied by the entity entitled to the income derived from exploiting such intangibles. Furthermore, the royalty causes Company S’s profit margins to be consistently lower than those of independent enterprises with comparable functions performed, assets used and risks assumed during the corresponding years of similar long-term marketing and distribution arrangements. Accordingly, a transfer pricing adjustment disallowing the royalties paid would be appropriate based on the facts of this example ...

8. The facts are the same as in Example 2. However, after licensing the patents to associated and independent enterprises for a few years, Company S, again acting under the direction and control of Premiere, sells the patents to an independent enterprise at a price reflecting appreciation in the value of the patents during the period that Company S was the legal owner. The functions of Company S throughout the period it was the legal owner of the patents were limited to performing the patent registration functions described in Examples 1 and 2. 9. Under these circumstances, the income of Company S should be the same as in Example 2. It should be compensated for the registration functions it performs, but should not otherwise share in the returns derived from the exploitation of the intangibles, including the returns generated from the disposition of the intangibles ...

5. The facts related to the development and control of patentable inventions are the same as in Example 1. However, instead of granting a perpetual and exclusive licence of its patents back to Premiere, Company S, acting under the direction and control of Premiere, grants licences of its patents to associated and independent enterprises throughout the world in exchange for periodic royalties. For purposes of this example, it is assumed that the royalties paid to Company S by associated enterprises are all arm’s length. 6. Company S is the legal owner of the patents. However, its contributions to the development, enhancement, maintenance, protection, and exploitation of the patents are limited to the activities of its three employees in registering the patents and maintaining the patent registrations. The Company S employees do not control or participate in the licensing transactions involving the patents. Under these circumstances, Company S is only entitled to compensation for the functions it performs. Based on an analysis of the respective functions performed, assets used, and risks assumed by Premiere and Company S in developing, enhancing, maintaining, protecting, and exploiting the intangibles, Company S should not be entitled ultimately to retain or be attributed income from its licensing arrangements over and above the arm’s length compensation for its patent registration functions. 7. As in Example 1 the true nature of the arrangement is a patent administration service contract. The appropriate transfer pricing outcome can be achieved by ensuring that the amount paid by Company S in exchange for the assignments of patent rights appropriately reflects the respective functions performed, assets used, and risks assumed by Premiere and by Company S. Under such an approach, the compensation due to Premiere for the patentable inventions is equal to the licensing revenue of Company S less an appropriate return to the functions Company S performs ...

Also in the case where a local operation disposes of the legal ownership of its intangibles to a foreign associated enterprise and continues to use the intangibles further to the disposal, but does so in a different legal capacity (e.g. as a licensee), the conditions of the transfer should be assessed from both the transferor’s and the transferee’s perspectives. The determination of an arm’s length remuneration for the subsequent ownership, control and exploitation of the transferred intangible should take account of the extent of the functions performed, assets used and risks assumed by the parties in relation to the intangible transferred, and in particular analysing control of risks and control of functions performed relating to the development, enhancement, maintenance, protection, or exploitation of the intangibles ...

Business restructurings sometimes involve the transfer of the legal ownership of intangibles or rights in intangibles that were previously owned by one or more local operation(s) to a central location situated in another tax jurisdiction (e.g. a foreign associated enterprise that operates as a principal or as a so-called “IP company”). In some cases the transferor continues to use the intangible transferred, but does so in another legal capacity (e.g. as a licensee of the transferee, or through a contract that includes limited rights to the intangible such as a contract manufacturing arrangement using patents that were transferred; or a limited risk distribution arrangement using a trademark that was transferred). In accordance with the guidance in Chapter VI, it is important to remember that the legal ownership of an intangible by itself does not confer any right ultimately to retain returns derived by the MNE group from exploiting that intangible (see 6.42). Instead, the compensation required to be paid to associated enterprises performing or controlling functions related to the development, enhancement, maintenance, protection, or exploitation of intangibles may comprise any share of the total return anticipated to be derived from the intangibles (see 6.54). Therefore, the change in legal ownership of an intangible in a business restructuring may not affect which party is entitled to returns from that intangible ...

Under a development CCA, each participant has an entitlement to rights in the developed intangible(s) or tangible asset(s). In relation to intangibles, such rights often take the form of separate rights to exploit the intangible in a specific geographic location or for a particular application. The separate rights obtained may constitute actual legal ownership; alternatively, it may be that only one of the participants is the legal owner of the property but the other participants have certain rights to use or exploit the property. In cases where a participant has such rights in any property developed by the CCA, there is no need for a royalty payment or other further consideration for the use of the developed property consistent with the interest to which the participant is entitled under the CCA (however, the contributions of a participant may need to be adjusted if they are not proportionate to their expected benefits; see Section C.5) ...

Comparability, and the possibility of making comparability adjustments, is especially important in considering potentially comparable intangibles and related royalty rates drawn from commercial databases or proprietary compilations of publicly available licence or similar agreements. The principles of Section A.4.3.1 of Chapter III apply fully in assessing the usefulness of transactions drawn from such sources. In particular, it is important to assess whether publicly available data drawn from commercial databases and proprietary compilations is sufficiently detailed to permit an evaluation of the specific features of intangibles that may be important in conducting a comparability analysis. In evaluating comparable licence arrangements identified from databases, the specific facts of the case, including the methodology being applied, should be considered in the context of the provisions of paragraph 3.38 ...

When the distributor actually bears the cost of its marketing activities (for example, when there is no arrangement for the legal owner to reimburse the expenditures), the analysis should focus on the extent to which the distributor is able to share in the potential benefits deriving from its functions performed, assets used, and risks assumed currently or in the future. In general, in arm’s length transactions the ability of a party that is not the legal owner of trademarks and other marketing intangibles to obtain the benefits of marketing activities that enhance the value of those intangibles will depend principally on the substance of the rights of that party. For example, a distributor may have the ability to obtain benefits from its functions performed, assets used, and risks assumed in developing the value of a trademark and other marketing intangibles from its turnover and market share when it has a long-term contract providing for sole distribution rights for the trademarked product. In such a situation the distributor’s efforts may have enhanced the value of its own intangibles, namely its distribution rights. In such cases, the distributor’s share of benefits should be determined based on what an independent distributor would receive in comparable circumstances. In some cases, a distributor may perform functions, use assets or assume risks that exceed those an independent distributor with similar rights might incur or perform for the benefit of its own distribution activities and that create value beyond that created by other similarly situated marketers/distributors. An independent distributor in such a case would typically require additional remuneration from the owner of the trademark or other intangibles. Such remuneration could take the form of higher distribution profits (resulting from a decrease in the purchase price of the product), a reduction in royalty rate, or a share of the profits associated with the enhanced value of the trademark or other marketing intangibles, in order to compensate the distributor for its functions, assets, risks, and anticipated value creation. Examples 8 to 13 in the Annex I to Chapter VI illustrate in greater detail the application of this Section B in the context of marketing and distribution arrangements ...

The guidance contained in this chapter is intended to address transfer pricing matters exclusively. It is not intended to have relevance for other tax purposes. For example, the Commentary on Article 12 of the OECD Model Tax Convention contains a detailed discussion of the definition of royalties under that Article (paragraphs 8 to 19). The Article 12 definition of “royalties” is not intended to provide any guidance on whether, and if so at what price, the use or transfer of intangibles would be remunerated between independent parties. It is therefore not relevant for transfer pricing purposes. Moreover, the manner in which a transaction is characterised for transfer pricing purposes has no relevance to the question of whether a particular payment constitutes a royalty or may be subjected to withholding tax under Article 12. The concept of intangibles for transfer pricing purposes and the definition of royalties for purposes of Article 12 of the OECD Model Tax Convention are two different notions that do not need to be aligned. It may occur that a payment made between associated enterprises may be regarded as not constituting a royalty for purposes of Article 12, and nevertheless be treated for transfer pricing purposes as a payment to which the principles of this chapter may apply. Examples could include certain payments related to goodwill or ongoing concern value. It may also occur that a payment properly treated as a royalty under Article 12 of a relevant Treaty may not be made in remuneration for intangibles for purposes of this chapter. Examples could include certain payments for technical services. Similarly, the guidance in this chapter is not intended to have relevance for customs purposes ...

The following example illustrates the concept of differences between written contractual terms and conduct of the parties, with the result that the actual conduct of the parties delineates the transaction. Company S is a wholly-owned subsidiary of Company P. The parties have entered into a written contract pursuant to which Company P licenses intellectual property to Company S for use in Company S’s business; Company S agrees to compensate Company P for the licence with a royalty. Evidence provided by other economically relevant characteristics, and in particular the functions performed, establishes that Company P performs negotiations with third-party customers to achieve sales for Company S, provides regular technical services support to Company S so that Company S can deliver contracted sales to its customers, and regularly provides staff to enable Company S to fulfil customer contracts. A majority of customers insist on including Company P as joint contracting party along with Company S, although fee income under the contract is payable to Company S. The analysis of the commercial or financial relations indicates that Company S is not capable of providing the contracted services to customers without significant support from Company P, and is not developing its own capability. Under the contract, Company P has given a licence to Company S, but in fact controls the business risk and output of Company S such that it has not transferred risk and function consistent with a licensing arrangement, and acts not as the licensor but the principal. The identification of the actual transaction between Company P and Company S should not be defined solely by the terms of the written contract. Instead, the actual transaction should be determined from the conduct of the parties, leading to the conclusion that the actual functions performed, assets used, and risks assumed by the parties are not consistent with the written licence agreement ...

Delta Beverages Ltd, a subsidiary of Delta Corporation, had been issued a tax assessment for FY 2009, 2010, 2011, 2012, 2013 and 2014 where various fees for service, technology license of trademarks, technology and know-how paid to a group company in the Netherlands (SAB Miller Management BV) had been disallowed by the tax authorities (Zimra) of Zimbabwe resulting in additional taxes of US$42 million which was later reduced to US$30 million. An appeal was filed with the Special Court (for Income Tax Appeals) where, in a judgment dated 11 October 2019, parts of the assessment was set aside. Not satisfied with the result, an appeal (Delta Beverages) and cross-appeal (tax authorities) was filed with the Supreme Court. Judgement of the Supreme Court. The Supreme Court set aside the judgement of the Special Court (for Income Tax Appeals) and remanded the case for reconsiderations in relation to the issue of tax avoidance. Excerpts from the Supreme Court judgement regarding deductions for royalties paid for trademarks: “I respectfully agree with the reasoning of the court a quo. A product’s standing and marketability is enhanced by its trademark which has acquired a reputation and become desirable on the market. The trademarks in issue are of international repute. They in my view add value to the main appellant’s beverages and make it possible for the appellant to make an income from the trademarked products. It is apparent from the various agreements entered into between the franchisors and the holding company that what was being sought was to benefit from the reputation of the international brands and trademarks.” “In respect of the royalties the issue is whether or not the main appellant was a party to the agreements on the royalties, which were to be paid for or had ratified the agreements entitling it to claim its payments for them as deductions in its tax returns. A reading of the record establishes that the agreements in terms of which royalties were payable were entered into by Delta Corporation or its predecessors in title and there is no specific mention of the appellant. There is however mention of Delta Corporation’s subsidiaries. It is common cause that the main appellant is a subsidiary of Delta Corporation (Private) Limited.” “In any event, evidence on record establishes that the cross appellant’s main challenge cannot prevail because the Exchange Control Authority granted authority for the payment of those royalties. The record proves that on 19 August 2011, the exchange control authority granted authority to the holding company to pay royalties of up to 5 percent to the Dutch Company less withholding tax.” “Once it is established that the main appellant is the one which operated the beverages business and benefited from the contract between the Dutch company and the holding company, it follows that it lawfully deducted the royalties it paid to the Dutch company.” Excerpts from the Supreme Court judgement regarding deductions for technical services (calculated based on turnover) – tax avoidance: In determining this issue the court [Special Court (for Income Tax Appeals)] a quo commented on its perception that there might have been tax avoidance in the manner in which the technical services agreement was concluded between the parties. It commented that if the Commissioner had attacked the deduction of these services from the main appellant’s taxable income it would have been fatal to the main appellant’s claim. “The witness failed to explain why the Dutch company paid the South African entity that supplied the technical services to the appellant on its behalf on a cost plus mark-up basis but charged the local holding company on a percentage of turnover basis. Such a failure may have been fatal to the appellant’s case had the Commissioner disallowed the technical fees in terms of s 98 the Income Tax Act.” “It is apparent from the court a quo’s comments that it perceived that there might have been a case of tax avoidance by the main appellant’s holding company and the Dutch company. It is also apparent that it took no further steps to inquire into that possibility but proceeded to determine the appeal on other factors not connected to tax avoidance as if the appeal before it was an appeal in the strict sense. It thus left the issue of tax avoidance hanging as no further inquiry into it was made, nor did it make a decision on the issue.” “It is clear from the underlined part of the quotation that the issue of avoidance should be determined to enable the Commissioner or as in this case the Special Court to determine how the tax payer should be taxed. The determination of tax issues require clarity and incisiveness in decision making. This is because the law requires that those who should pay tax should do so and those who fall outside that requirement should not be taxed. There should be no room for those within the group which should be taxed escaping through failure by the Commissioner to net them in and if he fails the Special Court in the exercise of its full jurisdiction should net them in. … It is therefore my view that once the court a quo realised that there might be tax avoidance it should have exhaustively inquired into and made a determination on it. It should have sought to determine the correct position of the law instead of identifying a possible error by the Commissioner and allowing it to pass. Taxation is by the law and not official errors or laxity. …where a tax matter has been placed before the Special Court for adjudication a taxpayer should not escape liability simply because the Commissioner failed to invoke the appropriate taxing provision. In casu the omission by the court a quo to determine the issue of tax avoidance will have the effect of allowing the main appellant to get away with tax avoidance, if that can be proved on inquiry. That view is strengthened by the court a quo’s view that the failure by ...

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 ...

An assessment was issued for FY 2017, whereby additional income tax was imposed on “GSS Ltd” in the amount of 843.344,38 €, plus a fine of 421.672,19 €, i.e. a total amount of 1.265.016,57 €. Various adjustments had been made and among them interest rates on intra group loans, royalty payments, management fees, and losses related to disposal of shares. Not satisfied with the assessment, an appeal was filed by “GSS Ltd.” Judgement of the Tax Court The court dismissed the appeal of “GSS Ltd.” and upheld the assessment of the tax authorities Excerpts “Because only a few days after the entry of the holdings in its books, it sold them at a price below the nominal value of the companies’ shares, which lacks commercial substance and is not consistent with normal business behaviour. Since it is hereby held that, by means of the specific transactions, the applicant indirectly wrote off its unsecured claims without having previously taken appropriate steps to ensure its right to recover them, in accordance with the provisions of para. 4 of Article 26 of Law 4172/2013 and POL 1056/2015. Because even if the specific actions were suggested by the lending bank Eurobank, the applicant remains an independent entity, responsible for its actions vis-à-vis the Tax Administration. In the absence of that arrangement, that is to say, in the event that the applicant directly recognised a loss from the write-off of bad debts, it would not be tax deductible, since the appropriate steps had not been taken to ensure the right to recover them. Because on the basis of the above, the audit correctly did not recognise the loss on sale of shareholdings in question. The applicant’s claim is therefore rejected as unfounded.” “Since, as is apparent from the Audit Opinion Report on the present appeal to our Office, the audit examined the existence or otherwise of comparable internal data and, in particular, examined in detail all the loan agreements submitted by the applicant, which showed that the interest rates charged to the applicant by the banks could not constitute appropriate internal comparative data for the purpose of substantiating the respective intra-group transactions, since the two individual stages of lending differ as to the nature of the transactions. (a) the existence of contracts (the bank loans were obtained on the basis of lengthy contracts, unlike the loans provided by the applicant for which no documents were drawn up, approved by the Board of Directors or general meetings), (b) the duration of the credit (bank loans specify precisely the time and the repayment instalments, unlike the applicant’s loans which were granted without a specific repayment schedule), (c) the interest rate (bank loans specify precisely the interest rate on the loan and all cases where it changes, unlike the applicant’s loans, (d) the existence of collateral (the bank loans were granted with mortgages on all the company’s real estate, with rental assignment contracts in the case of leasing and with assignment contracts for receivables from foreign customers (agencies), unlike the applicant’s loans which were granted without any collateral), (e) the size of the lending (the loans under comparison do not involve similar funds), (f) security conditions in the event of non-payment (the bank loans specified precisely the measures to be taken in the event of non-payment, unlike the applicant’s loans, for which nothing at all was specified), (g) the creditworthiness of the borrower (the banks lent to the applicant, which had a turnover, profits and real estate, unlike the related companies, most of which had no turnover, high losses and negative equity), (h) the purpose of the loan (83 % of the applicant’s total lending was granted to cover long-term investment projects as opposed to loans to related parties which were granted for cash facilities and working capital). Since, in the event that the applicant’s affiliated companies had made a short-term loan from an entity other than the applicant (unaffiliated), then the interest rate for loans to non-financial undertakings is deemed to be a reasonable interest rate for loans on mutual accounts, as stated in the statistical bulletin of the Bank of Greece for the nearest period of time before the date of the loan (www.bankofgreece.gr/ekdoseis-ereyna/ekdoseis/anazhthsh- ekdosewn?types=9e8736f4-8146-4dbb-8c07-d73d3f49cdf0). Because the work of this audit is considered to be well documented and fully justified. Therefore, the applicant’s claim is rejected as unfounded.” Click here for English translation Click here for other translation ...

S GmbH was an Austrian trading company of a group. In the course of business restructuring, the real estate division of the Austrian-based company was initially separated from the “trading operations/brands” division on the demerger date of 31 March 2007. The trademark rights remained with the previous trading company, which was the parent company of the group, now M GmbH. On 25 September 2007, M GmbH transferred all trademark rights to a permanent establishment in Malta, which was set up in the same year, to which it also moved its place of management on 15 January 2008. Licence agreements were concluded between S GmbH and M GmbH, which entitle S GmbH to use the trademarks of M GmbH for advertising and marketing measures in connection with its business operations in return for a (turnover-dependent) licence fee. The tax authorities (re)assessed the corporate income tax for the years 2008 and 2009. The audit had shown that the licence fees were to be attributed in their entirety to S GmbH as the beneficial owner of the trade marks, which meant that the licence payments to M GmbH were also not to be recognised for tax purposes. S GmbH had created the trademark rights, which had been valued at a total value of €383.5 million in the course of its spin-off; the decisions regarding the use, creation, advertising and licensing of the trademark rights continued to lie with the decision-makers of the operational company advertising the revisions at the Austrian group location. The Maltese management was present at meetings with advertising agencies in Austria, but its activities did not actually go beyond support and administration. The aim of the chosen structure had been a tax-saving effect, whereby the actual taxation of the licence income in Malta had been 5%. A complaint filed by S GmbH was dismissed by the Bundesfinanzgericht. S GmbH then filed an appeal with the Verwaltungsgerichtshof. Judgement of the Court The Court dismissed the appeal of S GmbH and upheld the decision of the tax authorities Excerpts: “In the appeal case, the BFG found that the trademark rights had been created before the separation of the companies. No new trademarks had been registered during the audit period. The advertising line was determined by a two-year briefing of the group and was based on the requirements of the licensees. The brand managers of M GmbH participated in the process, but the decisions were made by the organs of the appellant, which spent over €56 million in 2008 and almost €68 million in 2009 on advertising and marketing.. In contrast, M GmbH had hardly incurred any advertising expenses, and its salary expenses were also disproportionate to the tasks of a company that was supposed to manage corporate assets of almost €400 million in trademark rights and to act as the (also economic) owner of these assets. The minimal salary expenditure, which amounted to a total of € 91,791.0 in 2008 and € 77,008.10 in 2009 and was distributed among eight persons (most of whom were part-time employees), could only be explained by the fact that all relevant trademark administration, maintenance and management tasks were, as in the past, handled either by group companies (by way of group-internal marketing activities) or by specialists commissioned by the group (trademark lawyer, advertising agency) and that M GmbH only acted in a supporting capacity. If, against this background, the BFG assumes, despite the formal retention of the legal ownership of the trademark rights, that the economic ownership of the trademark rights, which had already been created at that time, was also transferred to the appellant at the time of the spin-off, this cannot be seen as an unlawful act which the Administrative Court should take up. If, in the case at hand, the appellant nevertheless concluded licence agreements with M GmbH, the reason for this cannot have been the acquisition of the right of use to which it was entitled from the outset as the beneficial owner. The BFG was therefore correct in denying that the amounts paid by the appellant under the heading of “licence payments” were business expenses. …” Click here for English translation Click here for other translation ...

By judgment of 22 May 2020, the Administrative Court set aside a tax assessment in which CBS International Netherlands B.V. had been denied reimbursement of withholding tax related to royalties and license payments. An appeal was filed by the tax authorities with the Supreme Administrative Court. In the appeal the tax authorities held that the beneficial owner of the licence and royalty payments was not CBS International Netherlands B.V. but instead CBS CORPORATION, a company incorporated and domiciled in New York, USA. According to the tax authorities the main function of CBS International Netherlands B.V. was that of an intermediary between the end customers and the beneficial owner. This was further supported by the transfer pricing documentation, according to which the US company that bears the risk of the development activity, the market risk is borne equally by the two companies, and the only risks borne by the Dutch company are the currency, operational and credit risks, which in turn are not directly related to the development activity. Judgement of the Supreme Administrative Court The court canceled the 2019 tax assessment and returns the case to the competent authority to issue decision in accordance with the instructions on the interpretation and application of the law given by this decision. Excerpt “There is no information source for the fact that CBS International Netherlands B.V. has no right to dispose of the income and to assess its use. Conversely, according to article 13 of the company’s articles of association, the decision to distribute the result for the year is to be made by the general meeting of shareholders. This disqualifies the company as the nominee instead of the owner of the income /refer to the Commentary to Article 12 of the Organisation for Economic Co-operation and Development Model DTT/. The Dutch company does not have the limited powers of a formal owner – it does not direct the income to another person who actually receives the benefit; it does not act as a fiduciary or administrator on behalf of the stakeholders /see Commentary/. The activity from which the income is derived is that of granting rights under underlying television licence contracts. Corresponding to this activity is the risk identified in the transfer pricing documentation – development risk, market risk, currency risk, operational risk, credit risk. Neither the applicant nor the administration have alleged that the Dutch company was involved in the creation of the rights from the grant of which the income arose. Nor did the tax authorities deny that company’s right to grant the Bulgarian company the use of the copyright objects in return for consideration constituting the income on which the withholding tax was levied. To the contrary, there would be an assertion that there was no basis for the exchange of property and, accordingly, no object of taxation. The appellant is not an income directing company under Section 136A(2) of the Income-tax Act. It has not been shown to be controlled by a person not entitled to the same type or amount of relief on direct receipt of income. The control of CBS International Netherlands B.V. is exercised by another Dutch company which is within the personal scope of the Netherlands DTT. There are no sources of information that control is exercised by the “ultimate parent company” CBS Corporation based in New York, USA. It is unclear what type and amount of assets the Dutch company is expected to own beyond the USD 72,000 in property, plant and equipment listed in the APA and with a staff of 22 employees given the intellectual property rights management activities carried out. The existence of control over the use of the rights from which the income was earned is indicated by the content of the underlying contracts, which provide for penalties for non-performance and Fox Networks’ obligation to submit monthly reports. In so far as the grounds laid down in Article 136 of the VAT Code for the application of the Netherlands DTT are met, the applicant is also entitled to the relief provided for in Article 12(1) of the VAT Code. 1 of the Royalty Income Tax Treaty in the country of residence. There is therefore also a right to a refund of the withholding tax under Article 195(1) of the Treaty. The refusal to refund the tax withheld and deposited as provided for in the APA challenged before the ACCA is unlawful and the dismissal of the challenge to the refusal is incorrect. The first instance decision and the APV must be annulled in accordance with the rule of Article 160 para. 3 of the Code of Administrative Offences, the case file should be returned to the competent revenue authority at the Directorate General of the National Revenue Service, GDO, Sofia. Sofia to issue an APV in accordance with the instructions on the interpretation and application of the law given by this decision.” Click here for English Translation Click here for other translation ...

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

Toyota Kirloskar Auto Parts Private Limited manufactures auto parts and sold them to Toyota Kirloskar Motors Limited, another Indian corporation in the Toyota Group. In FY 2013-14 Toyota Kirloskar Auto Parts Private Limited paid a 5% royalty to the Japanese parent Toyota Motor Corporation for use of know-how. The royalty rate had been determined by application of the TNMM method. The Indian tax authorities did not agree with the choice of method and argued that the most appropriate method was the Profit Split Method (PSM). Judgement of the Tax Appellate Tribunal The Tribunal decided in favor of Toyota Kirloskar Auto Parts and set aside the assessment. Excerpt “17. It is clear from the above OECD guidelines that in ‘order to determine the profits to be split, the crux is to understand the functional profile of the entities under consideration. Although the comparability analysis is at the “heart of the application of the arm’s length principle”, likewise, a functional analysis has always been a cornerstone of the comparability analysis. In the present case the Assessee leverages on the use of technology from the AE and does not contribute any unique intangibles to the transaction. It may be true that the Assessee aggregated payment of royalty with the transaction of manufacturing as it was closely IT(TP)A Nos.1915/Bang/2017 & 3377/Bang/2018 linked and adopted TNMM but that does not mean that the transactions are so interrelated that they cannot be evaluated separately for applying PSM. Further, the Assessee does not make any unique contribution to the transaction, hence PSM in this case cannot be applied. 18. Therefore, we are of the view that TNMM is the Most Appropriate Method in the case of assessee. The decision of the Tribunal in the earlier AY 2008-09 has also been upheld by the Hon’ble High Court of Karnataka in ITA No.104/2015, judgment dated 16.7.2018, which was an appeal of the revenue against the order of Tribunal for AY 2008-09. The Tribunal has upheld TNMM as MAM from AY 2007-08 to 2011-12. In those AYs the dispute was whether TNMM or CUP was the MAM. It is for the first time in AY 2013-14 that the revenue has sought to apply PSM as MAM. In the given facts and circumstances, we are of the view that TNM Method is the Most Appropriate Method and the AO is directed to apply the said method in determining the ALP, after affording opportunity of being heard to the assessee. The grounds of appeal of the assessee are treated as allowed. 19. The facts in AY 2014-15 are identical and the reasoning given in AY 2013-14 will equally apply to the AY 2014-15 also and the TPO is directed to compute the ALP for AY 2014-15 by applying TNMM as the MAM , after affording due opportunity to the assessee. 20 The other issues with regard to the objections regarding the manner in which ALP was determined by applying PSM as the MAM does not require any adjudication because of the conclusion that TNMM is the MAM.” Click here for other translation ...

The main activity in a Danish branch of a German group was development, licensing and services related to engines that were being produced by external licensees. Under a restructuring of the group, it was decided that royalty income for a particular engine type previously received by the Danish branch should be transferred to the German company. The Danish branch received a compensation corresponding to the net earnings for a two-year notice period. The tax administration increased the taxable income of the branch claiming that the branch had made valuable contributions to the development of the type of engine in question and thereby obtained co-ownership. The Tax Tribunal found that valuable intangible assets had been transferred, The decision was based on prior contractual arrangements and conduct of the parties.  Click here for other translation ...

Nestlé del Uruguay S.A. had deducted royalty payments to its parent company located in Switzerland for the right to use certain local brands such as Águila, El Chaná, Vascolet, Bracafé and Copacabana. Royalties were calculated as 5% of sales, with the exception of payments for the Águila brand products, where royalties were calculated as 2% of sales. The tax administration (DGI) found that the royalty payments had not been at arm’s length. In defense of this position, it was argued that these local brands had been developed by Nestlé Uruguay itself, and then transferred to Nestlé Switzerland in 1999 for a sum of USD 1. Nestle Uruguay disagreed and argued that the tax administration was applying transfer pricing rules retroactively to a transaction concluded in 1999, when such rules did not yet exist. Judgement of the Court The Court considered that the Nestlé Uruguay should not pay 5% in royalties for the right to use trademarks it had developed itself. “…the Court shares the report of the tax inspectors of the International Taxation Department of the DGI insofar as they state: “It is… questionable… that Nestlé del Uruguay S.A. pays royalties for the use of trademarks developed and operated by the company itself… Nestlé Uruguay developed, maintained and operated the local brands… in Uruguay, contributing to generate the value of these brands…”. “This conclusion… does not imply the retroactive application of the transfer pricing rules to previously operated brand assignments, but rather the application of such rules only for the period… where there was relevant activity by the plaintiff with respect to the exploitation of the local brands”. Instead royalties for use of all the local brands – not only on the Águila brand – should be calculated as 2% of sales. Click here for English translation Click here for other translation ...

Due to the economic situation of automotive suppliers in Germany in 2006, “Cutting Tech GMBH” established a subsidiary (CB) in Bosnien-Herzegovina which going forward functioned as a contract manufacturer. CB did not develop the products itself, but manufactured them according to specifications provided by “Cutting Tech GMBH”. The majority of “Cutting Tech GMBH”‘s sales articles were subject to multi-stage production, which could include various combinations of production processes. In particular, “Cutting Tech GMBH” was no longer competitive in the labour-intensive manufacturing processes (cut-off grinding, turning, milling) due to the high wage level in Germany. Good contribution margins from the high-tech processes (adiabatic cutting, double face grinding) increasingly had to subsidise the losses of the labour-intensive processes. Individual production stages, however, could not be outsourced to external producers for reasons of certification and secrecy. In addition, if the production had been outsourced, there would have been a great danger that a third company would have siphoned off “Cutting Tech GMBH”‘s know-how and then taken over the business with “Cutting Tech GMBH”‘s customer. This could have led to large losses in turnover for “Cutting Tech GMBH”. Furthermore, some of the labour-intensive work also had to cover one or more finishing stages of the high-tech processes, so that this business was also at risk if it was outsourced. For these reasons, the decision was made to outsource the labour-intensive production processes to Bosnia-Herzegovina in order to become profitable again and to remain competitive in the future. There, there were German-speaking staff with the necessary expertise, low customs duties and a low exchange rate risk. CB functioned as a contract manufacturer with the processes of production, quality assurance and a small administrative unit. Cost advantages existed not only in personnel costs, but also in electricity costs. CB prevented the plaintiff’s good earnings from the high-tech processes in Germany from having to continue to be used to subsidise the low-tech processes. “Cutting Tech GMBH” supplied CB with the material needed for production. The deliveries were processed as sales of materials. “Cutting Tech GMBH” received as purchase prices its cost prices without offsetting profit mark-ups or handling fees/commissions. The material was purchased and supplied to CB by “Cutting Tech GMBH”, which was able to obtain more favourable purchase prices than CB due to the quantities it purchased. The work commissioned by “Cutting Tech GMBH” was carried out by CB with the purchased material and its personnel. CB then sold the products to “Cutting Tech GMBH”. In part, they were delivered directly by CB to the end customers, in part the products were further processed by “Cutting Tech GMBH” or by third-party companies. “Cutting Tech GMBH” determined the transfer prices for the products it purchased using a “contribution margin calculation”. Until 2012, “Cutting Tech GMBH” purchased all products manufactured by CB in Bosnia and Herzegovina. From 2013 onwards, CB generated its own sales with the external company P. This was a former customer of “Cutting Tech GMBH”. Since “Cutting Tech GMBH” could not offer competitive prices to the customer P in the case of production in Germany, CB took over the latter’s orders and supplied P with the products it manufactured in accordance with the contracts concluded. CB did not have its own distribution in the years in dispute. The tax audit of FY 2011 – 2013 The auditor assumed that the transfer of functions and risks to the CB in 2007/2008 basically fulfilled the facts of a transfer of functions. However, since only a routine function had been transferred, “Cutting Tech GMBH” had rightly carried out the transfer of functions without paying any special remuneration. Due to CB’s limited exposure to risks, the auditor considered that the cost-plus method should be used for transfer pricing. In adjusting the transfer prices, the auditor assumed a mark-up rate of 12%. The material invoiced by “Cutting Tech GMBH” and the scrap proceeds was not included in the cost basis used in the assessment. For 2013, the auditor took into account that the customer P had agreed contracts exclusively with CB and reduced the costs by the costs of the products sold to P. Furthermore, the auditor took the legal view that the entire audit period should be considered uniformly. Therefore, it was appropriate to deduct an amount of €64,897 in 2011, which had been calculated in favour of “Cutting Tech GMBH” in 2010 and not taken into account in the tax assessment notices, in order to correct the error. The auditor did not consider it justified to determine the transfer prices for “Cutting Tech GMBH”‘s purchases of goods by means of a so-called contribution margin calculation. Based on the functional and risk analysis, the auditor concluded that CB was a contract manufacturer. On the grounds that this profit of CB was remuneration for a routine function, the auditor refrained from recognising a vGA because of the transfer of client P from the applicant to CB. However, he stated that according to arm’s length royalty rates, values between 1% and 3% could be recognised as royalty “according to general practical experience.” “Cutting Tech GMBH” filed an appeal against the assessment in 2015. Judgement of the Fiscal Court The Fiscal Court adjusted the assessment issued by the tax authorities and thus parcially allowed the appeal of “Cutting Tech GMBH”. Excerpts “In the case at issue, the decisive cause for the plaintiff losing the customer P is not to be seen in the transfer of business to CB. The applicant lost the customer because it could not offer him competitive prices. The takeover of the business with P by CB is thus not the cause of the loss of the customer. The plaintiff’s factual submission is undisputed in this respect and is confirmed by the small profit that CB made from the business according to the calculations of the foreign auditor.” “The FA was correct to add € … to the taxable income in the year 2013 due to the supply of materials to CB for the processing of its business with ...

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

A Danish subsidiary in the German MAN group was the owner of certain intangible assets. The German parent, acting as an intermediate for the Danish subsidiary, licensed rights in those intangibles to other parties. In 2002-2005, the Danish subsidiary received royalty payments corresponding to the prices agreed between the German parent company and independent parties for use of the intangibles. The group had requested an adjustment of the royalty payments to the Danish subsidiary due to withholding taxes paid on inter-company license fees received by the German Parent. This was rejected by the Danish tax authorities. The Supreme Court found no basis for an adjustment for withholding taxes as the agreed prices between the German parent and the Danish Subsidiary matched the market price paid by independent parties. Click here for translation ...

“Drinks Distributor S.A.” was involved in purchase, sale and distribution of alcoholic beverages in Mexico. “Drinks Distributor s.a” had entered into a non-exclusive trademark license agreement with a related party for the sale of its product. Following a restructuring process, the related party moved to Switzerland. Following an audit the Mexican tax administration, determined that deductions for marketing and advertising costs related to brands and trademarks used under the licensing agreement, were not “strictly indispensable” and therefore not deductible, cf. requirement established by the Income Tax Law in Mexico. Drinks Distributor S.A on its side held that the marketing and advertising costs were strictly indispensable and that the tax deductions should be accepted. The dispute ended up in the Federal Court of Administrative Justice. Judgement: The Court determined what should be understood as “strictly indispensable“. To establish this concept the purposes of the specific company and the specific costs must first be determined – in particular that the costs are directly related to the activity of the enterprise the costs are necessary to achieve the aims of its activity or the development of this activity; in the absence of the costs, the commercial activity of the taxpayer will be hindered. “ADVERTISING AND PUBLICITY EXPENSES. THE DEDUCTION IS INAPPROPRIATE, AS THEY ARE NOT STRICTLY INDISPENSABLE FOR THE COMPANY SELLING PRODUCTS UNDER TRADEMARKS WHOSE USE AND EXPLOITATION WERE GRANTED TO IT BY MEANS OF A NON-EXCLUSIVE LICENSE AGREEMENT. Article 31, section I of the Income Tax Law provides that the deductions must comply with various requirements, including that they are strictly indispensable for the purposes of the taxpayer’s activity; the latter being understood to mean that said expenses are directly related to the activity of the company, that they are necessary to achieve the purposes of its activity or the development thereof and that if they do not occur they could affect its activities or hinder its normal operation or development. Therefore, in order to determine whether such expenditure satisfies that requirement, account must be taken of the aims of the undertaking and the specific expenditure itself. Therefore, if a company has as its object the sale of a certain product, and to this end has entered into a non-exclusive license agreement for the use and exploitation of intangibles, which grants it the use and exploitation of a brand name to sell this product; The latter is prevented from deducting advertising and publicity expenses, since, as it does not own the trademark it uses to sell its product, the aforementioned expenses – understood as the acts through which something is made known in order to attract followers or buyers through the means used to disseminate or spread the news of things or facts – are not strictly indispensable for the development of its activity, as they increase the value of the trademark for the benefit of a third party; That is to say, the owner of the trade mark, since they are not aimed at the article, but at positioning the trade mark on the market, in order to give it notoriety, fame and recognition among the consumer public.” Click here for English Translation Click here for other translation ...

The Swiss company X SA (hereinafter: the Company or the Appellant), is part of the multinational pharmaceutical group X, whose parent holding is X BV (hereinafter referred to as the parent company) in Netherlands, which company owns ten subsidiaries, including the Company and company X France SAS (hereinafter: the French company). According to the appendices to the accounts, the parent company did not employ any employees in 2006 or in 2007, on the basis of a full-time employment contract. In 2010 and 2011, an average of three employees worked for this company. By agreement of July 5, 2006, the French company undertook to carry out all the works and studies requested by the parent company for a fee calculated on the basis of their cost, plus a margin of 15%. The French company had to communicate to the parent company any discoveries or results relating to the work entrusted to it. It should also keep the parent company informed of the progress of the transactions, directly or through the Company. The results of all studies became the property of the parent company. By an agreement of February 19, 2008, the parent company granted the Swiss Company access to the research and development activities carried out by the French company, in exchange for paying the parent company a royalty of 2.5% of all revenues generated on the products or registered by the parent company through the French company. In 2013, the Swiss Tax Administration informed the Company of the initiation of a tax assessment for the years 2008 to 2010, as well as a tax evasion attempt procedure for the year 2011. These proceedings resulted from a communication from the Federal Tax Administration that mentioned the existence of charges not justified by commercial use during the years in question. Later the same year the Tax Administration informed the Company that the proceedings were extended to the years 2003 to 2007. In 2014 a tax assessment was issued for the tax years 2003 and 2005 to 2010. The Tax Administration estimated that the Company had paid royalties to the parent company for the use of research and development of certain molecules. However, the latter company had no substance or technical expertise to carry out this activity. In practice, the research and development of the X group was led by the Swiss Company, which subcontracted some of the tasks to the French company. The amount of royalties paid by the Swiss Company to the parent company, after deduction of the costs actually borne by the company for subcontracting, constituted unjustified expenses on a commercial basis. The Swiss company stated that the parent company assumes important financial, regulatory and operational risks, for which it should be compensated. The Supreme Court concluded that the parent company was a mere shell company, and as a result, disregarded the transaction. The court found that the parent did not hold the required substance to be entitle to any royalty payments. The parent was not involved in the group’s R&D activity and had no/very few employees. It was not even the legal owner because the patents were registered in the Swiss company’s name. The Swiss company had 60 employees and made all the strategic decisions over the R&D functions. The Federal Tribunal ruled in favor of the Swiss Tax Administration. The Court found the transactions and payments to be a hidden distribution of profit leading to tax evasion. Click here for translation ...

Sogefi Filtration S.p.A. received a notice of assessment for the 2003 financial year concerning various issues, including the deduction of royalties paid for the use of a trademark, interest income on a loan granted to a foreign subsidiary and the denial of a tax credit for dividends received by a French subsidiary. Sogefi appealed to the Regional Court, which ruled largely in its favour. Not satisfied with the decision, the tax authorities appealed to the Supreme Court. Judgement of the Supreme Court On the issue of transfer pricing the Supreme Court clarified, that the French arm’s length provision is not an anti-avoidance rule. Excerpt “4.1. The plea – admissible as it does not concern questions of merit but the correct application of the rule – is well founded. 4.2. It should be noted, in fact, that Art. 76 (now 110) tuir does not incorporate an anti-avoidance regulation in the strict sense, but is aimed at repressing the economic phenomenon of transfer pricing (shifting of taxable income following transactions between companies belonging to the same group and subject to different national regulations) considered in itself, so that the proof incumbent on the tax authorities does not concern the higher national taxation or the actual tax advantage obtained by the taxpayer, but only the existence of transactions, between related companies, at a price apparently lower than the normal price, it being incumbent on the taxpayer, pursuant to the ordinary rules of proximity of proof under Art. 2697 et.e. and on the subject of tax deductions, the taxpayer bears the burden of proving that such transactions took place for market values to be considered normal in accordance with the specific provisions of Article 9(3) of the Income Tax Code (see Court of Cassation no. 11949 of 2012; Court of Cassation no. 10742 of 2013; Court of Cassation no. 18392 of 2015; Court of Cassation no. 7493 of 2016). Such conclusion, moreover, is in line with the ratio of the legislation that is to be found “in the arm’s length principle set forth in Article 9 of the OECD Model Convention””, so that the assessment on the basis of the normal value concerns the “economic substance of the transaction” that is to be compared “with similar transactions carried out under comparable circumstances in free market conditions between independent parties” (see. in particular, Court of Cassation No. 27018 of 15/11/2017 which, in recomposing the different interpretative options that have emerged in the Court’s case law, expressly stated “the ratio of the rules set forth in Article 11O, paragraph 7, of the Income Tax Code must be identified in the arm’s length principle, excluding any qualification of the same as an anti-avoidance rule”). Incidentally, it should be noted that the current OECD Guidelines, in terms not dissimilar from what has been provided for since the 1970s, are unequivocal in clarifying (Chapter VII of the 2010 Guidelines, paras. 7.14 and 7.15 with respect to the identification and remuneration of financing as intra-group services, as well as 7. 19, 7.29 and 7.31 with respect to the determination of the payment), that the remuneration of an intra-group loan must, as a rule, take place through the payment of an interest rate corresponding to that which would be expected between independent companies in comparable circumstances. 4.3. However, in the case in point, the CTR excluded the application of the institute on the assumption that “a more favourable interest rate granted to a subsidiary for the acquisition of a company operating in the same sector in Spain is not necessarily of an avoidance nature” and, therefore, although faced with the objective fact of the divergence from the normal value, it excluded its relevance on the basis of an irrelevant assumption extraneous to the provision, the application of which it misapplied, resulting, in part, in the cassation of the judgment.” Click here for English translation Click here for other translation ...

92. Osnovni is the parent company of an MNE Group engaged in the development and sale of software products. Osnovni acquires 100% of the equity interests in Company S, a publicly traded company organised in the same country as Osnovni, for a price equal to 160. At the time of the acquisition, Company S shares had an aggregate trading value of 100. Competitive bidders for the Company S business offered amounts ranging from 120 to 130 for Company S. 93. Company S had only a nominal amount of fixed assets at the time of the acquisition. Its value consisted primarily of rights in developed and partially developed intangibles related to software products and its skilled workforce. The purchase price allocation performed for accounting purposes by Osnovni allocated 10 to tangible assets, 60 to intangibles, and 90 to goodwill. Osnovni justified the 160 purchase price in presentations to its Board of Directors by reference to the complementary nature of the existing products of the Osnovni group and the products and potential products of Company S. 94. Company T is a wholly owned subsidiary of Osnovni. Osnovni has traditionally licensed exclusive rights in all of its intangibles related to the European and Asian markets to Company T. For purposes of this example it is assumed that all arrangements related to the historic licences of European and Asian rights to Company T prior to the acquisition of Company S are arm’s length. 95. Immediately following the acquisition of Company S, Osnovni liquidates Company S, and thereafter grants an exclusive and perpetual licence to Company T for intangible rights related to the Company S products in European and Asian markets. 96. In determining an arm’s length price for the Company S intangibles licensed to Company T under the foregoing arrangements, the premium over the original trading value of the Company S shares included in the acquisition price should be considered. To the extent that premium reflects the complementary nature of Osnovni group products with the acquired products in the European and Asian markets licensed to Company T, Company T should pay an amount for the transferred Company S intangibles and rights in intangibles that reflects an appropriate share of the purchase price premium. To the extent the purchase price premium is attributable exclusively to product complementarities outside of Company T’s markets, the purchase price premium should not be taken into account in determining the arm’s length price paid by Company T for Company S intangibles related to Company T’s geographic market. The value attributed to intangibles in the purchase price allocation performed for accounting purposes is not determinative for transfer pricing purposes ...

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

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

49. Shuyona is the parent company of an MNE group. Shuyona is organised in and operates exclusively in country X. The Shuyona group is involved in the production and sale of consumer goods. In order to maintain and, if possible, improve its market position, ongoing research is carried out by the Shuyona group to improve existing products and develop new products. The Shuyona group maintains two R&D centres, one operated by Shuyona in country X, and the other operated by Company S, a subsidiary of Shuyona, operating in country Y. 50. The Shuyona group sells two lines of products. All R&D with respect to product line A is conducted by Shuyona. All R&D with respect to product line B is conducted by the R&D centre operated by Company S. Company S also functions as the regional headquarters of the Shuyona group in North America and has global responsibility for the operation of the business relating to product line B. However, all patents developed through Company S research efforts are registered by Shuyona. Shuyona makes no or only a nominal payment to Company S in relation to the patentable inventions developed by the Company S R&D centre. 51. The Shuyona and Company S R&D centres operate autonomously. Each bears its own operating costs. Under the general policy direction of Shuyona senior management, the Company S R&D centre develops its own research programmes, establishes its own budgets, makes determinations as to when R&D projects should be terminated or modified, and hires its own R&D staff. The Company S R&D centre reports to the product line B management team in Company S, and does not report to the Shuyona R&D centre. Joint meetings between the Shuyona and Company S R&D teams are sometimes held to discuss research methods and common issues. 52. The transfer pricing analysis of this fact pattern would begin by recognising that Shuyona is the legal owner/registrant of intangibles developed by Company S. Unlike the situation in Example 14, however, Shuyona neither performs nor exercises control over the research functions carried out by Company S, including the important functions related to management, design, budgeting and funding that research. Accordingly, Shuyona’s legal ownership of the intangibles does not entitle it to retain or be attributed any income related to the product line B intangibles. Tax administrations could arrive at an appropriate transfer pricing outcome by recognising Shuyona’s legal ownership of the intangibles but by noting that, because of the contributions of Company S in the form of functions, assets, and risks, appropriate compensation to Company S for its contributions could be ensured by confirming that Company S should make no royalty or other payment to Shuyona for the right to use any successfully developed Company S intangibles, so that the future income derived from the exploitation of those intangibles by Company S would be allocated to Company S and not to Shuyona. 53. If Shuyona exploits the product line B intangibles by itself, Shuyona should provide appropriate compensation to Company S for its functions performed, assets used and risks assumed related to intangible development. In determining the appropriate level of compensation for Company S, the fact that Company S performs all of the important functions related to intangible development would likely make it inappropriate to treat Company S as the tested party in an R&D service arrangement ...

42. The facts in this example are the same as those set out in Example 10 with the following additions: At the end of Year 3, Primair stops manufacturing watches and contracts with a third party to manufacture them on its behalf. As a result, Company S will import unbranded watches directly from the manufacturer and undertake secondary processing to apply the R name and logo and package the watches before sale to the final customer. It will then sell and distribute the watches in the manner described in Example 10. As a consequence, at the beginning of Year 4, Primair and Company S renegotiate their earlier agreement and enter into a new long term licensing agreement. The new agreement, to start at the beginning of Year 4, is for five years, with Company S having an option for a further five years. Under the new agreement, Company S is granted the exclusive right within country Y to process, market and distribute watches bearing the R trademark in consideration for its agreement to pay a royalty to Primair based on the gross sales of all such watches. Company S receives no compensation from Primair in respect of the renegotiation of the original marketing and distribution agreement. It is assumed for purposes of this example that the purchase price Company S pays for the watches from the beginning of Year 4 is arm’s length and that no consideration with respect to the R name is embedded in that price. 43. In connection with a tax audit conducted by country Y tax administrations in Year 6, it is determined, based on a proper functional analysis, that the level of marketing expenses Company S incurred during Years 1 through 3 far exceeded those incurred by independent marketers and distributors with similar long term marketing and distribution agreements. It is also determined that the level and intensity of marketing activity undertaken by Company S exceeded that of independent marketers and distributors, and that the relatively greater activity has been successful in expanding volumes and/or increasing the Primair group’s overall margins from sales in country Y. Given the extent of the market development activities undertaken by Company S, including its strategic control over such activities, it is evident from the comparability and functional analysis that Company S has assumed significantly greater costs and assumed greater risks than comparable independent enterprises. There is also evidence that the individual entity profit margins realised by Company S are significantly lower than the profit margins of comparable independent marketers and distributors during the corresponding years of similar long-term marketing and distribution arrangements. 44. The country Y audit also identifies that in Years 4 and 5, Company S bears the costs and associated risks of its marketing activities under the new long-term licensing arrangement with Primair, and because of the long-term nature of the agreement, Company S may have an opportunity to benefit (or suffer a loss) from its activities. However, Company S has undertaken market development activities and incurred marketing expenditure far beyond what comparable independent licensees with similar long-term licensing agreements undertake and incur for their own benefit, resulting in significantly lower anticipated profit margins for Company S than those of comparable enterprises. 45. Based on these facts, Company S should be compensated with an additional return for the market development functions it performs, the assets it uses and the risks it assumes. For Years 1 through 3, the possible bases for such an adjustment would be as described in Example 10. For Years 4 and 5 the bases for an adjustment would be similar, except that the adjustment could reduce the royalty payments from Company S to Primair, rather than the purchase price of the watches. Depending on the facts and circumstances, consideration could also be given to whether Company S should have received compensation in connection with the renegotiation of the arrangement at the end of Year 3 in accordance with the guidance in Part II of Chapter IX ...

39. The facts in this example are the same as in Example 9 with the following additions: By the end of Year 3, the R brand is successfully established in the country Y market and Primair and Company S renegotiate their earlier agreement and enter into a new long-term licensing agreement. The new agreement, which is to commence at the beginning of Year 4, is for five years with Company S having an option for a further five years. Under this agreement, Company S agrees to pay a royalty to Primair based on the gross sales of all watches bearing the R trademark. In all other respects, the new agreement has the same terms and conditions as in the previous arrangement between the parties. There is no adjustment made to the price payable by Company S for the branded watches as a result of the introduction of the royalty. Company S’s sales of R brand watches in Years 4 and 5 are consistent with earlier budget forecasts. However, the introduction of the royalty from the beginning of year 4 results in Company S’s profit margins declining substantially. 40. Assume that there is no evidence that independent marketers/distributors of similar branded products have agreed to pay royalties under similar arrangements. Company S’s level of marketing expenditure and activity, from Year 4 on, is consistent with that of independent enterprises. 41. For transfer pricing purposes, it would not generally be expected that a royalty would be paid in arm’s length transactions where a marketing and distribution entity obtains no rights for transfer pricing purposes in trademarks and similar intangibles other than the right to use such intangibles in distributing a branded product supplied by the entity entitled to the income derived from exploiting such intangibles. Furthermore, the royalty causes Company S’s profit margins to be consistently lower than those of independent enterprises with comparable functions performed, assets used and risks assumed during the corresponding years of similar long-term marketing and distribution arrangements. Accordingly, a transfer pricing adjustment disallowing the royalties paid would be appropriate based on the facts of this example ...

8. The facts are the same as in Example 2. However, after licensing the patents to associated and independent enterprises for a few years, Company S, again acting under the direction and control of Premiere, sells the patents to an independent enterprise at a price reflecting appreciation in the value of the patents during the period that Company S was the legal owner. The functions of Company S throughout the period it was the legal owner of the patents were limited to performing the patent registration functions described in Examples 1 and 2. 9. Under these circumstances, the income of Company S should be the same as in Example 2. It should be compensated for the registration functions it performs, but should not otherwise share in the returns derived from the exploitation of the intangibles, including the returns generated from the disposition of the intangibles ...

5. The facts related to the development and control of patentable inventions are the same as in Example 1. However, instead of granting a perpetual and exclusive licence of its patents back to Premiere, Company S, acting under the direction and control of Premiere, grants licences of its patents to associated and independent enterprises throughout the world in exchange for periodic royalties. For purposes of this example, it is assumed that the royalties paid to Company S by associated enterprises are all arm’s length. 6. Company S is the legal owner of the patents. However, its contributions to the development, enhancement, maintenance, protection, and exploitation of the patents are limited to the activities of its three employees in registering the patents and maintaining the patent registrations. The Company S employees do not control or participate in the licensing transactions involving the patents. Under these circumstances, Company S is only entitled to compensation for the functions it performs. Based on an analysis of the respective functions performed, assets used, and risks assumed by Premiere and Company S in developing, enhancing, maintaining, protecting, and exploiting the intangibles, Company S should not be entitled ultimately to retain or be attributed income from its licensing arrangements over and above the arm’s length compensation for its patent registration functions. 7. As in Example 1 the true nature of the arrangement is a patent administration service contract. The appropriate transfer pricing outcome can be achieved by ensuring that the amount paid by Company S in exchange for the assignments of patent rights appropriately reflects the respective functions performed, assets used, and risks assumed by Premiere and by Company S. Under such an approach, the compensation due to Premiere for the patentable inventions is equal to the licensing revenue of Company S less an appropriate return to the functions Company S performs ...

Also in the case where a local operation disposes of the legal ownership of its intangibles to a foreign associated enterprise and continues to use the intangibles further to the disposal, but does so in a different legal capacity (e.g. as a licensee), the conditions of the transfer should be assessed from both the transferor’s and the transferee’s perspectives. The determination of an arm’s length remuneration for the subsequent ownership, control and exploitation of the transferred intangible should take account of the extent of the functions performed, assets used and risks assumed by the parties in relation to the intangible transferred, and in particular analysing control of risks and control of functions performed relating to the development, enhancement, maintenance, protection, or exploitation of the intangibles ...

Business restructurings sometimes involve the transfer of the legal ownership of intangibles or rights in intangibles that were previously owned by one or more local operation(s) to a central location situated in another tax jurisdiction (e.g. a foreign associated enterprise that operates as a principal or as a so-called “IP company”). In some cases the transferor continues to use the intangible transferred, but does so in another legal capacity (e.g. as a licensee of the transferee, or through a contract that includes limited rights to the intangible such as a contract manufacturing arrangement using patents that were transferred; or a limited risk distribution arrangement using a trademark that was transferred). In accordance with the guidance in Chapter VI, it is important to remember that the legal ownership of an intangible by itself does not confer any right ultimately to retain returns derived by the MNE group from exploiting that intangible (see 6.42). Instead, the compensation required to be paid to associated enterprises performing or controlling functions related to the development, enhancement, maintenance, protection, or exploitation of intangibles may comprise any share of the total return anticipated to be derived from the intangibles (see 6.54). Therefore, the change in legal ownership of an intangible in a business restructuring may not affect which party is entitled to returns from that intangible ...

Under a development CCA, each participant has an entitlement to rights in the developed intangible(s) or tangible asset(s). In relation to intangibles, such rights often take the form of separate rights to exploit the intangible in a specific geographic location or for a particular application. The separate rights obtained may constitute actual legal ownership; alternatively, it may be that only one of the participants is the legal owner of the property but the other participants have certain rights to use or exploit the property. In cases where a participant has such rights in any property developed by the CCA, there is no need for a royalty payment or other further consideration for the use of the developed property consistent with the interest to which the participant is entitled under the CCA (however, the contributions of a participant may need to be adjusted if they are not proportionate to their expected benefits; see Section C.5) ...

Comparability, and the possibility of making comparability adjustments, is especially important in considering potentially comparable intangibles and related royalty rates drawn from commercial databases or proprietary compilations of publicly available licence or similar agreements. The principles of Section A.4.3.1 of Chapter III apply fully in assessing the usefulness of transactions drawn from such sources. In particular, it is important to assess whether publicly available data drawn from commercial databases and proprietary compilations is sufficiently detailed to permit an evaluation of the specific features of intangibles that may be important in conducting a comparability analysis. In evaluating comparable licence arrangements identified from databases, the specific facts of the case, including the methodology being applied, should be considered in the context of the provisions of paragraph 3.38 ...

When the distributor actually bears the cost of its marketing activities (for example, when there is no arrangement for the legal owner to reimburse the expenditures), the analysis should focus on the extent to which the distributor is able to share in the potential benefits deriving from its functions performed, assets used, and risks assumed currently or in the future. In general, in arm’s length transactions the ability of a party that is not the legal owner of trademarks and other marketing intangibles to obtain the benefits of marketing activities that enhance the value of those intangibles will depend principally on the substance of the rights of that party. For example, a distributor may have the ability to obtain benefits from its functions performed, assets used, and risks assumed in developing the value of a trademark and other marketing intangibles from its turnover and market share when it has a long-term contract providing for sole distribution rights for the trademarked product. In such a situation the distributor’s efforts may have enhanced the value of its own intangibles, namely its distribution rights. In such cases, the distributor’s share of benefits should be determined based on what an independent distributor would receive in comparable circumstances. In some cases, a distributor may perform functions, use assets or assume risks that exceed those an independent distributor with similar rights might incur or perform for the benefit of its own distribution activities and that create value beyond that created by other similarly situated marketers/distributors. An independent distributor in such a case would typically require additional remuneration from the owner of the trademark or other intangibles. Such remuneration could take the form of higher distribution profits (resulting from a decrease in the purchase price of the product), a reduction in royalty rate, or a share of the profits associated with the enhanced value of the trademark or other marketing intangibles, in order to compensate the distributor for its functions, assets, risks, and anticipated value creation. Examples 8 to 13 in the Annex to Chapter VI illustrate in greater detail the application of this Section B in the context of marketing and distribution arrangements ...

Rights under contracts may also be important to a particular business and can cover a wide range of business relationships. They may include, among others, contracts with suppliers and key customers, and agreements to make available the services of one or more employees. Rights under contracts are intangibles within the meaning of Section A. 1 ...

The guidance contained in this chapter is intended to address transfer pricing matters exclusively. It is not intended to have relevance for other tax purposes. For example, the Commentary on Article 12 of the OECD Model Tax Convention contains a detailed discussion of the definition of royalties under that Article (paragraphs 8 to 19). The Article 12 definition of “royalties” is not intended to provide any guidance on whether, and if so at what price, the use or transfer of intangibles would be remunerated between independent parties. It is therefore not relevant for transfer pricing purposes. Moreover, the manner in which a transaction is characterised for transfer pricing purposes has no relevance to the question of whether a particular payment constitutes a royalty or may be subjected to withholding tax under Article 12. The concept of intangibles for transfer pricing purposes and the definition of royalties for purposes of Article 12 of the OECD Model Tax Convention are two different notions that do not need to be aligned. It may occur that a payment made between associated enterprises may be regarded as not constituting a royalty for purposes of Article 12, and nevertheless be treated for transfer pricing purposes as a payment to which the principles of this chapter may apply. Examples could include certain payments related to goodwill or ongoing concern value. It may also occur that a payment properly treated as a royalty under Article 12 of a relevant Treaty may not be made in remuneration for intangibles for purposes of this chapter. Examples could include certain payments for technical services. Similarly, the guidance in this chapter is not intended to have relevance for customs purposes ...

At issue was the existence of a basis for taking into account the deductibility of the costs of services, the costs related to the repurchase and destruction of products and the tax deductibility of royalty expenses charged between related parties. Judgment of the Court The Administrative Court concluded that “Buy/Sell Distributor” had failed to prove that the disputed services charged to it were actually supplied and necessary for it. As regards the costs relating to the redemption and destruction of the products, it held that “Buy/Sell Distributor” was not obliged to bear those costs in view of the functions it performed within the multinational company’s system and the risks it bore. The Court also held that there was no basis for treating the royalty payment as a tax deductible expense. Click here for English translation Click here for other translation ...

The 2013 Draft Handbook on Transfer Pricing Risk Assessment is a detailed, practical resource that countries can follow in developing their own risk assessment approaches. The handbook supplements useful materials already available with respect to transfer pricing risk assessment. The OECD Forum on Tax Administration published a report entitled “Dealing Effectively with the Challenges of Transfer Pricing” in January 2012. One chapter of that report also addresses transfer pricing risk assessment ...