Insight
Cross-border brands, transfer pricing and the impact of BEPS
August 2017
For multinational groups, a change in a local tax regime may lead to higher overall corporate income taxes for the group. Nowadays, with tax authorities around the world on the lookout for tax avoidance, there is little room left for tax planning. Early compliance is now the key and may open up new opportunities or reduce your tax risks.
One area that is often neglected, in the context of transfer pricing, is the cross-border use of corporate brands or trademarks by related companies. Often, subsidiaries trade under the same name as their parent, and use the same brands or trademarks. This raises the question of when intra-group licence fees or royalties are chargeable for the privilege.
Use of a company name and brand in German tax law
Conclusions from various court cases, and changes in German tax law, prompted the German Ministry of Finance to issue guidance in April 2017, setting out criteria for defining a chargeable transaction. A chargeable transaction arises where:
- a licence agreement exists allowing the use of a name or product related brand; and
- there is an unbreakable connection between the name and the brand; and
- the name or brand has a clearly distinguishable value (benefit test).
Until 2013, the absence of a licence fee agreement, or the presence of an uncompensated usage agreement in a company's articles of association, shareholder agreements or bylaws could prevent any obligation to charge for the use of a name or brand. However, changes to the tax law in 2013 and 2015 have now regulated that the tax authorities can deem a level of licence income with no written or oral agreement. And the authorities will disregard shareholder agreements regarding the uncompensated usage of a name or brand, if not intrinsically associated with the shareholding.
This does not apply if the usage of a name or brand has been charged for in another way, for example through the sale of goods to a sales subsidiary. On the other hand, if a company gains an advantage from manufacturing products or rendering services by exercising its right to use a name or brand, the tax authorities could easily value these rights, giving rise to a chargeable transaction.
Impact of the OECD's BEPS project
Now, in the case of a German company paying a foreign company royalties for the use of its name or brand, a question arises regarding the tax deductibility of these payments.
For some time now, jurisdictions have been competing to attract inward investment in research and development (R&D).Initiatives include favourable tax treatment of licence income through 'patent box', 'licence box', and 'IP box' regimes.However, the OECD's report into base erosion and profit shifting (BEPS) found this had the potential to encourage companies to shift profit artificially from one jurisdiction to another with lower taxes.
BEPS Action 5 - Countering Harmful Tax Practices More Effectively aims to tackle these abuses.One example would be where a company produces patents in a high-tax jurisdiction, incurring tax-deductible expenses, but accrues its profits in a low-tax jurisdiction.Because the jurisdiction carrying the expense burden earns no tax revenue from any profits, Action 5 introduced the 'modified nexus' approach.
This approach requires that, for a business to benefit from a favourable regime, it must not only make profits in that regime but must also engage in a significant proportion of R&D activities and incur actual expenditure that contributes to the profit in the same jurisdiction.
As of January 2018, Germany will restrict the tax deductibility of licence payments and royalties that do not follow the modified nexus approach.
This restriction will only apply where the licence income is taxed in the destination jurisdiction at a rate lower than 25%. Where the rate is lower, the tax-deductibility of the licence fee will be partly restricted to offset the preferential tax treatment.
Where related companies use common names or brands, the new legislation is likely to create non-deductible licence expenses for German companies paying a licence fee to a company in a preferential tax jurisdiction. It may be difficult to gain an exemption under the modified-nexus approach as it will be hard to prove the necessary local R&D spend.
What to do next?
The new tax legislation applies to both German inbound and outbound usage of rights.
Where it is a German company using a name or brand, an agreement may reduce the taxable base. However, the BEPS rules we've discussed, and in some cases German rules on controlled foreign companies (CFCs), could restrict this.
Where it is a German company allowing the use of a name or brand, the tax authorities may deem a contract exists even if there is none in place, or if the usage right exists in a shareholder related document, taxing deemed income.
Multinational groups with German companies should evaluate their branding and trademarks and seek professional advice to mitigate any risks.