Withholding tax on fees for the right to use a trademark

Last week, we learned from the press that the Czech Financial Administration has started to focus more intensively on transactions in groups of related persons, the subject of which are fees paid for the right to use a trademark or trade mark.
According to the tax administration, tax officials are increasingly encountering cases where transactions are part of optimization schemes whose main goal is to take part of the profits out of the Czech Republic.
The fact that fees for the use of a trademark or trade name are subject to withholding tax has been left somewhat aside. The Czech Republic is entitled to collect this tax under a number of double taxation treaties when the remuneration to the beneficial owner of the trademark is paid abroad. 
According to our experience, much more often than with optimization schemes in practice, we are confronted with clients' queries as to how much, on what amount and whether withholding tax should be paid at all if the fee for the right to use a trademark or trade name is part of a so-called mixed contract. This contract has a completely different nature as the main object of the transaction between related parties, instead of the express provision of the right to use the trademark.
This is exactly the situation that the Australian Tax Office dealt with in the PepsiCo case. This case is important because it ended in a court decision in favour of the Tax Office.

So what was it all about?
Under an exclusive agreement with two US companies, the Australian company was provided with beverage concentrate for the production of finished beverages. For the subsequent sale of the finished beverages in a retail network in Australia, the Australian company used trademarks and brand names owned by the US companies, for which it had obtained the right of use under the aforementioned exclusive contract.
The court concluded that part of the payments made by the Australian company, in relation to the concentrate required for the production of the beverages, was a royalty for the right to use the trademark/trademark as defined in the US-Australia Double Tax Treaty. The court determined that the amount of the royalty was 5.88% of the US company's revenue from the sale of the concentrate.
The court emphasised that the right to use the trademark was essential to the transaction in that, without compliance with the terms of the product designation for the Australian market, the US company would not have entered into the exclusive concentrate sales agreement.
The court held that even though the exclusive contract expressly provided that the fee did not include royalty payments, the actual terms of the transaction were relevant to the assessment of the entire case. During his testimony, one of the witnesses stated that he was not informed that the sale of PepsiCo concentrate was offered without a brand license.

An interesting feature of Australian tax legislation is the Diverted Profits Tax (DPT), which was introduced in 2017. In this case, this tax was not applied because the court concluded that the correct solution for the situation was to apply withholding tax.
In transfer pricing, we very often encounter a situation where group distributors distribute in their assigned markets products that have been manufactured in another jurisdiction thanks to know-how that is protected and owned by other companies in the group. In order to protect the product in foreign markets, trademarks or trade names are often registered in multiple foreign jurisdictions. It is important to understand who remains the legal and who becomes the economic owner of such intangible assets and how remuneration is set for granting the right to use them.

Also, would you like to know how the Australian court arrived at the royalty amount of 5.88% of sales of concentrate?
The Transfer Pricing Directive, as updated in 2017, already speaks of the necessity to prepare a so-called DEMPE analysis for the purpose of setting the correct royalty rate. This is an analysis of the contributions made by each company in the group to the value of the licensed intangible asset. We will say more about the use of this analysis for the correct pricing next time.