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Published on October 10, 2017
Local companies no longer perform only routine activities within groups, but also directly contribute to the value creation. The financial success often depends on the deployment of intangibles. Especially when it comes to the exploitation or development of trademark assets, a question arises as to how the income resulting from those trademarks should be split between the enterprises.
Using tradenames within a Group Where subsidiaries conduct operations also abroad, they usually use the tradename of the group’s ultimate parent. It is assumed that the ”mere” use of the company name is not subject to a fee, if, in accordance with the arm’s length principle, an external third party would not pay any such fee, either. This is the case when no economic benefits are derived from the use of the tradename. If, for example, an associated enterprise sells only merchandise of its own corporate group, the exploited intangibles (company marks, company name, trademark etc.) do not have any separate significance. In such case, the fee for the exploitation of intangibles should be included in the purchase price paid by the distribution company. The situation is different when an enterprise uses a trademark of another enterprise to derive a financial benefit. If the subsidiary makes its own value-adding contribution in that it manufactures products or provides services by itself, the trademark should be examined for impairment and appropriately set off.
Where foreign subsidiaries contribute to the further development of the existing or the development of new intangibles, this is no longer considered to be a routine activity and it is often difficult in practice to delineate to whom the revenue flowing from the use of intangibles should be allocated. This is because, according to the new OECD Transfer Pricing Guidelines 2017, the legal ownership is no longer the only criterion for the allocation of income; decisive is also the fact who effectively performs functions relating to the creation and maintenance of the assets. Accordingly, enterprises will have to receive adequate fees appropriate for the contributions they make when performing significant functions and assuming significant risks in the area of developing, enhancing, maintaining, protecting and exploiting the intangibles (the so-called DEMPE functions). This also applies to the (further) development of trademarks. Especially in the case of distribution companies with greater marketing responsibilities in terms of the functions performed and responsibility for assuming costs for significant trademarks, we believe that the so-called profit split method will be immensely growing in importance. However, the prerequisite for the application of this method is that the application of one of the standard transactional methods (CUP, cost plus, or resale price method) would not lead to sufficiently reliable results, and companies must share economically significant risks and contribute valuable intangibles in the course of a transaction (e.g. know-how). In this context, the profit measurement method should be determined ex ante. This can be done based on either actual or anticipated profits, whereas the splitting of profits based on actual profits better takes into account business uncertainties because profits are split after risk has already materialised; but this also involves a higher degree of integration.
The recent debate at the level of OECD about the applicability of the profit split method shows how high the relevance of this topic is in practice. Especially, when it comes to the creation of trademark rights within a company, an allocation method should be appropriately determined and implemented. Companies should thus early on review their existing structures for whether they are appropriate in terms of such constellations.
Michael Scharf
Partner
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Benjamin Vießmann
Senior Associate
