Tag: Economic substance

§ 1.482-9(i)(2)(ii) Economic substance and conduct.

The arrangement, including the contingency and the basis for payment, is consistent with the economic substance of the controlled transaction and the conduct of the controlled parties. See § 1.482-1(d)(3)(ii)(B) ... Read more

§ 1.482-1T(ii)(B) Example.

P and S are controlled taxpayers. P licenses a proprietary process to S for S’s use in manufacturing product X. Using its sales and marketing employees, S sells product X to related and unrelated customers outside the United States. If the license between P and S has economic substance, the Commissioner ordinarily will not restructure the taxpayer’s transaction to treat P as if it had elected to exploit directly the manufacturing process. However, because P could have directly exploited the manufacturing process and manufactured product X itself, this realistic alternative may be taken into account under § 1.482-4(d) in determining the arm’s length consideration for the controlled transaction. For examples of such an analysis, see Examples 7 and 8 in paragraph (f)(2)(i)(E) of this section and the Example in § 1.482-4(d)(2) ... Read more

§ 1.482-1(d)(3)(ii)(C) Example 6.

Contractual terms imputed from economic substance. (i) Company X is a member of a controlled group that has been in operation in the pharmaceutical sector for many years. In years 1 through 4, Company X undertakes research and development activities. As a result of those activities, Company X developed a compound that may be more effective than existing medications in the treatment of certain conditions. (ii) Company Y is acquired in year 4 by the controlled group that includes Company X. Once Company Y is acquired, Company X makes available to Company Y a large amount of technical data concerning the new compound, which Company Y uses to register patent rights with respect to the compound in several jurisdictions, making Company Y the legal owner of such patents. Company Y then enters into licensing agreements with group members that afford Company Y 100% of the premium return attributable to use of the intangible property by its subsidiaries. (iii) In determining ... Read more

§ 1.482-1(d)(3)(ii)(C) Example 4.

Contractual terms imputed from economic substance. (i) FP, a foreign producer of athletic gear, is the registered holder of the AA trademark in the United States and in other countries worldwide. In year 1, FP enters into a licensing agreement that affords its newly organized United States subsidiary, USSub, exclusive rights to certain manufacturing and marketing intangible property (including the AA trademark) for purposes of manufacturing and marketing athletic gear in the United States under the AA trademark. The contractual terms of this agreement obligate USSub to pay FP a royalty based on sales, and also obligate both FP and USSub to undertake without separate compensation specified types and levels of marketing activities. Unrelated foreign businesses license independent United States businesses to manufacture and market athletic gear in the United States, using trademarks owned by the unrelated foreign businesses. The contractual terms of these uncontrolled transactions require the licensees to pay royalties based on sales of the merchandise, and obligate ... Read more

§ 1.482-1(d)(3)(ii)(C) Example 3.

Contractual terms imputed from economic substance. (i) FP, a foreign producer of wristwatches, is the registered holder of the YY trademark in the United States and in other countries worldwide. In year 1, FP enters the United States market by selling YY wristwatches to its newly organized United States subsidiary, USSub, for distribution in the United States market. USSub pays FP a fixed price per wristwatch. USSub and FP undertake, without separate compensation, marketing activities to establish the YY trademark in the United States market. Unrelated foreign producers of trademarked wristwatches and their authorized United States distributors respectively undertake similar marketing activities in independent arrangements involving distribution of trademarked wristwatches in the United States market. In years 1 through 6, USSub markets and sells YY wristwatches in the United States. Further, in years 1 through 6, USSub undertakes incremental marketing activities in addition to the activities similar to those observed in the independent distribution transactions in the United States market ... Read more
Portugal vs "GAAR S.A.", January 2022, Supremo Tribunal Administrativo, Case No : JSTA000P28772

Portugal vs “GAAR S.A.”, January 2022, Supremo Tribunal Administrativo, Case No : JSTA000P28772

“GAAR S.A” is a holding company with a share capital of EUR 55,000.00. In 2010, “GAAR S.A” was in a situation of excess equity capital resulting from an accumulation of reserves (EUR 402,539.16 of legal reserves and EUR 16,527,875.72 of other reserves). The Board of Directors, made up of three shareholders – B………… (holder of 21,420 shares, corresponding to 42.84% of the share capital), C………… (holder of a further 21,420 shares, corresponding to 42.84% of the share capital) and D………… (holder of 7. 160 shares, corresponding to the remaining 14.32% of the share capital) – decided to “release this excess of capital” and, following this resolution, the shareholders decided: i) on 22.02.2010 to redeem 30,000 shares, with a share capital reduction, at a price of EUR 500.00 each, with a subsequent share capital increase of EUR 33. 000.00, by means of incorporation of legal reserves, and the share capital of the appellant will be made up of 20,000 shares at ... Read more
Italy vs Stiga s.p.a., formerly Global Garden Products Italy s.p.a., July 2020, Supreme Court, Case No 14756.2020

Italy vs Stiga s.p.a., formerly Global Garden Products Italy s.p.a., July 2020, Supreme Court, Case No 14756.2020

The Italian Tax Authorities held that the withholding tax exemption under the European Interest and Royalty Directive did not apply to interest paid by Stiga s.p.a. to it’s parent company in Luxembourg. The interest was paid on a loan established in connection with a merger leverage buy out transaction. According to the Tax Authorities the parent company in Luxembourg was a mere conduit and could not be considered as the beneficial owner of the Italian income since the interest payments was passed on to another group entity. The Court rejected the arguments of the Italian Tax Authorities and recognized the parent company in Luxembourg as the beneficial owner of the interest income. In the decision, reference was made to the Danish Beneficial Owner Cases from the EU Court of Justice to clarify the conditions for application of the withholding tax exemption under the EU Interest and Royalty Directive and for determination of beneficial owner status. The Court also found that no ... Read more
Luxembourg vs L SARL, January 2020, Luxembourg Administrative Tribunal, Case No 41800

Luxembourg vs L SARL, January 2020, Luxembourg Administrative Tribunal, Case No 41800

In 2013, L SARL requested in writing an “advance tax agreement” regarding the tax treatment of Mandatory Redeemable Preference Shares (MRPS) which generated a preferred dividend for its sole shareholder. L SARL wanted confirmation that the MRPS would be characterised as debt and that payments under the MRPS would therefore be tax deductible. The tax administration issued an advance tax agreement confirming that the content of the request complied with the tax laws and administrative practices in force. However, despite the agreement the tax authorities challenged the 2013 tax return and demanded proof that the return on the MRPS complied with the arm’s length principle. L SARL found that such proof was not necessary since the MRPS’ tax treatment had already been agreed by the tax administration agreement. The tax administration disagreed and issued an assessment. The case was brought before the Administrative Tribunal. The Administrative Tribunal held that an advance tax agreement is binding upon the tax administration where ... Read more
Hungary vs "Seeds Kft", September 2018, Supreme Administrative Court, Curia No. Kfv. VI. 35.585/2017

Hungary vs “Seeds Kft”, September 2018, Supreme Administrative Court, Curia No. Kfv. VI. 35.585/2017

The Hungarian tax office had carried out an an audit of “Seeds Kft” – a group company engaged in the trade in cereals and oilseeds – in relation to accounting for commodity futures. In the assessment decision, the tax office emphasized that the economic substance of the given transaction and the purpose to be achieved by the transaction are relevant. Clearing transactions are not settled by the delivery of the underlying commodities of the transaction and the payment of the forward price, but by financial settlement of the difference between the market price of the commodity and the forward price. With regard to the transfer pricing documentation, the tax office agreed with the pricing method chosen by Seeds Kft but found the application thereof arbitrary and therefore not resulting in establishment of a market price. The Court of First Instance found the tax office’s claim to be partly well-founded and ordered the tax authorities to reopen the proceedings. On the ... Read more
Luxembourg vs PPL-Co, July 2017, Cour Administrative, Case No 38357C

Luxembourg vs PPL-Co, July 2017, Cour Administrative, Case No 38357C

The Administrative Court re-characterised a profit-participating loan into equity for tax purposes. The court provided the following reasoning: “Compared with the criteria specified above for a requalification as a disguised contribution of capital, it should firstly be noted that the sums made available to the two subsidiaries were allocated to investments in properties intended in principle to represent investments in the medium or long term as assets of the invested assets and in the absence of a clause providing for a repayment plan or a fixed maturity, the sums were intended to remain at the disposal of the subsidiaries for a period otherwise limited. In addition, this availability of funds did not give rise to any fixed consideration from the two subsidiaries, but only to a share of the appellant in the capital gains generated by hotel disposals, this interest amounting to three quarters of the capital gains obtained by the affiliates.” “...the sums made available to the two subsidiaries ... Read more
UK vs CJ Wildbird Foods Limited, June 2018, First-tier Tribunal, case no. UKFTT0341 (TC06556)

UK vs CJ Wildbird Foods Limited, June 2018, First-tier Tribunal, case no. UKFTT0341 (TC06556)

In the transfer pricing case of C J Wildbird Foods Limited the issue was whether a related party loan should be treated as such for tax purposes. There was a loan agreement between the parties and the agreement specified that there was an obligation to repay the loan and interest. However, no interest had actually been paid and a tax deduction had also been claimed by the tax payer on the basis that the debt was unlikely to be repaid. The tax authorities argued that the loan did not have the characteristics of a loan. The borrower was loss making  and did not have the financial capacity to pay any interest. The tribunal found that there was a legal obligation to repay the loan and interest. Whether the loan or interest was actually repaid was irrelevant. “The modern business world has many famous examples of companies, especially in the technology sector, with no cash and no immediate prospect of generating ... Read more
US vs Wells Fargo, May 2017, Federal Court, Case No. 09-CV-2764

US vs Wells Fargo, May 2017, Federal Court, Case No. 09-CV-2764

Wells Fargo, an American multinational financial services company, had claimed foreign tax credits in the amount of $350 based on a “Structured Trust Advantaged Repackaged Securities” (STARS) scheme. The STARS foreign tax credit scheme has two components — a trust structure which produces the foreign tax credits and a loan structure which generates interest deductions. Wells Fargo was of the opinion that the STARS arrangement was a single, integrated transaction that resulted in low-cost funding. In 2016, a jury found that the trust and loan structure were two independent transactions and that the trust transaction failed both the objective and subjective test of the “economic substance” analysis. With respect to the loan transaction the jury found that the transaction passed the objective test by providing a reasonable possibility of a pre-tax profit, but failed the subjective test as the transaction had been entered into “solely for tax-related reasons.” The federal court ruled that Wells Fargo had not been entitled to ... Read more
Malaysia vs Ensco Gerudi, June 2016, High Court, Case No. 14-11-08-2014

Malaysia vs Ensco Gerudi, June 2016, High Court, Case No. 14-11-08-2014

Ensco Gerudi provided offshore drilling services to the petroleum industry in Malaysia. The company did not own any drilling rigs, but entered into leasing agreements with a rig owner within the Ensco Group. One of the rig owners in the group incorporated a Labuan company to facilitate easier business dealings for the taxpayer. Ensco Gerudi entered into a leasing agreement with the Labuan company for the rigs. Unlike previous transactions, the leasing payments made to the Labuan company did not attract withholding tax. The tax authorities found the Labuan company had no economic or commercial substance and that the purpose of the transaction had only been to benefit from the tax reduction. The High Court decided in favour of the taxpayer. The Court held that there was nothing artificial about the payments and that the transactions were within the meaning and scope of the arrangements contemplated by the government in openly offering incentives. The High Court ruled that taxpayers have ... Read more
US vs Buyuk LLC and Beyazit LLC, November 2013, US Tax Court, Case No. 11051-10, 6853-12

US vs Buyuk LLC and Beyazit LLC, November 2013, US Tax Court, Case No. 11051-10, 6853-12

The dispute in this case was transactions involving distressed asset/debt transaction. The tax authorities found the DAD transactions of russian receivables under a “DBO distressed debt structure scheme” lacked economic substance, and denied the taxpayers involved tax decuctions of USD 4.5 and 12.2 million. A report provided on behalf of the government analyzed whether a rational investor would have entered into the transaction were it not for the claimed tax benefits. The Courts opinion: “there was no realistic possibility for the transactions at issue to break even absent any tax benefits.” Hence the transactions were not recognized. US Tax Court, Case No. 11051-10, 6853-12 US Tax Court 2013-253 ... Read more
Taiwan vs Cadence Taiwan, January 2012, Supreme Administrative Court, Case No 1 of 101

Taiwan vs Cadence Taiwan, January 2012, Supreme Administrative Court, Case No 1 of 101

Cadence is a US group active in the business of electronic design automation. Cadence Taiwan provided R&D services to Cadence US. In 2003, based on a transfer pricing study, Cadence US concluded that the service fees that it had paid to Cadence Taiwan in 2002 were too high and therefore instructed Cadence Taiwan to book a significant sales allowance amount in it’s 2003 and 2004 accounts. A debit note was send to Cadence Taiwan and a tax deduction was claimed. Cadence brought the case to court The Supreme Administrative court rejected Cadence’s appeal. The service agreement between Cadence US and Cadence Taiwan did not contain any provision for a retroactive adjustment of the service fees. The debit notes from Cadence US were not signed off by Cadence Taiwan to acknowledge its agreement to the adjustments. Therefore, the subsequent sales allowances booked by Cadence Taiwan were purely for the purpose of allocating profits without any economic substance, and thus could not ... Read more
US vs. Sherwin-Williams Company, March 2011, Massachusetts Appeals Court Decisions, Case No 79 Mass. App. Ct. 159

US vs. Sherwin-Williams Company, March 2011, Massachusetts Appeals Court Decisions, Case No 79 Mass. App. Ct. 159

In the case of Talbots Inc, the Massachusetts Appeals Court Decisions found that the Appellate Tax Board correctly affirmed the denial by the Commissioner of Revenue (commissioner) of a taxpayer’s request to abate corporate excise taxes that were assessed against the taxpayer on the basis of disallowed deductions for royalty payments the taxpayer made to a wholly owned subsidiary for the use of intellectual property, where sufficient evidence supported the board’s finding that the commissioner properly disregarded, under the “sham transaction doctrine,” the transfer and licensing of the intellectual property between the taxpayer and the subsidiary; further, the board correctly affirmed the commissioner’s reattribution of the royalty and interest income earned by the subsidiary to the taxpayer, where the taxpayer controlled the intellectual property from which the income was generated, and in fact received substantially all of the income. US vs Talbots 2011 ... Read more
US vs. Sherwin-Williams Company, October 2002, Massachusetts Supreme Judicial Court, Case No 438 Mass. 71

US vs. Sherwin-Williams Company, October 2002, Massachusetts Supreme Judicial Court, Case No 438 Mass. 71

Sherwin-Williams is an Ohio corporation, headquartered in Cleveland, and is engaged in the manufacture, distribution and sale of paints and paint-related products. In 1991, it formed two subsidiaries under Delaware law to hold certain tradenames, trademarks and service marks that it had developed. Sherwin-Williams and the subsidiaries teen entered into nonexclusive licensing agreements for the right to use these various intangibles. In filing its 1991 state income tax return, Sherwin-Williams deducted all royalty and interest expenses accrued under the agreement, in computing taxable income. Following an audit, the Department of Revenue disallowed the deductions and assessed additional tax, because the transfer and license back of the marks was a “sham” disallowed under the “sham-transaction doctrine”. According to the Department of Revenue the royalty payments were not deductible, because the transactions had no valid business purpose and transactions were not at “arm’s-length.” On appeal, the Appellate Tax Board upheld the assessment of the tax authorities. Judgement for the Court The Supreme ... Read more