Transfer pricing: Danish Supreme Court rules in favor of Adecco on trademark royalty payments

Transfer pricing: Danish Supreme Court rules in favor of Adecco – After a complaint, the Danish Supreme Court had to deal with the question of whether the deduction of royalties by Adecco SA’s Danish subsidiary for the use of the Adecco brand is legal. One of the reasons given for the rejection in the first instance was that the comparative figures for royalties used were insufficient. Adecco has now made improvements, which apparently convinced the court. The ruling shows one thing above all: In transfer pricing concepts, it is essential to be able to present reliable comparable data. MARKABLES is one provider of such data, probably unmatched in breadth and depth.

Adecco A/S, the Danish subsidiary of Swiss staffing multinational Adecco SA, paid trademark royalties of 2% on revenues in Denmark from low-skilled staff and 4% from professional staff to its parent in Switzerland.

In Oct 2019, the Danish High Court had rejected the tax deductibility of such trademark royalties, thereby following the reasoning of Danish tax authority SKAT. Read the main arguments of the Danish High Court in our previous post here.

However, in June 2020, the Danish Supreme Court overturned the decision of the High Court and ruled in favor of Adecco. The Supreme Court held – among other:

• Adecco A/S’s royalty payments for the use of the trademark had the nature of deductible operating costs, irrespective of Adecco A/S making losses during the years in question.
• Adecco A/S’s transfer pricing documentation for the income years in question was not insufficient to such an extent that it could be considered equal to lack of documentation. The company’s income could therefore not be determined on a discretionary basis by the tax authorities.
• SKAT’s reasoning that Adecco’s royalty rate of 2% was not at arm’s length on the Danish market was insufficient. In particular, SKAT missed to provide its own analysis of comparable royalty rates and to demonstrate which other royalty rate would be at arm’s length instead. Hence, the Supreme Court considered the 2% royalty rate as submitted by Adecco to be acceptable under the arm’s length standard.

Adecco had applied the CUP method (comparable uncontrolled price) to determine an arm’s length royalty rate:

• No similar license agreements between Adecco and unrelated parties existed (internal CUPs).
• Searches for license agreements between two unrelated parties (external CUPs) using Lexis-Nexis, EDGAR and RoyaltySource yielded no similar license agreements for the staffing industry.
• Finally, Adecco provided an analysis of franchise agreements in the staffing industry, both internal (from their US subsidiary) and external CUPs. To isolate the trademark components in the franchise agreements from the service components, Adecco made adjustments to arrive at trademark royalty rates ranging from 1.24%-2.62% (internal CUPs), 2.03%-3.70% (external CUPs office and industrial business) and 1.84%-4.53% (external CUPs professional business).

SKAT, on the other hand, points out several shortcomings in the comparability analysis provided by Adecco:

• There is too much speculative element about the adjustments made for the value of additional services that franchisees receive from Adecco.
• Internal franchise agreements lack other significant adjustments for being comparable. In particular, SKAT holds that all CUPs are for the US territory with different market characteristics.
• SKAT considers both the rejection of incomparable agreements and the selection of comparable agreements for the analysis to be inconsistent.

Beyond a detailed rebuttal of Adecco’s comparability analysis, SKAT did not provide its own evidence of potentially comparable license agreements. Realistically speaking, such trademark license agreements in the staffing sector are not accessible in the public domain or through license agreement databases. It is painfully obvious that the number of trademark license agreements in the public domain is far too small to provide evidential royalty rates for any and all sectors, like i.e. in temporary staffing.

Read the original document of the Supreme Court’s ruling here.

MARKABLES is a different database for the valuation of intangible assets. It is not based on license agreements, but on the parameters and results of intangible valuations instead. Among other, MARKABLES has 15x more trademark royalty rates on file than license agreement databases. In the employment services sector, MARKABLES has 113 different trademark royalty rates on file, of which 56 cases relate to the temporary staffing sector.

A royalty rate analysis of the 19 most recent cases in the temporary staffing industry (from 2015-2019) shows a median trademark royalty rate of 1.3%, and an interquartile range from 0.9%-1.7% (see our sector snapshot here). The same analysis for the tax period in question (2005-2008, 20 different cases) reveals a median trademark royalty rate of 0.8%, and an interquartile range from 0.5%-1.3%.

Peer group analyses for both periods suggest that the 2.0% trademark royalty rate concluded in the Adecco case is outside (above) the arm’s length range. Needless to think about what the Supreme Court would have decided if one of the parties would have used comparable data from MARKABLES.