The Administrative Court of Appeal of Stockholm issued a judgment in a case concerning ownership of intellectual property (IP) from a transfer pricing perspective, and held that ownership of intangibles may change following a third-party acquisition.
The judgment has a number of implications for multinational entity (MNE) groups that are currently in the process of acquiring, or contemplating to acquire, a Swedish company with significant IP ownership.
The case concerns a Swedish development company that in 2013 was acquired by a U.S. company. After the acquisition, the Swedish company and the U.S. company concluded an agreement (a “Sales and Distribution Agreement”) pursuant to which the U.S. company was granted the right to market, sell, and distribute products developed by the Swedish company. As remuneration, the Swedish company would receive 25% 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 was treated as a royalty.
Positions of tax agency, taxpayer
According to the Swedish tax agency, rights to retain returns from exploiting IP developed by the Swedish company had been transferred to the U.S. company when the U.S. company acquired the shares in the Swedish company. In the tax agency’s view, the Swedish company would therefore have received remuneration for the IP transferred. It was uncontested that the Swedish company was the legal owner of the IP.
The tax agency asserted 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 U.S. company after the acquisition (and had hence been transferred to the U.S. company). The tax Swedish agency contended that the risks had been transferred since the U.S. company decided on marketing, sales strategies, agreements with customers, pricing and product development. As proof of this decision-making, the tax agency 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 because the value of the IP, and the possibility to exploit the IP, was derived from the development of the IP and given that it was only employees of the Swedish company that had the competence to develop the IP. According to the Swedish company, the U.S. company could not decide on issues relating to the IP because it lacked knowledge about the IP.
Previous judgement by Administrative Court of Stockholm
In an earlier judgment, the lower court (the Administrative Court of Stockholm) held in favor of the Swedish company and concluded that no transfer of IP had taken place. In short, the court accepted the taxpayer’s position 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 found that a transfer of ownership was not apparent from the agreement that was in place between the parties.
Appellate court decision
On appeal, the appellate court reversed and held for the Swedish tax agency. The appeals court in its decision emphasized that the Swedish company had, in initial responses to the tax agency 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 later retracted these comments, but the appellate court found no reason had been given to why the comments had been made in the first place if they were wrong, and thus they were to be regarded as accurate.
The appeals court considered that it had been proved that the U.S. 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 therefore would be allocated to the U.S. company given that the U.S. company was always informed about product development initiatives and could always block them.
In terms of pricing, the appellate court found 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 tax agency’s view that the arm’s length remuneration must 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 acquiring, 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 position of the Swedish tax agency and the appeals court’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 tax agency and the appeals court, if applied more broadly, may result in a standard 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, according to tax professionals in Sweden, such an effect may be in conflict with the OECD Transfer Pricing Guidelines, as those guidelines state that the right to retain returns from IP are to be awarded to the entity that performs and controls the relevant DEMPE functions (which may not be the parent company in many cases). There are tax professionals who believe that the appeals court’s decision is not in line with the Swedish arm’s length principle, and thus, taxpayers need to wait and see if the case will be appealed to the Supreme Court and whether the high court grants leave to appeal.
In any event, MNEs need to consider how to defend their position if IP related to an acquired company is not centralized subsequent to an acquisition. Certain steps for MNE groups to consider prior to an acquisition include:
Read an April 2020 report prepared by the KPMG member firm in Sweden
For more information, contact a KPMG tax professional in Sweden:
Karolina Viberg | +46 8 723 94 52 | firstname.lastname@example.org
Fredrika Wendleby | +46 709 39 67 98 | email@example.com
The KPMG logo and name are trademarks of KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent member firms. KPMG International provides no audit or other client services. Such services are provided solely by member firms in their respective geographic areas. KPMG International and its member firms are legally distinct and separate entities. They are not and nothing contained herein shall be construed to place these entities in the relationship of parents, subsidiaries, agents, partners, or joint venturers. No member firm has any authority (actual, apparent, implied or otherwise) to obligate or bind KPMG International or any member firm in any manner whatsoever. The information contained in herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG's Federal Tax Legislative and Regulatory Services Group at: + 1 202 533 4366, 1801 K Street NW, Washington, DC 20006.