The case law illustrates that ownership of intangibles may change following a third-party acquisition.
The Administrative Court of Appeal of Stockholm (“Court of Appeal”) has delivered a judgement on March 24, 2020 concerning ownership to intellectual property (“IP”) from a transfer pricing perspective. The judgment has several implications and will inter alia affect MNE groups that are currently in the process of acquiring, or contemplating to acquire, a Swedish company with significant IP ownership.
The judgement concerned a Swedish development company, which was acquired by a US company in 2013. After the acquisition, the Swedish company and the US company concluded an agreement titled “Sales and Distribution Agreement” according to which the US company was granted the right to market, sell and distribute products developed by the Swedish company. As remuneration, the Swedish company would receive 25 percent of the net profit from the sale of products. In the transfer pricing documentation of the Swedish company, the agreement was referred to as a licensing agreement and the payment under the agreement as a royalty.
According to the Swedish Tax Agency (“STA”) rights to retain returns from exploiting IP developed by the Swedish company had been transferred to the US company when the US company acquired the shares in the Swedish company. In the STA’s view, the Swedish company should therefore have received remuneration for the IP transferred. It was uncontested that the Swedish company was the legal owner of the IP.
The STA argued that the IP had been transferred since the material risks connected to the IP, and more specifically the market risk and the product development risk, were controlled by the US company after the acquisition (and had hence been transferred to the US company). The STA stated that the risks had been transferred since the US company decided on marketing, sales strategies, agreements with customers, pricing and product development. As proof of this decision-making, the STA referred to initial answers provided by the Swedish company during the tax audit, interviews, messages to shareholders, the group consolidated report and press releases.
Conversely, the Swedish company argued that no transfer of IP had taken place, since the value of the IP, and the possibility to exploit the IP, was derived from the development of the IP and it was only employees of the Swedish company that had the competence to develop the IP. According to the Swedish company, the US company could not decide on issues relating to the IP since it lacked knowledge about the IP.
Previous judgement by the Administrative Court of Stockholm
In a previous judgment, the Administrative Court ruled in favor of the Swedish company and judged that no transfer of IP had taken place. In short, the court accepted the argument put forward by the taxpayer that it was unlikely that the IP could be transferred while the competence to develop the product was still in the Swedish company. The court also stated that a transfer of ownership was not apparent from the agreement that was in place between the parties.
Judgement by the Administrative Court of Appeal of Stockholm
In contrast to the Administrative Court, the Court of Appeal ruled in favor of the STA. The court emphasized that the Swedish company had, in initial responses to the STA during the tax audit, stated that the agreement in place between the parties did not reflect the actual conduct and that significant functions and risks had been transferred following the acquisition. The Swedish company had later retracted these comments, but the court stated that as no reason had been given to why the comments had been made in the first place if they were wrong, they should be regarded as accurate.
The Court of Appeal considered that it was proven that the US company did not have the knowledge required to develop the IP. However, in the court’s opinion, the decisive factor when determining which company controlled the product development risk was which company could say no to new projects. According to the court, the risk should therefore be allocated to the US company since the US company was always informed about product development initiatives and could always block them.
In terms of pricing, the Court of Appeal stated that the royalty applied under the Sales and Distribution Agreement could not be considered as arm’s length remuneration for the transfer of IP. The court instead agreed with the STA’s view that the arm’s length remuneration should be calculated based on the acquisition price for the shares in the Swedish company, while subtracting the value of the business that was still in place in the Swedish company after the transfer.
The case has implications for MNE groups that are either contemplating to acquire, or are in the process of acquiring, a Swedish company with significant IP ownership. The case implies that there is a risk that a third-party acquisition of shares in a company holding IP for which the control of the development, enhancement, maintenance, protection and exploitation (“DEMPE”) functions are shifted to the acquiring entity, may result in a transfer of said IP and a subsequent exit taxation.
It is rather common that the overall strategy relating to IP development and sales changes upon acquisition, as these are normally included in the overall governance of a parent company in relation to its group. As a result, the STA’s and Court of Appeal’s view results in a reclassification of the transaction and implies that an acquisition of shares in a Swedish company owning IP would in most cases result in a subsequent transfer of IP to the ultimate parent.
Moreover, the interpretation of the STA and Court of Appeal, if applied more broadly, may result in that it will not be possible for any other entity within an MNE group apart from the ultimate parent company which has the ultimate decision rights to be regarded as the economic owner of IP. However, in KPMG’s view, such an effect may be in conflict with the OECD Guidelines, as the Guidelines state that the right to retain returns from IP should be awarded to the entity that performs and controls the relevant DEMPE functions, which may not be the parent company in many cases. It is our view that the ruling is not in line with the Swedish arm’s-length principle. We are hopeful that the case will be appealed and that the Supreme Court grants leave to appeal.
Nevertheless, MNEs should prepare to defend its position if IP related to an acquired company is not centralized subsequent to an acquisition. Following the judgement, we recommend that the following aspects are considered by MNE groups prior to an acquisition:
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