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Napoleão Dagnese

Balthasar Denger

Thomas Hugh

International transactions involving intellectual property

Workshop by Napoleão Dagnese, Balthasar Denger and Thomas Hug on the occasion of the ISIS) seminar on 27 June 2022 entitled "International transactions involving intellectual property".

06/2022
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Basic facts

An international, listed group with global headquarters in the canton of Zurich is active in the production of beverages. Various market analyses show that the main value drivers of the group are the ABC brand ("brand") and the distinctive design of the beverage bottles ("design"). The beverages are produced according to the company's own secret recipe ("recipe"). The brand is used for the external appearance of the Group on the one hand and for the distribution of the beverages on the other hand.

The Group's operating business is structured legally and operationally as follows:

  • ABC AG, based in Zurich (the Group's ultimate parent company and headquarters), is responsible for the legal protection of the brand and design in the various sales markets (including renewal of local registration rights, defence against unauthorised use of the brand), the strategic further development of the brand and the development and coordination of the global marketing campaigns. While the marketing department ("global marketing") is located at ABC AG with headquarters in Zurich itself, the legal department ("legal department") responsible for the global protection of the brand and the design was outsourced to the 100% subsidiary ABC Management AG with headquarters in Zug, which is compensated for this by ABC AG on the basis of the transactional net margin method with a net cost premium of 5% (Transactional Net Margin Method with Net Cost Plus as Profit Level Indicator, in short "NCP "1). In addition, ABC AG had developed the beverage recipe years ago, which had since been kept secret, and incorporated it into ABC IP Ltd (see below). The group's research and development department at ABC AG is also responsible for the further development and adaptation of the recipe ("R&D").
  • The formal owner of the property rights to the brand and the design in the various countries is the 100% subsidiary ABC IP Ltd. based in the Bahamas. In addition, this company owns the recipe for the production of the concentrate, which is sold by the production companies to independent bottlers and distributors. ABC IP Ltd. pays all fees for the registration and extension of the worldwide trademark and property rights, which are initiated by ABC AG and carried out by ABC Management AG on behalf of ABC IP Ltd. ABC IP Ltd. compensates ABC AG for this on the basis of the NCP with a mark-up of 5%. In addition, it remunerates ABC AG for the development and coordination of the global marketing campaigns as well as the research and development activities, also on the basis of the NCP with a mark-up of 8% according to a benchmarking study by independent marketing agencies. In return, ABC IP Ltd. charges the Group's production companies a licence fee based on short, written contracts. According to the wording of the contracts, the subject of the licence is "various IP rights necessary for the business".
  • In the individual sales markets, the group has local country companies, including ABC (Österreich) AG. The country companies are responsible for country-specific marketing, which is implemented within the framework of the global conditions set by ABC AG (e.g. global marketing campaigns that are adapted to the individual countries). Furthermore, the national companies are the contact for the independent licence partners who are responsible for the bottling and distribution of the beverages (see below). The national companies are also compensated by ABC IP Ltd. on the basis of the above-mentioned benchmarking study by means of NCP and a premium of 8%.
  • Furthermore, the group has regional production companies which produce the concentrate of the beverages on the basis of a secret recipe ("recipe") according to the specifications of ABC IP Ltd. and subsequently resell it to the independent licence partners (licence production). This activity is carried out on the basis of the above-mentioned licence agreements with ABC IP Ltd. For the Western and Northern Europe region, the Dutch ABC Production BV is responsible for this. Due to a conscious decision by the management, the secret recipe has not been protected under intellectual property law in any country. This is to prevent competitors from gaining access to the ingredients via local protection registers.
  • The concentrate is then sold by the respective production companies to independent third parties who dilute the concentrate on the basis of a licence agreement per country, fill it into bottles and then sell it independently to the customers (retail trade, gastronomy) according to the guidelines. In Austria, the independent Lizenzpartner AG is responsible for this and buys the concentrate from ABC Production BV in the Netherlands. The purchase price of the concentrate covers the exclusive filling and distribution rights for the beverages, i.e. no separate licence fees are charged.

(Basic facts based on US court decision Coca-Cola Co. v. Commissioner, 155 T.C. No. 10 (2020), but with a different structure regarding the exploitation of intellectual property rights)

Case 1: Attribution of intangible assets

1. facts of the case

See basic facts.

Questions

  • Question 1: How do the OECD Transfer Pricing Guidelines 2022 define the term "intangibles" and which ones are involved in the present case?
  • Question 2: Since the BEPS project, the OECD distinguishes - even if these terms are not explicitly mentioned in the OECD Transfer Pricing Guidelines 2017 or 2022 - between a "legal", a "financial" and a "functional" ownership of intangible assets. What is meant by this and what are the transfer pricing consequences?
  • Question 3: To which group company(ies) are the following intangible assets to be allocated for transfer pricing purposes:
    - trademark;
    - design;
    - recipe;
    - production know-how;
    - sales rights;
    - customer relationships?
  • Question 4: May the written contracts be completely ignored in the transfer pricing attribution of the trademark, design and recipe?
  • Question 5: Can the parent company ABC AG charge the subsidiaries compensation "on the merits" for the use of the trademark "ABC" in its business appearance (e.g. in the company name)?
  • Question 6: ABC AG has a subsidiary in India, XYZ Ltd, which produces and sells chocolate bars in India. The subsidiary appears in business transactions as "XYZ Ltd. - An ABC Group Company". Can ABC AG charge its Indian subsidiary a trademark licence for this "on the merits"?
  • Question 7: How is the fact that the marketing activities are carried out by ABC AG but the legal activities by ABC Management AG taken into account in terms of transfer pricing?

Case 2: Third-party compensation IP licensing

1. facts of the case

See basic facts. Assumption that the transfer pricing effectively flows to ABC IP Ltd.

Questions

  • Question 1: What methods could be used to determine royalty payments from the production companies to ABC IP Ltd?
  • Question 2: What should be considered with regard to the royalty payments collected by ABC IP Ltd?

Case 3: Third-party compensation IP transfer

1. facts of the case

As part of an internal reorganisation, the ABC Group plans to sell the intangible assets (brand, design, recipe) together with global marketing and R&D to the newly founded company ABC Development Ltd. in the UK. The legal department will remain in Switzerland. In order to use existing loss carry-forwards in ABC AG, the sale is to be made at fair value. As the legal ownership of the brand and the design is with ABC IP Ltd, both ABC AG and ABC IP Ltd will act as sellers.

Questions

  • Question 1: Which methods or models for determining the intra-group purchase price do the OECD foresee in its Transfer Pricing Guidelines 2022?
  • Question 2: Which company is the seller from a transfer pricing perspective?

Case 4: Preventive conflict resolution

1. facts of the case

See facts of case 3 (assuming that functional ownership of the relevant intangible assets was with ABC AG in Switzerland).

Question

  • What options are open to ABC AG to create legal certainty in advance with regard to the arm's length nature of the compensation for the transfer of assets and functions to the UK? What are the advantages and disadvantages of these instruments?
    - Unilateral (Switzerland)
    - Bilateral (Switzerland and UK)

Case 5: Curative conflict resolution

1. facts of the case

See basic facts.

As part of an audit of ABC AG's books in March 2017 by the Zurich Cantonal Tax Office for the years 2014 - 2015, the company's tax commissioner offset royalty income for the use of the trademark and design by the subsidiaries. The offsets amounted to the following amounts:
- ABC Production BV: CHF 3,000,000 per year;
- Other production sites: CHF 2,000,000 per year each.

The offsets were accepted by ABC AG in April 2017, as they corresponded to the licence fees that these companies had effectively paid to ABC IP Ltd. with its registered office in the Bahamas. The assessment became legally effective on 3 May 2017.

Questions

  • Question 1: In the course of a tax audit by the Belastingdienst, a part of the licence fee amounting to CHF 1,000,000 will be charged to the company ABC Production BV as a hidden profit distribution in November 2019. The assessment will be served on 2 November 2019. The corporate tax department of the ABC Group in Switzerland will be informed immediately. How can the ABC Group legally defend itself? How does the situation differ from that of the other production sites? What could be the consequences of similar tax audits at the other production sites?
  • Question 2: In the course of a tax audit by the Vienna tax office, a turnover-based compensation in the amount of CHF 500,000 was offset against the company ABC (Österreich) AG as a hidden profit distribution in October 2019. This offset became legally effective on 15 December 2019. Unfortunately, the Group Tax Department will not learn of this final assessment until 1 December 2022. How can the ABC Group still legally defend itself?
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