Poland vs “Fertilizer Licence SA”, April 2022, Provincial Administrative Court, Case No I SA/Po 788/21

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“Fertilizer Licence SA” (“A”) transferred its trademarks to “B” in 2013, previously financed the transfer through a cash contribution, and then, following the transfer, paid royalties to “A” in exchange for the ability to use the assets.

According to the tax authorities, a situation where an entity transfers its assets to another entity, finances the transfer and then pays for access to use those assets does not reflect the conditions that unrelated parties would establish. An unrelated party, in order to obtain such licence fees from another unrelated party, would first have to incur the costs of manufacturing or acquiring the trademarks and to finance these costs itself without the involvement of the licensee. An independent entity which has finances the creation or purchase of an intangible asset, should not incur further costs for the use of that asset.

Furthermore, in determining the licence fee to “B” for the use of trademarks, “A” relied on formal legal ownership, granting “B” a share in the revenues generated by “A” despite the fact that “B” did not take any part in the creation of these revenues. As a result, almost all the profits of “A” were transferred as royalties to company “B”. According to the authority, such an approach is inconsistent with the arm’s length principle. The remuneration of “B” (the legal owner of trademarks) did not take into account the functions performed by entities in creating the value of trademarks nor the risks and assets involved in the creation.

The authority concluded that “B” was not entitled to share in the profit of “A”, because “B” was only the legal owner of internally created trademarks in the group and performed no significant DEMPE functions, had not used significant assets nor borne significant risks. This role of “B” entitled only to reimbursement of the costs incurred for the registration and legal protection of trademarks added a arm’s length margin for this type of services.

As a result of the findings, the authority of first instance concluded that “A” had overstated tax deductible costs in connection with the disclosure of trademark licence fees as costs. “A” had reported income lower than it would have expected if the above-mentioned relationships had not existed.

In the opinion of the authority of the second instance, an independent entity would not have entered, on the terms and conditions set by the company and its affiliates, into transactions leading to the divestment of ownership of valuable assets necessary for its operations, additionally financing their acquisition by another company, taking up shares in return with a nominal value significantly lower than the value of the lost assets (subsequently not receiving any dividends therefrom), and additionally being forced to incur additional costs as a result of the need to pay licence fees for the use of the trademarks held earlier.

An appeal was filed by “A”.

Judgement of the Court

“What is important in the case, however, is the conclusion of the authorities that in fact the legal relationship justifying the incurrence of expenses recognised as tax deductible costs is a contract for the provision of services consisting only in the administration of trademarks. The Court notes, however, that this conclusion is in conflict with the position of the authorities, which did not question the validity of the legal transactions resulting in the transfer of the rights to the trade marks to company ‘B’ and thus to another entity. As the applicant rightly submits, it cannot be disregarded in this case that the applicant was not the owner of the trade marks but acquired the right to use them on the basis of a licence agreement, for which it should pay remuneration to company ‘B’ (page […] of the application).

In principle, the authorities did not present any arguments showing which interpretation rules they applied to reach the conclusion that this manner of applying the abovementioned provisions is legally possible and justified in the present case. It should be pointed out here that Article 11(1) in fine speaks of the determination of income and tax due without – ‘[…] taking into account the conditions resulting from the link …’, but does not permit the substitution of one legal transaction (a licence agreement) for another (an agreement for the provision of administration services) and the derivation of legal effects from the latter in terms of determining the amount of the tax liability.

As the applicant rightly argued, such a possibility exists from 1 January 2019, since Article 11c(4) uses the expression- “[…] without taking into account the controlled transaction, and where it is justified, it determines the income (loss) of the taxpayer from the transaction relevant to the controlled transaction”. This is the so-called recharacterisation, i.e. reclassification of transactions, which was actually done by the tax authorities in this case.

The company’s claims that the transfer of the trade mark into a separate entity was motivated by a desire to increase the company’s recognition and creditworthiness, which was a normal practice for business entities at the time, are unconvincing. On that point, it should be noted that, operating under the GKO with the same name, the applicant’s recognition and the name under which it operated were already sufficiently well established. As regards the increase in the creditworthiness or market power of the users of the trade mark, the applicant’s contentions on this point too are empty. Moreover, even if it were to be accepted, at least in the context of the activities of ‘A’, that the creditworthiness of ‘A’ had been increased, the advantage which the applicant derives from such an operation would appear to be of little significance. In fact, it obtained this benefit to a significant extent from the formation of relations with “A”, as a result of which the value of its income taxable income, and thus its tax liability in 2015, was significantly reduced.

The benefits, mainly tax ones, are also indirectly pointed out by the applicant herself, indicating, inter alia, that there were no grounds for the authorities to question the tax optimisations, prior to 15 July 2016. This only confirms the position of the authority in the discussed scope.”

“The authority carefully selected appropriate comparative material, relying on reliable data concerning a similar category of entrepreneurs.
Contrary to the applicant’s submissions, the authority analysed the terms and conditions of the cooperation between the applicant and ‘A’ when it embarked on the analysis of the appropriate estimation method in the circumstances of the case. In doing so, it took into account both the specific subject-matter of the cooperation and the overall context of the cooperation between the two entities.

As for the method itself, the authority correctly found that “A” carried out simple administrative activities, and therefore took into account the general costs of management performed by this entity. In this respect it should be noted that the Head of the Customs and Tax Office accepted the maximum calculated indicator of transaction margin amounting to 19.55%.

The applied method, which should be emphasised, is an estimation method, which allows only for obtaining approximate values by means of it. Moreover, it is based on comparative data obtained independently of the circumstances of the case, therefore it is not possible to adjust the results obtained on the basis of its principles by the costs of depreciation, as suggested by the applicant, alleging, inter alia, that § 18(1) of the Regulation was infringed by the authority. Moreover, the costs of depreciation of the trade mark by ‘A’ related strictly to its business and therefore did not affect its relations with the applicant.

The company also unjustifiably alleges that the authority breached Article 23(3) of the Regulation by failing to take account of the economic reasons for the restructuring of its business in the context of the GKO’s general principles of operation. For, as already noted above, there is no rational basis for accepting the legitimacy of carrying out such restructuring, both in 2015 and thereafter. And the fact of the return of the trademark right to the Applicant only supports this kind of conclusion.

Nor can there be any doubt as to the availability to the applicant, in 2015, of an adequate range of data relating to aspects of its transactions. Indeed, it was the applicant that initiated the transfer of the trade mark rights and “A” was headed by a representative of its management. Therefore, it cannot be assumed that the scope of data on the counterparty, as well as its characteristics and qualities, was significantly narrower in the case of the company than that which was within the reach of the authority at the time the contested decision was issued.”

“In the Court’s assessment, the evidence gathered in the case allowed its resolution, and in this respect the authorities did not fail to comply with Article 122 in conjunction with Article 187(1) of the C.C.P. The allegation of a breach of Article 191 of the C.C.P., consisting in the authorities’ incorrect assessment of the market nature of the legal transactions examined, is well-founded. In the context of this allegation, however, it should be stipulated that the reclassification of the legal action by the bodies is not so much the result of a defective assessment of the evidence collected, but results from the interpretation and manner of application of substantive law provisions adopted by the bodies (Article 11(1) and (4) of Ustawa o.p.o.p.). As it was correctly pointed out in the judicature, in such a situation the factual state was not so much determined, but accepted by the tax authority. The tax authority determines the factual state not on the basis of established circumstances, but reconstructs it by accepting, as a directional guideline, the taxpayer’s intention to achieve the intended fiscal goal (unauthorised tax benefit). Thus, the factual state adopted by the tax authorities does not so much result from the evidence gathered in the case, but from the assumption that if the taxpayer was guided only by economic and economic reasons and not by the intention to achieve an unauthorised tax benefit, he would arrange his relations in exactly the way the tax authority wants (judgment of the NSA of 8 May 2019, II FSK 2711/18).”

“As a consequence of the violation of substantive law, the allegations of violation of Articles 120 and 121 § 1 of the Tax Act by the authorities in this case are justified.
Due to the length of the complaint, the Court referred to the allegations contained therein and their justification to the extent necessary to carry out a review of the appealed decisions (judgment of the Supreme Administrative Court of 26 May 2017, I FSK 1660/15). In particular, the Court held that in view of the interpretation and manner of application of the substantive law adopted by the authorities, the facts, events and circumstances broadly described in the complaint, which make up the economic (business) context of the legal actions performed by the applicant and related entities (p. […] of the complaint) were not material for the resolution of this case.
When re-examining the case, the authorities will take into account the legal assessment presented above as to the interpretation and application, in the factual circumstances of the case, of Article 11(1)-(4) of the A.l.t.c., including the assessment as to the nature and significance of the OECD Guidelines when applying this provision. The consequence of the tax authorities’ assumption in this case of the validity and effectiveness of legal transactions performed by the claimant and company “B”, including the conclusion of a licence agreement, must be the application of the provision of Article 11 (1) and (4) of the Tax Act as an instrument for controlling the amount of determined licence fees between related entities, and not as a provision containing a clause preventing tax avoidance. When re-examining the correctness of the tax settlement of the applicant in the audited period and the legitimacy of determining the amount of the expenses as tax deductible costs (Article 15 par. 1 of the Tax Act), the authorities will take into account the correct amount of the expenses on account of licence fees.

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