In the context of German tax audits, the offsetting of licence fees for trademark rights is increasingly becoming the focus of the tax authorities. In particular, inbound trade mark settlements - i.e. payments made by companies based in Germany to affiliated foreign companies for the use of trade mark rights - are increasingly being scrutinised. According to representatives of the tax authorities, this is taking place against the background that German affiliated companies of US groups, for example, regularly record such payments, while many German groups refrain from charging their subsidiaries for a licence for trademark rights. Companies should therefore review their documentation and offsetting structures at an early stage in order to minimise potential risks during tax audits.
We have summarised the most important audit aspects and recommendations for documentation and risk minimisation for you below:
Necessity of the licence payment
As part of tax audits, the tax authorities require a clear and comprehensible explanation of why a trade mark is used and what specific benefits this has for the company. In the opinion of the tax authorities, the focus here is often on the need to quantify and substantiate the specific financial benefits that (may) accrue to the German group units. Detailed evidence is often requested in order to substantiate the economic justification for the payments. This is not onsity of the licence paymently required at the time of the initial payment of the licence fee, but also on an ongoing basis, for example if the licence agreement contains an annual clause for the automatic renewal of the licence relationship.
Appropriateness of the amount
Determining the appropriateness of a licence fee in accordance with the arm's length principle presents companies with a number of challenges that require a detailed and well-founded analysis. A key problem is that there are often very few (at least limited) comparable transactions between independent parties, particularly in the case of specialised brands or licensing rights. A lack of corresponding comparative data makes it considerably more difficult to determine an appropriate licence fee.
Different valuation methods such as the market price, income or cost method can lead to differing results. The choice of method depends on the specific framework conditions of the licence agreement, which causes uncertainties in the amount of the licence fee. Market conditions, regional differences and industry-specific characteristics influence the licence fee and make it difficult to compare transactions, as licence fees for the same brand can vary depending on the territory or product category.
In practice, the uncontrolled price method (or "CUP method" for short) is often used to determine the licence fee. This method is based on a comparison of the licence fee with the price that independent companies would pay for similar brands or intangible assets. However, the application of the CUP method requires that factors such as the use of the trademark, the geographical scope, the duration of the licence and the specific terms of the agreement are taken into account in order to ensure that the compared transactions are comparable (at least to a limited extent). Many of these parameters are not only difficult to measure, but also cannot always be directly reflected in a price comparison. Differences in brand awareness, licence exclusivity and market position can lead to significant price differences. Geographical differences and agreements on future exclusive rights are also difficult to reflect in a simple price comparison. These factors complicate the application of the CUP method, as relevant differences are often not sufficiently taken into account, which can lead to distorted results.
The hypothetical arm's length comparison also entails uncertainties. This is used to assess the appropriateness of transactions between affiliated companies by comparing them with comparable transactions between independent third parties. The assumption that an independent company would pay a certain licence fee is often based on model calculations or assumptions that cannot be verified with real transactions. This theoretical construction harbours the risk of subjective assessments and methodological inconsistencies, which in turn can lead to different results.
Overall, these factors mean that both the CUP method and the hypothetical arm's length comparison do not always provide a precise or reliable basis for determining an appropriate licence fee. The choice of valuation method and the interpretation of the comparative values must therefore always be critically scrutinised and checked for appropriateness in each individual case.
Regardless of the method chosen, however, it is important that companies document the analysis precisely in order to be able to transparently demonstrate the appropriateness of the royalty in the event of a tax audit and thus minimise audit risks. Characteristics such as exclusivity, legal protection, geographical scope, stage of development and future benefit should be taken into account in order to determine the licence fee in line with the market.
Contractual basis
A written licence agreement is an important reference point in tax audits for the appropriateness of licence fees and compliance with tax regulations. It should contain all relevant details such as licence rights, fee, payment modalities and valuation methods. However, it is crucial that the actual practice is consistent with the agreement, as the tax authorities apply the "substance over form" approach. This means that it is not only the written agreement that counts, but also the actual implementation in practice. Deviations can increase audit risks, which is why a consistent and transparent implementation of licence accounting is crucial.
Scope of use
The scope of use of a trade mark is a key factor in assessing the appropriateness of licence fees, as it forms the basis for how much a trade mark is actually worth in practice. In order to set the licence fee in line with the market, it must be clearly defined how and where the brand is used in the operational business. This includes analysing whether the brand is used globally or only in specific geographical regions or markets, and whether it is used across different product categories or only in certain areas. This distinction is important, as the value of a brand that is only used in limited markets or regions does not correspond to that of a brand used internationally.
Conclusion
Determining the reasonableness of licence fees and justifying their necessity are key issues in German tax audits. Companies must ensure that their licence agreements comply with tax requirements and that the licence fees are in line with actual market conditions. A careful analysis of the relevant factors, such as scope of use and geographical area of application, is essential to prove the appropriateness of the payments.
Companies should therefore ensure comprehensive documentation of the licence agreements and the valuation methods used. It is advisable to conduct regular market analyses and identify comparable transactions (at least to a limited extent) in order to validate the appropriateness of the licence fee.
Our KPMG transfer pricing experts will be happy to answer any questions you may have.
Publication date:
27.03.2025
