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B S R & Associates LLP

Intellectual Property Holding p y gJurisdictions/ Migration

M G Ramachandran

July 2014

0© 2014 B S R & Associates LLP a firm of Chartered Accountants. All rights reserved

Overview

Background 1

2

IP provisions under the Income-tax Act 1961 (‘the Act’)

Definitions, type and ownership

3

2

IP planning and migration

IP provisions under the Income tax Act, 1961 ( the Act )

4

IP valuation and transfer pricing issues5

E it Ch6

Exit Charge

Case Study7

1© 2014 B S R & Associates LLP a firm of Chartered Accountants. All rights reserved

It all started here…

© 2014 B S R & Associates LLP a firm of Chartered Accountants. All rights reserved 2

In the news..

“From now on I’ll be putting away my Kindle and feeding my caffeine addiction somewhere other than St b k W k th t A

“Starbucks paid just £8.6M in UK tax over 14 years.” BBC

Starbucks. We know that Amazon, Google and Starbucks are raking in profits from their economic activity in Britain but using a range of devices to avoid paying their fair share of corporation tax.” UK Observer,

4 yNews, October 16, 2012

IT'S NOT JUST APPLE: The Ultra-Complicated Tax Measures That MicrosoftUses To Avoid $2.4 Billion In corporation tax. UK Observer,

November 18, 2012

“[Google’s] highly contrived tax arrangement has no purpose other than to enable the company to avoid UK corporation tax “ Margaret Hodge “Apple pays just 2% UK tax as Amazon

U.S. Taxes

corporation tax. Margaret Hodge, Chair of UK PAC, June 12, 2013

“International retailers evade tax via the Netherlands

Apple pays just 2% UK tax as Amazon and Google face questioning.” International Business Times, November 5, 2012.

“Google caught in crossfire over French tax planning.” Le Figaro, October 19, 2012

Companies that have lowered UK tax by holding trademarks in the Netherlands include not only Starbucks and IKEA but also SABMiller, Nike, Bacardi-Martini, Zara, Speedo en Volkswagen. Het Financieele Dagblad, 15 November 2012


Intellectual Property (‘IP’)- An Introduction

Intellectual property is defined as the rights relating to “literary artistic and scientific works; performancesIntellectual property is defined as the rights relating to literary, artistic and scientific works; performances of performing artists, phonograms and broadcasts; inventions in all fields of human endeavour; scientific

discovery; industrial designs; trade marks; service marks and commercial marks and designations; protection against unfair competition and all other rights resulting from intellectual activity in the

industrial, scientific and artistic fields.”

- World Intellectual Property Organization (‘WIPO’)


IP- Definition

Intangible property “includes rights to use industrial assets such as patents, trademarks, trade names, designs or models. It also includes literary and artistic property rights, and intellectual property such as

know-how and trade secrets” – Section 6.2, OECD Guidelines

A category of intangible rights protecting commercially valuable products of the human intellect. The g y g g p g y pcategory comprises primarily trademark, copyright, patent right , but also includes trade secret right,

publicity rights, moral rights and rights against unfair competition.

A commercially valuable product of the human intellect, in a concrete or abstract form such as a copyrightable work a protectable trade mark a patentable invention or a trade secretcopyrightable work, a protectable trade mark, a patentable invention or a trade secret.

- Black’s Law Dictionary

An intangible asset is: “an identifiable non- monetary asset without physical substance, controlled by the entity and held for use in the production or supply of goods or services, for rental to other, or for

administration purposes”- IFRS


Types of Intangibles

Marketing Intangible Trade intangibles

Includes trademarks, trade names product customer lists, distribution

channels, symbols or pictures that have some sort of promotional connection

with the product

Includes patents, know how, designs, models for production and assets that

are used in operations such as computer software

These types of intangible is more often created

through risky and costly research and

d l t d

These types of intangible are more frequently created through marketing


development endeavorthrough marketing endeavor

Ownership of IP

ABC Inc a company incorporated in US had registered brand named “Z” in its nameABC Inc, a company incorporated in US had registered brand named Z in its name with the US authorities. However, Z is developed and maintained by ABC Private Limited, India, a subsidiary of ABC Inc.

(a) Who is owner of brand ?(b) How far the ownership of the brand relevant ?


Ownership of IP’s- Legal vs. Economic

• The Economic Owner of an intangible is:g

- the party who has borne the costs of developing the intangible and incurred the risks of success/failure

- the party which is entitled to the intangible profit

• Legal owner may be treated as the economic owner for TP purposes unless economic substance regarding ownership varies

• Licensee can:

- have an interest in the intangible property

- enhance intangible property for its own benefit or for the benefit of the owner

• If intangibles are centrally (i) registered (ii) developed (iii) managed (iv) funded and (v)If intangibles are centrally (i) registered, (ii) developed, (iii) managed, (iv) funded and (v) maintained, the ownership is clear

• If one or more of the elements is performed by different group companies the ownership is unclear


Some relevant provisions to be kept in mind

Under the Income-tax Act, 1961 Particulars

Section 9(1)(vi) Royalty

Section 9(1)(i) and Capital Gains Provisions Income accruing from capital asset in India

Section 115A /Section 44DA Taxation of royalty income of non-resident

Section 194J/195 of the Act Deduction of taxes at source

Section 32(1)(ii) Depreciation on intangible asset

Chapter X Transfer Pricing Provisions

Under the Treaty Particulars

Article 11/12 Royalties

Article 13 Capital Gains


Comparative view- UN vs OECD Model

Article UN Model OECD Model

Article 12- Royalties The term "royalties" as used in this Article meanspayments of any kind received as aconsideration for the use of, or the right to use,any copyright of literary, artistic or scientific worki l di i t h fil fil t

The term "royalties" as used in thisArticle means payments of any kindreceived as a consideration for theuse of, or the right to use, any

i ht f lit ti tiincluding cinematograph films, or films or tapesused for radio or television broadcasting, anypatent, trademark, design or model, plan, secretformula or process, or for the use of, or the rightto use, industrial, commercial or scientific

copyright of literary, artistic orscientific work includingcinematograph films, any patent,trade mark, design or model, plan,secret formula or process, or for

equipment or for information concerningindustrial, commercial or scientific experience.

pinformation concerning industrial,commercial or scientific experience.

Taxing rights Source state may also tax royalty Taxing rights exclusively with state of residence


IP Planning

The transfer of intangibles to an affiliate that uses the intangibles, directly or indirectly to manufacture, market, and sell products outside the country where the intangibles were

originally ownedoriginally owned.

ParentTransfer foreign IP

rights Parentrights

F i M f t iLicense

Foreign IP Co.Foreign Manufacturing

and Distribution Op.cos.

Royalty


Steps in IP Planning

Jurisdictional Analysis

Commercial Substance

Identifying IP to be transferred

Mi ti O tiMigration Options

Valuation

Tax planning Strategies


IP Migration- Key strategies

Direct Sales Direct Licensing

Mergers and Acquisition

Cost sharing arrangementsStrategic alliance with third parties

- Economic Ownership


IP Migration- Key strategies

Cost Sharing Agreement (CSA)

Sale

Licensingg ( )

• Licensor has main intangibleAn effective CSA must: makebusiness and economic sense

• Valuation must reflect thenet present value of futurestream of income

creation functions in its homecountry

• Determination of extent of rightsto be licensed

• include upfront and well-documented terms

• Valuation to meet the testof Indian transfer pricingregulations

• Capital gains impact to be

• Further development of productvis-à-vis separate productsdevelopment

• Cross border royalty flows/ rates

• indicate costs incurred by eachparty relative to the reasonability ofexpected profits

• if providing for entry, exit, or


Capital gains impact to befactored

y yshould be based on approvedTransfer pricing approach

p g y, ,termination of a CSA, provisionsmust involve arm's length prices

IP Migration- Key Consideration

Commercial Rationale to be established and documented

t ith t d GAAR i

Selection of Jurisdiction

Economic Substance LocalTiming the migration critical

Business should not beto withstand GAAR in respective jurisdictions

Economic Substance, Local tax laws and tax treaties

Business should not be obstructed

Valuation of IP to be transferred

Scientific approach

Strategy to be tested in anticipation of the proposed CFC Rules to be introduced

One time tax cost (Capital gains) in case of outright sale

of IP to be factoredCost based v. Income Based v. Market Based

in India under the Direct Tax Code

of IP to be factored

FAR analysis for the respective entities to

determine royalty flows

Further development of intangible by research

Legal v. Economic ownership

Impact of Indirect taxes in the respective jurisdictions to be

factored


IP Holding Company - Attributes

• Entity regulations

- Simplicity in company incorporation, operation and winding up

• Legal IP

- Protection in jurisdiction, Foreign exchange controls

• Market perception:

- Globalization, volume of business and deregulation

Political and economic stability- Political and economic stability

- Professional infrastructure, telecommunications and banking

- Tax considerations on IP revenue flows

• Capital gains tax relief on exit/ internal reorganization

• Tax efficient repatriation – Tax treaty network - withholding taxes for dividend and royalties and stamp duty on assets


stamp duty on assets

IP- Valuation Approach

Common valuation principles to value intangible property may be classified into one of the following approaches:

Cost based approach

• Based on the principle of substitution, i.e., value of the intangible is estimated on thebasis of the estimated cost to construct a similar IP at current prices.

Income• Estimates the value of an intangible asset based on the expected income

attributable to the intangible asset during its remaining economic lifeIncome based

approach

attributable to the intangible asset during its remaining economic life.

E i h l f i ibl b d k i f blMarket based

approach

• Estimates the value of an intangible asset based on market prices of comparableintangible assets that have been bought / sold or licensed between independentparties.


IP- TP Issues

Application of the arm’s length principle in an IP context involves the following issues:

Particulars IssuesParticulars Issues

Cross-border related party licensing arrangements

• Is a market royalty rate being charged?• Cost vs. Benefit ?• Economic vs legal ownership• Economic vs. legal ownership

Cross-border related party IP transfers • Is the transfer at market value?• Does the transfer have economic substance?• Most appropriate method ?

Allocation of profits from an international related party transaction where both the parties

• Is the sharing of profits in accordance with what would be expected between independent parties?

contribute to IP (but no licensing or transfer of IP between them)


Why Exit Charge ?

• Chapter IX of the OECD Transfer Pricing guidelines notesthat in the context of restructuring a multinationalenterprise, it usually refers to a payment made tocompensate for the removal of an asset belonging to ancompensate for the removal of an asset belonging to anentity whose activity in the business is being simplified ofreduced.

• This view has been formulated based on the assumptionthat the local entity has a right to preserve future profitsthat the local entity has a right to preserve future profits.

• Tax authorities claim that as a result of moving thefunction and risks by transferring the IP, it becomesimperative to compensate for the loss of profitability as a

lt f d ti i l dd d iresult of reduction in value added services.

• Though the levy of exit charges has not yet beenexperienced in the Indian transfer pricing scenario, theinclusion of business restructuring transactions within thed fi iti f ‘i t ti l t ti ’ i di tdefinition of ‘international transactions’ indicatesincreased focus in this area going forward.


AAR Ruling - Fosters case

Fosters Australia (Owner of Brand and Brewing

Technology)

Sale of IPs

• Foster Australia (‘FA’) was engaged in business ofbrewing, processing, marketing and selling beer inAustralia and abroad. FA owned the Foster’s Brand andrelated logo (‘Brand IP’). Technology, know-how and brewing

DisMin Invt

Sale of IPs

Sale of sharesAustralia

g ( ) gy, gspecification were also owned by FA (‘Brewing IP’).

• FA brand was registered in India. FA had entered intolicense agreement with FA India for use of Brand IP andBrewing IP.

SabMiller UK

g

• FA entered into sale and purchase agreement (‘S&Pagreement) with SAB Miller UK for sale of Brand IP andshares in FBG India Holdings held by DisMin Invt. Inaddition, perpetual license to use brewing IP was granted

FBG India Holdings

I di

Overseas

addition, perpetual license to use brewing IP was grantedby FA.

• In terms of the agreement, SKOL India was nominated to usethe Brewing IP. FA executed a deed of assignment infavour of Skol India for grant of India related license

Skol India

Foster Brand

Registered

India

Brand License

favour of Skol India for grant of India related license(Brewing IP) with right to sublicense for consideration ofUSD 100.

• In pursuance of S&P agreement, there was termination ofuser license (Brand and Brewing IP) of FA India in favor of


FA IndiaSkol IndiaBrand License user license (Brand and Brewing IP) of FA India in favor of

FA for no consideration.

AAR Ruling - Fosters case

Questions before the AAR – Whether receipt on account of transfer of right / title in Brand IP and grant of exclusive license of Brewing IP was taxable in India?exclusive license of Brewing IP was taxable in India?

Ruling:

• Transfer of capital asset situated in India attracts charge under section 9(1)(i) of the Act

An intangible asset can have more than one situs• An intangible asset can have more than one situs.

• IP comprising of Brand IP were located in India where business was generated in India did not shift its location on extinguishment of license.

• Receipt from transfer of Brand IP was taxable in India

• The situs of Brewing IP was outside India upon termination of license given to Foster’s India. Hence, receipt on account of grant of license relating to Brewing IP was not taxable in India.


AAR Ruling – Pfizer Case

Pfizer Panama Acquisition of trade mark and technolog

• The applicant (‘Pfizer Panama’) owned the technologyinformation relating to the nutritional food supplementproducts which were manufactured and sold through itsIndian company (‘Pfizer India’) under certain trademarks

EAC Denmark

O

technology information

p y ( )registered in India.

• Pfizer India was using the said technology informationwithout making payment of any royalty.

India

Overseas • ‘EAC’, a company incorporated in Denmark, under anagreement acquired from the applicant, the trademarksand technology information related to the said productsand paid consideration for same.

Right to use t h l d

Trade Mark +

Technology Information

• A separate agreement was entered into between ‘EAC’and the Pfizer India for early termination of the licensegranted to Pfizer India to manufacture under the saidtrademarks and a sum was paid by ‘EAC’ to Pfizer Indiaas consideration for extinguishment of the said licence.

technology and information

Pfizer India

Registered in India

• It was claimed that as per agreement, the handing overof the dossier containing technical information took placein Bangkok.

‘EAC’ withheld certain tax from the consideration paid to


• ‘EAC’ withheld certain tax from the consideration paid tothe applicant and deposited the same with theGovernment of India.

AAR Ruling – Pfizer Case

Questions before the AAR – whether having regard to the provisions of the Act, the receipt by the applicant from thetransfer of documents containing know-how and technical information, outside India, under agreement, would bechargeable to tax in India.g

• The technology information was owned by Pfizer Panama, for a very long time it was used in India almostexclusively. Therefore, the transfer of technical information in the form of a dossier was transfer of a capitalasset.

• Situs of the asset which was subject-matter of transfer was available in India, both in tangible as well asintangible form before the transfer to ‘EAC’.

• However, the Indian company was only a licensee and original technical know-how was always availableith th i th li twith the owner, i.e., the applicant.

• On early termination of licence of Indian company to manufacture products, the technical know-how, both intangible as well as intangible form reverted back to its owner in Panama and, therefore, the situs of capitalasset transferred to ‘EAC’ was outside India. Therefore, the receipt under consideration was not chargeablep gto tax either under section 5 or 9 of the Act.

• Therefore, the receipt from transfer of technical information in the form of dossier in Bangkok was a receipton transfer of capital asset and was not chargeable to tax in India under section 5(2)(ii), read with section9(1)(i) as the asset in question was situated outside India


9(1)(i), as the asset in question was situated outside India.

The Maruti Suzuki (MS) Case

Facts

• The taxpayer is a joint venture company in India of Suzuki MotorCorporation (‘SMC’), Japan

Suzuki Motor Corporation, Japan

• MS engaged in manufacture of automobiles and its spares andcomponents

• SMC granted composite license for technical-know how and useof Suzuki (“S”) trade markof Suzuki ( S ) trade-mark

• Recurring royalty in addition to lump-sum payment

• Replaced “M” logo with logo “S”

Know

-how

and

nd n

ame

Paym

ents

• Mandatory use of “Maruti Suzuki” brand

Tech

nica

l K

Use

of B

ran

Roy

alty

P

Maruti Suzuki India Limited, India


The MS Case - Key points raised by TPO

• Maruti was a super-brand; “Suzuki” being a weaker brand in the Indian market, piggy-backed

• Maruti Replacement of “M” logo with “S” logo resulted in impairment/ migration of intangibles embedded in“Maruti” brand to “Suzuki” brandMaruti brand to Suzuki brand

• Attributed 50 percent of royalty payment to trademark royalty and determined its Arms Length Price (‘ALP’)as NIL

• Applied bright line test using M&M, Tata Motors and Hindustan Motors as comparables. Concluded that MSApplied bright line test using M&M, Tata Motors and Hindustan Motors as comparables. Concluded that MSincurred excess advertisement, marketing and promotion (‘AMP’) expense to develop Suzuki brand

• Disallowed the excess AMP expenditure


The MS case - Key points from Delhi HC Ruling

• Trademark: Whether the use of Associated Enterprise’s (‘AE’) trademark is discretionary or mandatory?

• Discretionary use in combination with local brand does not necessarily entail payment from AE toIndian entity if Indian entity is the sole beneficiary. Incidental benefits to AE need no compensation

• Mandatory use of Foreign brand needs a compensation by the AE

• AMP: Whether AMP exceeds the Bright-line test (‘BLT’)?

AMP d BLT th h ld AE h ld t• AMP exceeds BLT threshold- AE should compensate.

• Comparables used to apply the BLT should be appropriate

Revenue Authorities to remain uninfluenced by the High Court’sRevenue Authorities to remain uninfluenced by the High Court s observations ………SUPREME COURT


Special Bench Ruling- LG Electronics

Facts:

• Assessee is a subsidiary of L.G. Electronics Inc., Korea.

• Technical Assistance and Royalty agreement - right to use technical information designs etc - royalty @ 1 per• Technical Assistance and Royalty agreement, - right to use technical information, designs, etc - royalty @ 1 percent. Use of brand name and trademarks to products manufactured in India “without any restriction”.

• Revenue concluded that the assessee was promoting LG brand as it had incurred expenses on AMP to the tuneof 3.85% of sales vis-à-vis 1.39% incurred by a comparable. Accordingly, TPO held that the assessee shouldhave been compensated for the differencehave been compensated for the difference.

• Further, directed to charge a mark-up of 13% on such AMP expenses towards opportunity cost andentrepreneurial efforts.

Issues:Issues:

• TPO jurisdiction

• Whether AMP is an international transaction.

• Validity of BLT

• Whether prescribed methods as per Rule 10B were applied when benchmarking ALP?

• Selection of comparables for BLT


Selection of comparables for BLT

• Mark-up over and above the AMP difference is justified?

Special Bench Ruling- LG Electronics

Issue View of the SB

Existence and nature of International

Advertisements released by the assessee carrying brand/logo of its foreign AE coupled with higher AMP spend constitutes a transaction of “provision of services” to the brand owner.

InternationalTransaction “ apart from advertising the products and the assessee‘s name, it has also simultaneously or independently

advertised the brand or logo of the foreign AE, then the initial doubt gets converted into a direct inference aboutsome tacit understanding between the assessee and the foreign AE on this score.”• Concept of Economic ownership not relevant

A li ti f Si th i d b th I di t f it b i d f ti f b d fApplication of BLT

Since the expenses incurred by the Indian taxpayer for its own business purposes and for promotion of brand of the AE, are intermingled and otherwise inseparable, the bright line test is a way of finding out the cost / value of international transaction.

Choice of Comparables

determination of the cost/value of the international transaction of brand/logo promotion through AMP expenses incurred by the Indian AE – dependant on 14 factorsp y p

In choosing comparables the correct way to make a meaningful comparison is to choose comparable domesticcases not using any foreign brand. Where suitable adjustment is made for the 14 factors the same wouldcorrectly reflect the cost / value of the internationaltransaction.

Method Applied by TPO

Its in the nature of a cost plus – even though not explicitly referred to.

• High entity level profit cannot justify excessive AMP • Each international transaction is required to be benchmarked separately notwithstanding high net profitability .

S lli AMP d t i l d i d “i ti ” ith l (f l b / i i


Selling expenses

AMP expenses do not include expenses incurred “in connection” with sales (for example – bonus/ commission paid to dealers and agents)

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b s r & associates llp - ifa - · pdf fileoverview background 1 2 ip provisions under the...

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