Danish staffing company can’t deduct royalties paid to Swiss parent, High Court rules

By Peter S. Andersen, Transfer Pricing Partner, Questro International, Amsterdam

In a key decision, Denmark’s Eastern High Court, on 28 October, agreed with the tax authority that a Danish loss-making company could not deduct royalties paid to its Swiss parent for the use of marketing intangibles.

The 50-page published case (SKM2019.537OLR; decision dated 4 July 2019) is rather detailed in respect of the description of facts, the benchmarking review performed by the tax administration, and the financial data used.

The Danish subsidiary was ultimately owned by a Swiss company, and both companies were active in the staffing industry. This Swiss parent company is one of the largest staffing companies in the world, with operations in more than 60 countries. The Swiss parent company owned the intangibles of the group and licensed the intangibles to its subsidiaries.

Royalties for trademark, network access

From 1 January 2003 until 30 June 2006, the Danish subsidiary paid royalties to its Swiss parent at the rate of 1.5% of turnover for the right to use the trademark in Denmark, know-how, and access to the group’s international network.

On 1 July 2006, the group introduced a new business model which included expected larger investments in the group’s intangibles. At this time, the royalty rate was increased and tailored to different market segments so that a 2% rate applied to the industrial segment (office and production) and a 4% rate applied to the professional segment (professionals with higher university education).

The years under audit included 2006 to 2009, and for these years the total amount of royalties paid amounted to DKK 83.860 million (approximately EUR 11.275 million).

As to benchmarking, the group had based the determination of the 2% and 4% rates on internal CUPs from the group’s US holding company, which had franchise agreements with 39 unrelated parties in the US. Some adjustments were applied to adjust for differences in services provided as part of the licensing of intangibles.

The Danish tax administration undertook a transfer pricing audit of the Danish subsidiary as part of a simultaneous audit by the tax administrations of Denmark, Norway, and Sweden.

The Danish tax administration did not approve the deduction of any of the royalties paid.

The relevant market

In the analysis that led to the decision, the court concluded that the markets in which the group operated were national markets because of language conditions and different legal frameworks in each country.

The court also concluded that the markets were price-driven, and the fact that the parent company brand in its Swiss home market was considered very strong could not lead to another conclusion on this point.

Furthermore, in the group’s transfer pricing documentation, it was stated that “client loyalty is very low in this industry” and “revenues cannot be considered permanent revenues”.

Transfer pricing documentation

The court also concluded that the Danish subsidiary’s transfer pricing documentation did not sufficiently substantiate that the marketing intangibles assisted in earning its income.

In fact, it was noted that the transfer pricing documentation was based on group-wide documentation with limited mentions of the Danish subsidiary’s case and specific situation.

The court concluded that this group-wide approach seemed to indicate that the royalty rates were imposed by the parent company without regard to the circumstances of the individual subsidiaries.

Losses

It was noted also that the Danish subsidiary had realized substantial turnover during the years under audit and in the previous years but, at the same time, consistently realized losses.

The court found that an unrelated party would not have paid or continued to pay for the right to use a trademark in such a situation. In addition, the court suspected that the Swiss parent company had a commercial interest in keeping a presence on the Danish market for purposes of servicing the group’s global customers.

Marketing costs of the subsidiary

The accounts of the Danish subsidiary showed that the subsidiary had incurred direct marketing expenses in the amount of DKK 35 million (EUR 4.7 million) during 2006-2009. If its own personnel costs related to marketing were included, the total marketing expenses of the Danish subsidiary were estimated at DKK 177 million (EUR 24 million) during the period.

The court found that the marketing expenses of the subsidiary indicated that the right to use the group’s trademark did not constitute an independent benefit to the Danish subsidiary.

Value of access to global network

Because of undocumented information on the share of revenue originating from the group’s global network, the court disregarded this information and considered that the Danish subsidiary had not derived any benefit from access to the global network of the group.

New business model

The introduction of the new business model in July 2006, which included higher investments in the group’s intangibles, was used as an occasion to increase the royalty rates.

However, because it appeared from the financials of the Swiss parent company that its cost decreased during the years 2006-2009, the court did not consider that the new business model had provided any real benefit to the Danish subsidiary.

Based on the above, the court upheld the assessment of the tax administration. As a final point, it is worth noting that the outcome was also influenced by the burden of proof considerations and that the Danish subsidiary had not responded to a number of requests for providing on information during the court proceedings.