Denmark Supreme Court rules in favor of Adecco in landmark transfer pricing decision

By Susi Baerentzen, Industrial Ph.D. Student at Innovation Fund Denmark

Denmark’s Supreme Court on 25 June delivered a significant blow to the Danish Revenue, ruling in favor of Danish company, Adecco, and its Swiss parent company in a dispute involving the deductibility of royalties and the sufficiency of transfer pricing documentation.

In so concluding, the Supreme Court overruled the Danish Eastern High Court.

Adecco’s royalty payments 

The dispute arose from a joint Scandinavian transfer pricing tax audit involving the Norwegian, Swedish, and Danish tax authorities.

At issue were royalty payments of DKK 84 million (USD 12.6 million) made in 2006-2009 by the Danish unit of the global temp agency, Adecco, to the groups’ corporate headquarters in Switzerland.

The payments were made for the use of the Adecco trademark, know-how, and access to customer referrals within the global network of the group under a license agreement. The Danish company had been loss-making for several consecutive years.

Under a trademark license agreement, Adecco DK paid a royalty of 1.5 percent based on net sales to the Swiss parent company. As of 1 July 2006, the royalty was increased to 2 percent in relation to the office and industrial business lines.

The license also included know-how and international network intangibles, and the increase of the rate was introduced due to a new business strategy, which further necessitated additional investments into the trademark.

Adecco’s transfer pricing documentation

According to Adecco’s transfer pricing documentation, the applied royalty rates were established using the comparable uncontrolled price method.

No comparable license agreements had been identified, and a number of internal and external franchise agreements had been used for benchmarks with an adjustment to disregard the services rendered under the franchise agreements, which were not rendered as part of the intragroup trademark license agreement.

As a result of the joint audit, the Norwegian and Swedish tax authorities, unlike the Danish Tax Agency, accepted a royalty rate of 2 percent.

The Danish Ministry of Taxation made three arguments in support of the Tax Agency’s decision.

First, it argued that the royalty payments were fundamentally not deductible business expenses according to Danish tax law.

Second, the Ministry said that, even if they were deductible, the payments were not on arm’s length terms.

Finally, the Ministry argued that the payments should, in any event, be offset against a deemed remuneration from the Swiss parent company to the Danish company, essentially reducing the expenses to zero.

The Danish Ministry based this final argument on their view that the subsidiary was kept operational merely to substantiate the general interest of the group, i.e., to maintain an entity in Denmark.

Denmark’s Eastern High Court ruled in favor of the Tax Agency, by assessing that the royalty was not deductible as an operating expense rather than by assessing that the royalty was not at arm’s length terms.

The overall deductibility of the expenses

On appeal, the Supreme Court concluded that the royalty payments did indeed constitute operational costs that were deductible for tax purposes.

The royalty payments were made for the right to use the Adecco trademark, for accessing the know-how and the customer referrals within the group, and the question raised was whether these expenses were sufficiently related to the company’s income-generating activity to qualify as deductible.

The company had been loss-making in the years in question, but based on the documentation provided, the Supreme Court ruled that the payments were in fact made for services genuinely rendered to the subsidiary.

Transfer pricing documentation quality

According to the Supreme Court, the documentation provided by the taxpayer was not insufficient to a degree comparable to a complete lack of documentation.

Specifically, the Danish Tax Agency had questioned the company’s comparability analysis, which did not in itself render the documentation insufficient.

For this reason, there was no basis for assessing the company’s taxable income on a discretionary basis, the Court said.

Analysis of the arm’s length terms, 2 percent royalty rate

The license agreement between the Danish Adecco company and its Swiss parent provided for a royalty rate of 2 percent of the revenue, which constituted the payments for the use of the trademark, know-how, and customer referrals.

As described above, other license agreements between the subsidiary and unrelated companies were showcased as documentation for a royalty rate of 2 percent for the right to use the trademark, but without access to know-how or customer referrals.

While the company acknowledged that the rate could not be above 2 percent, the Ministry argued that the financial and commercial circumstances of the benchmark companies differed from those of the Danish company to the extent that it rendered them unsuitable as subjects for a comparability analysis.

The Supreme Court did not buy into this argument. It stated that the Ministry had not sufficiently clarified the differences between the Danish market and the foreign markets relevant to the license agreements displayed.

The Supreme Court did not buy into this argument. It stated that the Ministry had not sufficiently clarified the differences between the Danish market and the foreign markets relevant to the license agreements displayed.

In essence, the Ministry had failed to demonstrate the relevance of these differences in relation to determining the rate that an independent party would willingly pay to the parent company in those countries.

The Ministry’s argument that the loss-generating Danish subsidiary had merely been kept operational to preserve a local company in Denmark to serve the overall needs of the group did not alter the Court’s conclusion.

The Court did not find that the Ministry had sufficiently proved this argument, even on a balance of probabilities.

Likewise, the Court did not find that the Ministry had proved that the subsidiary’s marketing in Denmark should justify a deduction from the royalty payment, which reflects non-payment of remuneration or compensation for marketing of the global trademark.

Thus, the Court found that a royalty rate of 2 percent of revenue would not have been inconceivable between independent parties and that none of the Ministry’s other arguments and submissions could lead to another result.

Key takeaway and outlook

This recent landmark judgment by the Danish Supreme Court adds to the string of defeats to the Ministry of Taxation in transfer pricing cases since the introduction of the regime in 1998.

Recent Supreme court cases include the landmark Microsoft case from 2019, and the Danva case from 2018, in which the Court ruled 7-0 against the Ministry.

The ruling in the Adecco case is particularly interesting as on 8 June, the Danish Ministry of Taxation announced it will increase the level of scrutiny on the taxation of multinationals.

This will include, among other things, the establishment of a new audit center, which will further increase the focus on transfer pricing, thereby building on the already intense focus on transfer pricing cases in the audits.

It remains to be seen if and how the Ministry will alter their approach to the upcoming cases, but based on the most recent case law from the Danish Supreme Court, it suffices to say that there will be a number of hoops for them to jump to successfully substantiate their future arguments.