Brand licensing structures and challenges from a German perspective
Trademark licensing structures are increasingly important to multinational companies’ tax operations.
Companies headquartered out of Germany, however, are often not aware of specific German and EU regulations, to be considered when introducing a brand licensing structure.
This practise can lead to a tax field audit in Germany.
The main challenges to be considered, and questions to be answered, before introducing the structure are:
1. Tax deductibility of license fees: Are license fees, paid for the use of trademarks, tax deductible by a German based company if the trademark is equal to the group name and, if so, under which conditions?
2. Reason for license payments: Does the exhaustion doctrine need to be applied for intercompany transactions?
3. Determination of the brand value: Are there major differences between international brand valuation standard (ISO 10668) and the specific German brand valuation standard (IDW S5)?
4. Appropriateness of the license fee: Will rules of thumb for the determination of the appropriateness of a license fee-rate be recognised by German tax authorities in the light of the OECD discussion draft for intangibles?
1. Tax deductibility of trademark license fees in Germany
German fiscal authorities generally tend to deny the tax deductibility of license fees paid for the use of such trademarks/brands/logos etcetera where the trademark/brand/logo represents a component part of the group name (Group name trademarks). It is argued that the use of such intangibles is provided to group members as a function of the shareholder relationship, being part of the general group support (Rückhalt im Konzern).( See Ministry of Finance as of 23 February 1983, BStBl I 1983, Tz. 6.3.2)
German courts generally tend to follow the view of the fiscal authorities provided the group name is not independently protected as a trademark. However, in cases where the group’s name registration as a trademark is in Germany, this does not apply, as far as the trademark comprises its own economic value and helps the licensee in distributing the products. (See Supreme Tax Court, 9.900, I R 12/99)
To secure the tax deductibility from a German transfer pricing perspective, the taxpayer should first register the trademark in Germany before the effectiveness of a respective license agreement. In addition, it is recommended that the taxpayer can prove that the trademark has its own economic value and that there is a connected promotion of sales (Absatzförderung).
2. Doctrine of exhaustion and marketing of products (first sale doctrine)
In German trade mark law, the doctrine of exhaustion (first sale doctrine) qualifies as an exception to a trademark owner’s exclusive rights.
The exhaustion doctrine states that once goods bearing a trademark are put on the market in the European Economic Area (EEA) with the express consent of the trademark owner, the trade mark proprietor’s rights are exhausted. Practically, this means that the trademark owner can no longer be subject to further dealings (for example, grant of trademark) in those goods within the EEA.
It is therefore questionable at what time the goods are considered to have been put on the market. German fiscal authorities assume that products are put on market with the first (intercompany) supply of the goods, for example, from the production unit to a related distribution unit.( See Ministry of Finance as of 23 February 1983, BStBl I 1983, Tz. 18.104.22.168)
This assumption is refused by German judicative assuming - with certain limitations - that putting a product on the market can only be assumed if the products are leaving the intra group sphere and are entering into the free commerce as only in this case, the brand can attract its specific value. (See Federal Supreme Court decision as of 27 April 2006 (I ZR 162/03) and European Supreme Court Peak Holding/Axolin-Elinor decision (GRUR 2005, 507, 509 Tz. 44)
The exhaustion doctrine and its implication within the intercompany context requires a careful structuring.
3. Are there major differences between international brand valuation standards (ISO 10668) and the specific German brand valuation standards (IDW S5)?
On 12 July 2007 the German IDW standard Principles for the valuation of intangible assets (IDW S 5) was published. The IDW standard is neither a legal provision nor an official administrative ordinance but has to be seen as a guideline for German auditors, which are however also considered by German tax authorities.
In comparison to the international standard ISO 10668 (December 2010), the IDW differs in the following ways:
The IDW S 5 knows a clear hierarchy of methods. The income approach shall be used primarily. The market approach would not be applicable in most cases due to the missing of an active market for brands. According to the IDW S 5, the cost approach has to be treated as subordinate. According to ISO 10668 there is no clear hierarchy of methods, but it also mentions that the determination of appropriate prices would be difficult. Furthermore it states, that the cost approach shall only be applied if the application of the other approaches is not possible and if appropriate data (about the costs related to the invention, registration, protection and maintenance of the trademark ) is available.
Within the income approach the IDW S 5 mentions four different methods for the calculation of the brand value: Direct cash flow prognosis method, royalty relief method, incremental cash flow method and multi-period excess earnings method. The ISO 10668 also allows the above methods except the direct cash flow prognosis method; in addition the (quite similar) price premium method, volume premium method and income-split method might also be applied within ISO 10668.
IDW S 5 considers behavioral aspects only as a potential supporting tool for the financial models. ISO 10668 also demands that behavioral aspects shall be used for the determination of the brand strength (loyalty of the customers, public awareness of the brand, etcetera). The brand value drivers, such as customer brand awareness, recognition and loyalty shall, be used for calculating the relevant parameters needed for the application of the income approach.
According to IDW S 5, the product life cycle shall serve as a reference for the economic lifetime of the brand, which is limited in general. According to ISO 10668 the expected economic lifetime of the brand is relevant too, but it also allows for an indefinite lifetime, if necessary. The respective cash flows in the financial models shall be considered after taxes and a tax amortisation benefit (TAB) shall be taken into account, if necessary, according to both standards. Furthermore both approaches consider the WACC of the whole company as base value for the calculation of an appropriate discount rate. This value has to be adjusted for brand specific risks.
It can be summarised that the IDW S 5 and the ISO 10668 are quite similar in most areas. IDW S 5 is, in most cases, more detailed than the ISO standard, but also more restrictive. However the ISO 10668 also recommends for the comprehensive use of behavioral approaches, in contrast to the German standard.
4. Will rules of thumb for the determination of the appropriateness of a license fee rate be still recognised by German tax authorities in the light of the OECD discussion draft for intangibles?
A rule of thumb is frequently used in Germany to support the appropriateness of license fee rates (if no comparable uncontrolled prices are available). This requires an allocation of the (integrated) profits between the licensor and the licensee. See for example United States Court of Appeals for the Federal Circuit, UNILOC USA, INC. AND UNILOC SINGAPORE PRIVATE LIMITED vs. MICROSOFT CORPORATION (2010-1035, -1055), January 4, 2011 (25 % rule).
According to this rule of thumb, the licensor shall receive for the grant of IP a profit share of approximately 1/4 to 1/3 of the profits generated by licensee by using the granted IP (See Knoppe, BB 1967, S. 1117).
In the light of the new developments in the OECD discussion draft for intangibles, the further acceptance of the rules of thumb, for the determination or the validation of an appropriate license fee by the German tax authorities, might be highly questionable.
This indicates that the further application and acceptance of rules of thumbs might become uncertain in Germany in the future.
Consider local provisions
Although Germany is an OECD member, following the, and being influenced by the, OECD Transfer Pricing Guidelines, it is highly recommended that taxpayer consider local provisions, regulations and ordinances as they can cause adverse tax effects, like the non-deductibility of license fees.
By principal TPWeek correspondents for Germany, Susann van der Ham, partner; Jan Feldtkeller, manager; Steffen Voll, senior consultant; and Lorenz Leonhardt, consultant, at PwC, Germany