The Arbitration Court declares it legal to deduct license fees for use of trademarks
The Moscow Arbitration Court rendered the Decision of December 31, 2015 on case No. А40-153860/15. The case was essentially about the tax authority challenging the legality of a Russian taxpayer including license fee amounts payable to affiliated Russian entities for the use of their trademarks in expenses for profit tax purposes.
As substantiation of its claims the tax authority pointed to the fact that:
- affiliation of the licensee and licensors through a Russian citizen whom the tax authority considered to be the beneficiary of the entire structure (via equity participation in the foreign entity, a company incorporated under BVI law that acted as the shareholder of the licensee, and also via the participation of that individual in the licensee's governance as the chairman of the licensee's board of directors and adviser to the general director on investment development, and participation in its capital of the licensors as their participant);
- the entities acting as the rights holders of trademarks and licensors used the simplified taxation system;
- the license fees comprised the main income of the licensors, which income was almost entirely distributed to their participant (the above-mentioned individual);
- the licensee entity did not pay dividends to the foreign shareholder, so the foreign shareholder did not pay dividends to the above-mentioned individual; consequently, the tax authorities are of the opinion that the license fees were a concealed distribution of dividends by the licensee to the individual beneficiary.
However, the Moscow Arbitration Court declared the above-mentioned arguments of the tax authority unfounded and ruled in favor of the taxpayer for the following reasons:
- the licensee had to get the licenses to use the trademarks in order to engage in its core business;
- the mere fact that the licensor and the licensee are affiliated (related) (without establishing whether it affects the terms of the transactions between them) cannot evidence that the parties received an unjustified tax benefit; the fact that the parties to transactions are related may be a basis to check whether the prices they use are market prices; however, the tax authority did not carry out such an audit and did not advance such arguments;
- according to the expert opinion submitted by the taxpayer, the license fees it was charged were within the market range of royalty rates:
- the licensors performed their tax obligations in good faith and declared all of the license fees they received as income; the mere fact that the licensors used the simplified taxation system does not evidence that they received an unjustified tax benefit;
- the licensee's payments to the licensors cannot be treated as dividends because under the transactions concluded between the licensee and the licensors the latter acquired reciprocal obligations to the licensee, which is not consistent with the nature of dividends; the payments under the contracts with the rights holders were made without applying the corporate procedures that must be observed to pay dividends and, when not observed, the shareholder is not entitled to demand the payment of dividends and the licensee is not obligated to pay them.
It is obvious that the tax authority will not be satisfied with this outcome and will appeal the court's decision to a higher court. We will follow the development of this case closely. Its importance cannot be overestimated in light of the unfavorable judicial acts previously rendered on the Oriflame case, about which the Russian Supreme Court stated among other arguments that the taxpayer had not submitted evidence that the license fees paid were consistent with the market.
This case could serve as a starting point for shaping a reasonable approach to including license fees in expenses for profit tax purposes. Such an approach would eliminate the sweeping accusations that all Russian entities without exception who act as licensees in intragroup license agreements are using schemes intended to get an unjustified tax benefit.