Tax aspects for the use of trademarks

 

The importance of trademark rights in the current global economic system cannot especially in view of globalisation be overstated. Even when such trademark rights, at least with dynamic and charismatic world brands such as Coca-Cola or Nokia, are based on real, tangible products, it is nevertheless surprising that, for example, the brand value of the internet search machine Google or the IT group Apple are estimated to be valued at many billions of US dollars. Even for German medium-sized companies experts agree that it is not unusual for the brand to be one of the most valuable assets of the company.

 
It is today uncontested that an appropriate monetary brand valuation counts as one of the most urgent objectives of the growth-oriented company. This is valid in many respects, whereby in the meantime marketing and brand management are mostly exclusively understood to mean value based brand management and development. Also the finance-oriented communication of a company increasingly takes care in the sense of institutional and private investors and the mandatory accounting requirements (e.g. impairment test) to ensure a robust qualification of the brand value which has to be reported in the balance sheet and in the area of the legally making available of trademark rights (purchase and licencing of trademarks) or in particular with the infringement of trademark rights the importance of the value determination is also obvious.

 
The same applies to tax matters. Here it is in the interest of the holder of the trademark to appropriately determine the economic value of the brand (if necessary from scratch) and to successfully defend this value against a possible other opinion of the financial authority. This amount serves to illustrate a number of fundamental aspects of how the trademark rights are treated in terms of tax.

 

In the case of the licencing of trademark rights it must be observed that the payments of a domestic licensee are only deductible from income or corporate tax as operating expenses but not from German trade tax. In terms of the economic result, 6.25 percent of the expenses for the time-limited transfer of rights (in particular concessions and licences, with the exception of licences which exclusively allow the derived rights to be transferred to third parties) are added to the trade income of the company in the course of the so-called trade tax additions (§ 8 German Trade Tax Act, GewStG) and are therefore subject to taxation.
 

If a domestic licensee makes a payment with regard to trademark rights to a licence holder located abroad, the gross payment is acc. to § 50a of the German Income Tax act (EStG) subject to a national withholding tax rate of 15 percent (plus the German solidarity surcharge tax to the amount of 5.5 percent). For licence holders located in the EU and European economic area further differentiation is required, whereby if the licence holder wishes to offset operating expenses or advertising costs when his tax is treated as withholding tax, then the tax deduction for foreign natural persons is 30 percent and for foreign corporations unchanged at 15 percent. Most countries have comparable regulations which at the expense of foreign licence holders foresee a withholding tax on the side of the domestic licensee.
 

Against this background tax support for the licence agreement is essential. Although at first glance withholding tax appears to be low, it can result in a serious economic consequence for the taxpayer and recipient of the taxable income. In borderline cases this can even lead to insolvency or insolvency of the taxpayer as illustrated by the following example. Let us assume that the company A GmbH in country A has concluded a licence agreement with a company B GmbH in country B and as a result B GmbH is obliged to pay an annual fee of 100 000 euros to A GmbH as compensation for the transfer of a trademark right. The company B GmbH does not have any other business operation and as a result is not solvent and does not immediately have funds to make the payment. It therefore transfers the trademark for use by company C GmbH in country C which is contractually allowed and should correspond to the planned business model for the setting up of an international company for the exploitation of trademark rights. The company C GmbH pays an annual 110 000 euros to B GmbH which leads to the assumption that according to the arm's length principle a corresponding margin at the  company B GmbH remains available for taxation. With numerous licence allocations in different countries this can result in a substantial amount for the company B GmbH.
 
However, if country C now applies a withholding rate of 7 percent to the licence payments and the licence agreement between B GmbH and C GmbH does not include a tax clause, then C GmbH only has to pay 102 300 euros to  B GmbH, of which 100 000 euros are deducted for A GmbH. If the tax law of country B includes a regulation which corresponds to § 10 no. 2 of the German Corporation Tax Act (KStG), in country B the 10 000 euros is subject to an assumed corporate tax rate of 25 percent and this would lead to a tax liability of 2500 euros. However, the funds available to cover this tax liability would only be 2300 euros and as a result B GmbH would not be able to comply with its tax obligations.

 
Such tax traps can only be avoided by means of a tax clause adjusted for each individual case. Tax clauses are particularly necessary when the alleviation of withholding tax is not possible through the application of a corresponding double taxation agreement or, at a European level in a company group and with the participation of permanent establishments, when the withholding tax cannot be avoided through the interest or licence fee guideline. Many German double taxation agreements also foresee a domestic withholding tax rate of zero, which, however, is only ultimately granted if the foreign licence holder has sufficient economic substance and can verify this to the German Federal Central tax Office. Artificial structures which serve to avoid tax do not entitle the reduction of withholding tax. In order to be on the safe side here, the financial authorities have come up with a concept of firstly applying the withholding tax in all cases and then to refer the foreign licence holder to the tedious procedure of applying for a tax refund. This can only be avoided by applying for a certificate of exemption.

 

The consequences of the legally making available of a trademark right are different for the two possible scenarios of the sale or transfer of use in particular with regard to civil law. In terms of tax law it must be taken into account that the transfer of use and also the transfer of the original right in most countries will always lead to income or profits from the disposal which are subject to tax. Therefore as a result the tax burden can usually only be mitigated by the choice of the right international location.

 

The sale of trademark rights and also particularly cross-border licence fees must be made according to the arm's length principle. The regulations according to civil law in the licence agreement must correspond to the extent and amount which independent third parties would have agreed with each other under the same conditions. This has recently also been extended to include permanent establishments.
In order to at least approximately determine a price which would be usual for third parties, in practice use is made of databases, market analysis and freely available statistics in the area of licencing. These are also available to the financial authorities. The price determined according to the arm's length principle must then be documented in transfer pricing documentation. Violations against these documentation regulations are to be avoided. They lead to tax assessments which are upwardly adjusted and penal surcharges.

 

Many foreign countries, also within Europe, have in the meantime introduced special tax regimes for intangible assets whereas in Germany the financial ministry is not in favour of this. These taxation regimes frequently offer a (low) preferential tax rate for income from the transfer of use of trademarks or patent rights or lead to special tax subsidies. The Netherlands, Ireland and Luxemburg, for example, are happy to offer international companies a home for the establishment of a company for the exploitation of trademark rights which then controls the transfer of rights for the whole group.

 
From a German tax point of view such IP regimes are viewed critically and seldom lead to the desired success. On the one hand the question has to be asked how an existing, valued trademark right can be transferred from Germany to a foreign country without triggering taxes. The problem here mostly concerns the relocation of the function. On the other hand Germany will continue to tax a profit which has been realised abroad from the exploitation of rights when the foreign tax rate is below 25 percent and the trademark is not the result of an original research and development activity from abroad. It is therefore recommended that very dynamic companies with numerous new developments should already make the first steps of development of a new product or brand on their own abroad.

 

In recent times the capitalisation of trademark rights has established itself as an alternative financing method to generate fresh money for a company. While in tax terms this is about reducing as much as possible the discovery of hidden reserves, from the point of view of an active asset liability management the creation of additional liquidity is the main focus. Strategic considerations also have a role to play, i.e. does an entrepreneur really wish to dispose of "his" brand and what is the influence of external investors?

 
A monetarisation of a trademark right by a domestic GmbH company in Germany can therefore, for example, turn out as follows. The operative X GmbH (owner of a valuable brand) makes a 100 percent investment in the limited liability capital of a German KG company. Subsequently the trademark rights are introduced as a capital contribution to the KG in return for the granting of shareholder rights. In the negative supplementary balance sheet of the company X GmbH the continued carrying amount acc.to § 6 par. 5 sentence 3 of the German Income Tax act (EStG) is made which reversely in the tax balance sheet of the company X GmbH prevents the discovery of hidden reserves. In a second step the trademark right is licenced back to the GmbH with a long-term licence agreement, whereby the licensee in the event the agreement is terminated must make a final payment for the total investment costs of the licence holder which are not covered by the part of the licence fees which are deducted as expenses. In a last step the requirement for the licence fee against the KG is forfeited which leads to the removal of liquid funds from the KG and replaces the purchase price payment. With regard to the result on the balance sheet this concerns an accounting exchange which is neutral in terms of tax because the investment assets are diminished by the amount the bank balance is increased. In this respect the removal does not result in a taxation of hidden reserves which are identified.