Germany: Transfer Pricing Aspects of Intangibles in the light of new German jurisdiction

On February 14, 2014 the Fiscal Court of Muenster (Germany) came to an interesting judgment pertaining to the necessity of royalty fees charge to an entity for the right to use the company brand name in the same group of company. 

Simplified description of the situation 

The applicant, a German corporation, is the owner of a trademark since 1985. The applicant obtained a protection of the trademark for several countries (Austria, Switzerland, France, Spain, Italy, Poland and Portugal). The applicant had subsidiaries, inter alia, in Poland. The Polish company used the trademark on their Internet website, business papers and company cars without paying any fees to the German corporation. 

During a tax audit the German tax administration came to the conclusion that the free of charge use of the trademark would not have been made in arm´s length transactions. As the subsidiary could use the trademark and the use of the name provides a financial benefit to the subsidiary in Poland, the German tax administration determined the amount of payment with respect to the company brand name with 1% from the subsidiary´s turnover and additionally 25% from the EBIT (Earnings Before Interest and Tax). 

As the German corporation denied that the use of the company brand name provides a financial benefit for the subsidiary and therefore a free of charge use of the trademark was within the arm´s length principle, the corporation filed a suit. 

The decision of the Fiscal Court of Muenster came to the following results: 

Licensing of the Groups name in general 

Many difficulties will be incurred when identifying intangibles. First of all the Court made the attempt to clarify if the company name is an intangible in general. 

In fact, the trademark belongs to the German corporation and the subsidiary in Poland has the right to use this trademark. However, the Court came to the result, that the name provided a financial benefit, as by using the company brand name, possible customers assumed that the Polish trading company was a part of the group brand. 

The fact that the protection of the trademark was also obtained for Poland before the establishment of the company in Poland was also an indication, that the trademark provides a benefit. Furthermore, it has been used on the Polish company´s website, company cars and business papers and showed the intention to achieve advertising and recognition effects. 

Identifying and determining the prices for group name 

As the use of the trademark had a financial benefit, third parties would have agreed to pay a kind of fee for the right to use the trademark. Therefore the German tax administration had the right to correct the tax basis on the basis of the German Foreign Taxation act (AStG). 

The fee has to consider comparability features like: 

• Prices of the goods sold using the trademark 

• Name recognition 

• Geographic scope 

• extent and duration of legal protection 

With these features, the Fiscal Court came to the conclusion that a royalty fee has to be charged. In determining the amount of payment, the Fiscal Court compared the situation with a case of violation of the trademark right. The amount has to consider a possible compensation claim in case of trade mark infringements by a third person would use the company name without permission. The range can be 1% to 5% on basis of the subsidiary´s turnover. With considering the brand name recognition, the Fiscal Court accepted a 1% fee on basis of the turnover as in accordance with the arm´s length principle. 

Conclusion 

The Fiscal Court had not considered comparability features like the expectation of future benefits. It is questionable, if the amount that needs to be paid in case of a trade mark infringement really correlates with the future benefit. 

Furthermore, the Fiscal Court has not considered a functional and risk analysis. Therefore it is still unclear, if the 1% fee really is in accordance with the arm´s length principle. Also it can be doubted, whether the wide range for compensation claims of 1% to 5% leads to more precise royalty fees than the simplifying Knoppe formula. 

Finally, the Fiscal Court´s approach is not in accordance with the OECD document “Guidance on Transfer Pricing Aspects of Intangibles” from 16 September 2014. Hence the final decision of the Federal Fiscal Court (Bundesgerichtshof) remains to be seen.