Germany: 222. Transfer Pricing: Group Name Trademark Licensing: Federal Tax Court Overturns Lower Court Decision

In a judgement dated 9 August 2000 (IStR 2001, 54), the Federal Tax Court held that a German subsidiary of a foreign group may be charged a royalty for the right to use a trademark identical to the group name and contained in the subsidiary's own corporate name. The judgement by Germany's highest tax court overrules the judgement of the Rhineland-Palatinate Tax Court of 14 December 1998 (EFG 1999, 499; DStRE 1999, 597 – reported on in article no. 205).

The case involved the licensing of the group logo and the group name by a foreign affiliate to the German subsidiary of a British manufacturer of automotive brake systems and parts. The licensed intangibles were registered as trademarks. Trademarks of this sort are referred to in this article as "group name trademarks" for short. The royalty fee was 1.5 % of sales. The German subsidiary used the trademark and logo free of charge from 1985 to mid 1991, when a royalty was agreed on for the first time.

In considering the court's disposition of the case, one should distinguish between the following:

• The use of a corporate name containing the group name as its primary element (e.g. X GmbH as a member of the X Group); and
• The use of the group name contained in the corporate name as a trademark in connection with product marketing and advertising (e.g. using the term "X" as a product designation)

The court implies any royalty paid by X GmbH to the X Group for the right to use the term "X" in its corporate name would constitute a non-deductible constructive dividend for tax purposes. However, the decision contains no clear statement to this effect, much less an explanation of the underlying reasoning. Rather, the assumption that no fee may be charged for tax purposes for a subsidiary's right to include the group name in its corporate name is an unexamined premise on which the court's judgement rests.

The court goes to lengths to distinguish the corporate name as an identifying designation for the corporation from trademarks as identifying designations for corporate products. The court explains that trademarks and corporate names represent distinct protected rights that may be used independently of each other even where they are identical. In such situations, trademark rights may take precedence over the right to use a business name, not the other way around. The court states that a parent company is not required to permit its subsidiary to use a trademark free of charge even where the trademark in question is contained in the subsidiary's corporate name.

The relevant question in the court's mind thus becomes whether a fee is being paid for the right to use a corporate name containing the group name or for the right to use a trademark identical with the group name. An appropriate charge is permissible for the right to use the group name as a trademark as long as the trademark has some independent or intrinsic value.

Since the lower court applied fundamentally different standards in deciding the case, the Federal Tax Court remanded to the lower court for further deliberations on the issues of the trademark's intrinsic value and, if such exists, the appropriate amount of the royalty. The tenor of the court's decision indicates that only a low threshold need be crossed to affirm the presence of intrinsic value.

The high court's decision is remarkable in that it brushes aside the contentions of the tax authorities and the lower court alike regarding a subsidiary's entitlement to "general group support".

The lower court held that trademarks, brands, logos etc., to the extent representing component parts of the group name (group name trademarks), were generally provided to group members as a function of the shareholder relationship. They were part of "general group support" (Rückhalt im Konzern), an inherent benefit of membership in a controlled group to which subsidiaries were somehow entitled free of charge. Only where the economic importance of the group name as a trademark eclipsed that of the group name as such was a separate charge for trademarks permissible by way of exception. The lower court thus established a general rule that group name trademarks could not be licensed with tax effect and created a narrow exception to this rule.

The high court rejects the lower court's terms of reference. In the high court's view, group name trademarks can generally be licensed with tax effect just like any other intangible. No exception is warranted for group name trademarks because the right to use a corporate name and the right to use a trademark are fundamentally distinct rights even where they relate to one and the same designation. As long as a group name trademark has some economic value, a royalty may be charged for its use.

The key issue under the new terms of reference laid down by the Federal Tax Court is thus not whether a royalty may be charged for group name trademarks, but in what amount. The relative importance of the group name as a component of the subsidiary's corporate name and as a trademark is irrelevant when deciding whether a royalty may be charged in principle, but the court says it may have bearing on the amount of the royalty.

The fact that the group name trademarks had been used free of charge in the years prior to the implementation of a license agreement was of no concern to the Federal Tax Court, which considered that the parties were free to switch from a no-charge system to a charge system at any time.

In disallowing the deduction of the royalties on the grounds that the group name trademarks were not of paramount economic importance compared with the use of the group name in the subsidiary's own corporate name, the lower court cited various factors which cast light on the relative importance of using the group name in the subsidiary's corporate name and using the group name as a trademark.

Noting that the German subsidiary sold primarily to automobile manufacturers, the lower court contended that the purchasing decisions of automobile manufacturers were determined by considerations of price, quality, and reliability, hence that the trademarks attached to the products were of marginal importance. The high court comments that the lower court's findings on this point do not support the conclusion that the trademarks lack intrinsic value, which is the only grounds on which a deduction may be denied in toto.

The lower court furthermore attached importance to the failure of the subsidiary's sales to increase after the trademark and logo were licensed. The high court points out that the relevant question is not whether sales increased in fact, but whether a reasonable businessman in the subsidiary's situation might reasonably have expected sales to increase and hence agreed to pay a royalty. In other words, the issue of the trademark's value is to be assessed prospectively (ex ante), not retrospectively (ex post).

The lower court also gave weight to the fact that the subsidiary sold to automobile manufacturers instead of to final consumers and pointed out that the subsidiary had already established a certain reputation for itself before it licensed the trademark and logo. The high court states that trademarks may have economic value to companies at every level in the chain of production and distribution, and that even renowned companies may seek to improve their position further by licensing new trademarks.

The high court judgement provides little guidance on the permissible amount of royalties charged for the use of group name trademarks. While virtually all of the factors discussed by the lower court (see sec. 4 above) appear relevant to the permissible amount of royalty payments, the high court's decision casts no light on quantification of these factors.

Since group name trademarks are, almost by definition, not licensed to unrelated third parties, comparable uncontrolled transactions will seldom be identifiable.

The court states that trademarks and logos have independent or intrinsic value where they are likely to promote sales ("suitable for contributing to an increase in sales"). The court provides a non-exhaustive list of factors indicative of intrinsic value:

• Whether a premium can be charged for products marketed using the trademarks over comparable products which lacked the trademark
• The degree of trademark name recognition
• The worldwide or regional presence of the trademark
• The export quota of the specific group company
• Whether the licensor created and registered the trademark and bears the expense of maintaining and developing it, e.g. through advertising and other marketing measures

Most factors in the above list obviously bear both on whether a trademark has value and on the amount of such value.

The last factor in the list would appear to have less to do with the trademark's intrinsic value than with the question whether the licensor of the trademark controls the rights it purports to license. Where this is not the case, payment of the royalty would constitute a constructive dividend even if the trademarks were in fact valuable because the licensee would be regarded as having entered into the agreement because of the shareholder relationship instead of for arm's length reasons.

The decision rejects the theory that subsidiaries are somehow entitled to use group name trademarks free of charge because of an inherent right to "general group support". The high court makes clear that royalty fees for group name trademarks will be accepted for tax purposes except where the trademarks lack intrinsic value. The required threshold of intrinsic value appears to be low. Hence, one would expect some royalty to be chargeable in most situations for group name trademarks. The decision thus shifts the focus of attention from whether royalty payments for group name trademarks are permissible in principle to the question of their permissible amount.

Also noteworthy is the court's holding that related parties are free to switch at any time from a no-charge system to a charge system for the use of group name trademarks.