France: The Business of Multimedia - A Legal Viewpoint from France No. 5

Last Updated: 5 December 1995
In a series of articles we will be focusing on 2 sets of issues which are relevant to the business of multimedia. First, intellectual property rights and rights clearance. Second, structuring and financing new businesses.


Joint ventures
Financing a new business through a joint venture requires a lot of strategic thought and involves a good deal of groundwork. Significant time, effort and money often needs to be devoted to establishing the right financing structure, the right structure for the business and, most importantly, getting the working relationship right! A joint venture is not as straight forward as owning all the rights yourself, but it may be the only practicable solution where going it alone is not an option. A joint venture can enable you to penetrate a market more efficiently by sharing the know-how and facilities of others in return for offering your own.

In the following paragraphs we talk about tax planning and multimedia royalty structures, borrowing funds, and points to consider in constructing a joint venture.

Tax planning and multimedia royalty structures
Multimedia is as yet a relatively unexplored area from the tax point of view. Typically, multimedia publishers will process and integrate existing source materials into new multimedia products. These source materials (for example, motion pictures, music and other entertainment rights) may well be owned by others who will normally wish to receive some form of payment - commonly a royalty - for use of their material. Royalty payments may also be agreed between multimedia publishers and their distributors.

Careful tax planning in routing income flows generated from the licensing of intellectual property rights can result in reduced taxation, or deferred taxation as a means to enhancing cash flow. This, in turn, can result in an earlier pay-off of any financing raised to finance production.
In many situations, the parties involved in a multimedia transaction will be located in different countries. If, in those circumstances, cross-border royalty payments are made, the country of the payor will often wish to tax the royalty payments made abroad to the ultimate rights owner in the other country, generally by way of withholding tax from the gross royalty payments. Where the two countries involved have concluded a double income tax treaty (particularly when such treaty is based on the OECD Model Tax Convention) the taxation on the royalty payments in the source country is often significantly reduced, or sometimes eliminated altogether.

The recipient of the royalties may be able to credit against its own (local) tax liability the taxation on the royalty payments levied by the other country, whether the foreign taxation is reduced under an applicable double income tax treaty or not. In these circumstances, the foreign tax levied on the royalty payments received may not be an additional cost for the recipient. However, this is not always the case, for example, where the recipient cannot use the entire foreign tax charges as a credit against its own tax liability, or where such a credit cannot be used immediately. Alternatively, the recipient may have placed the rights in a low tax country (a tax haven), for example, to keep untaxed royalties out of its own high tax home jurisdiction. In those circumstances, the taxation on the royalty payments levied by the source country may easily become a real cost for the recipient.

It is for this type of situation, where the foreign tax charges on the royalty payments are a real additional cost, that international tax practice has developed certain royalty structures. To minimise foreign tax charges on royalty payments, royalty payments are often routed through a third country which has a double income tax treaty with the source country offering greater benefits in respect of withholding tax on royalty payments than is offered by the double income tax treaty, if any, between the source country and the country of the recipient of the royalties.

A typical royalty structure would involve the recipient of the royalties granting a licence to a company in the third country. That company, would in turn grant a sublicence to the person paying the royalties. This structure will only be beneficial where the tax on the royalty payments saved in the source country exceeds the total tax costs in the third country and the additional costs incurred in setting up and maintaining the licence company in the third country. A country that is often chosen as the location for this type of licence company is the Netherlands1. Hungary is also becoming increasingly popular for certain specific territories.

Using this type of licensing company is longstanding practice and the tax benefits can be significant. However, this type of licence company has recently come under attack in an increasing number of countries which reluctantly see an erosion of their tax claims on outgoing royalty payments as a result of what they consider "treaty shopping".

On this basis, these countries will often attempt to deny the reduction or exemption from local taxation on royalty payments made to the licence company in the third country as provided under the double income tax treaty with that third country. Some countries claim that the licence company cannot be regarded as the beneficial owner of the royalties, as is generally required for the purpose of claiming tax treaty benefits. Other countries will try to put a tax claim on the royalty payments made by the licence company in the third country to the recipient ("secondary withholding tax") although this is difficult to effect. Sometimes, a double income tax treaty provides that treaty protection may be denied where a given structure is set up and maintained not for bona-fide commercial reasons but primarily with a view to obtaining the benefits of the treaty (for example, the UK-Dutch double income tax treaty has such a provision in article 12(5)). Also, treaty protection is sometimes denied by countries where the royalty structure is considered a sham, or under application of domestic abuse of law provisions and principles. Notable examples of countries which are known to take a fairly aggressive stance in this regard are the USA, the UK and Germany.

As a separate issue, some recipients effect an outright assignment of intellectual property rights to a company in an appropriate jurisdiction such as the Netherlands. This can enable favourable amortisation of the value of the intellectual property rights. However, this is an area where tax planning possibilities are unclear. Apart from the practical difficulties of persuading the tax authorities to accept a sufficiently high valuation of the intellectual property in the first place, there may be no stated policy on how intellectual property rights such as trademarks or tradenames should be depreciated.

Other kinds of structures can combine the features of the two kinds of licensing arrangements discussed above. This may well be attractive in the case of multimedia products. For example, a Dutch licence company could become the registered proprietor of the intellectual property - but in circumstances where a spread ruling is obtained1. Such an arrangement would, for example, exist where the Dutch licence company acquires legal ownership of the property under a contingent sale agreement (e.g., the ultimate rights owner sells to the Dutch licence company for a percentage of royalties received) or where the Dutch licence company holds the property on trust for the economic benefit of the ultimate rights owner and receives a fee equal to a percentage spread for its trouble.

Tax planning in routing income flows raises complex issues and needs to be carefully thought through. Nevertheless, it can make a significant contribution to successful and profitable exploitation of rights.

Joint venture structures
The choice of vehicle for a joint venture will be affected by the tax and accounting implications for the business and the participants in the applicable jurisdictions. A strategic investor may attach importance to being able to use the start-up losses of the new venture to shelter tax liabilities relating to its other businesses. A company is a legal and taxable entity. A partnership, on the other hand, is transparent for tax purposes, each partner having to account separately for tax on its share of the profits and gains of the partnership's business, and, similarly, each partner being entitled, broadly, to set against its other taxable profits its share of any losses of the partnership's business.

It is probably true to say that, in the absence of compelling tax reasons - for example where participants come from very different tax jurisdictions - the most common vehicle for a joint venture remains the standard company whose members' liability is limited to the amounts payable on their shares. Companies are creatures of law and are subject to restrictions prescribed by applicable laws. Where a simple structure is required, these applicable laws may be unduly restrictive. On more complicated financings, however, the restrictions themselves may offer a useful framework for a complex investment structure. Where tax transparency is required some form of partnership structure often involving a limited partnership is used.

Finding the right investors
Having developed your business plan and determined how you wish to structure your joint venture, you now need to find investors who are willing to share in your vision. You may well enlist the help of a financial adviser to find potential investors. At this stage, a financial adviser will generally require the involvement of consultants specialising in your industry and accountants to review your business plan. If your financial adviser needs to market the investment to a number of prospective financial and strategic investors, it will prepare with you, and circulate to prospective investors, an information memorandum describing the business. The marketing and advertising of investment opportunities is heavily regulated in most jurisdictions. Your main concern, however, is likely to be confidentiality.

If your business depends on a novel invention or being first to the market with a new product or service, keeping it confidential will be essential. Leaving aside the enforcement of any intellectual property rights you may have in the business, each potential investor should be asked to sign up to a legally binding confidentiality undertaking in your favour before receiving any information about the business. This undertaking should not only require the investor to keep confidential the information which you provide, but also not to use that information for any purpose other than considering whether to invest in your business. A number of European countries impose a basic obligation on parties to negotiate in good faith and provide for pre-contractual liability where the trust or reliance of one party is abused by the other. This could work in your favour, or it could work against you if you choose arbitrarily to terminate negotiations with a potential investor, for example. National laws vary as to when and whether letters of intent or memoranda of understanding create binding legal obligations. Oral agreements may also be enforceable.

For further information please contact either Yves Wehrli or Francois Bloch, Avocats, Clifford Chance, 112 avenue Kleber, 75116 Paris, France, Tel: +33 1 44 05 52 52, Fax: +33 1 44 05 52 00 or enter text search "Clifford chance" and "Business Monitor".

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

NOTE: 1. Dutch companies are often established by the ultimate rights owner to act as licence companies in this type of royalty structure. The Netherlands has an extensive network of double income tax treaties which generally provide for significantly reduced withholding tax rates on royalty payments (often to nil). In addition, the level of Dutch taxation can often be kept at a relatively low level. In principle, the Dutch licence company will be subject to Dutch corporation tax levied at 40-35 per cent on the difference between royalties receivable and royalties payable. This royalty spread or margin is generally not challenged by the Dutch revenue where the Dutch licence company is unrelated to the ultimate rights owner and the ultimate licensee. Where the Dutch licence company would be related to either of these two, it will generally be possible to obtain advance clearance by way of a tax ruling confirming the minimum royalty margin that is acceptable for Dutch tax purposes. Under prevailing Dutch ruling practice, the minimum royalty spread is 7 reducing to 2 per cent of the royalties received, depending on the total amount of royalties received in the year concerned (for film royalties and lump-sum royalties the minimum spread is 6 per cent flat). Note that the margins under a tax ruling are minimum margins. If the actual royalty margin retained in the Dutch licence company is higher than the minimum margin under a tax ruling, the higher actual royalty margin will be subject to Dutch tax. A third important factor that would make the Netherlands a preferred choice of location is the fact that the Netherlands does not levy tax on outgoing royalty payments made by the Dutch licence company to the ultimate rights owner abroad, wherever located.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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