Conversion into being a commissionaire - transfer pricing

8 / 10 / 2020

According to the very recent judgment passed by the Danish National Tax Tribunal and published in the tax journal SKM2020.387, SKAT’s value assessment of intangible assets linked to a transfer to a foreign group company has been changed. In the case in question, SKAT found that the group had disposed of intangible assets when changing a group agreement concluded with a Danish company, in which case the status of a licence holder was converted into that of a commissionaire.

The case concerned a Danish company (H1 DK) which formed part of a group selling system software and application software, mainframe products, computing devices, cloud and other highly integrated solutions. In Denmark, the Danish company was responsible for direct (end user) and indirect sales ((agent/sub distributor). In addition, it was in charge of installation, training and other services.

For a number of years, H1 DK had been expanding on the Danish market through marketing activities and establishing a profitable customer base within its three core business areas: Licensing Business, Software-as-a-service and Professional Services.

“Licensing Business” primarily covered the sale of the group’s software products. “Software-as-a-Service” was web-based IT management solutions accessible via the Internet. H1 DK had no employees working on the development of this software. Instead, the company paid a royalty to the […] parent company in [country Y2]. “Professional Services” covered implementation services for which purpose H1 DK had hired project managers and architects.

As of 1 October 2010, the H2 group carried out a restructuring in connection with which all sales companies, including H1 DK were converted into commissionaires for the newly established company H4 in country Y1.

Overall, the reason given for the restructuring was a desire for a general cut-down on staff costs, having a long-term growth strategy and being able to benefit from economies of scale.

Before the restructuring, H1 DK paid royalties of x% to H5 corresponding to a 50/50 allocation of the system profit. Historically, H1 DK had realised negative results during the start-up phase. After the restructuring, the commissionaire payment was fixed at x% of the cost reimbursement + x% of the net amount invoiced. The change led to a significantly lower income for H1 DK.

According to SKAT, the group had moved intangible assets from H1 to the newly established company H4 as a result of the changed terms and conditions of the agreement concluded. Consequently, SKAT fixed the value of the company’s intangible assets according to the expected future cash flow and based its assessment on the past year’s operating result (considered standard income for H1 DK) prior to the restructuring of “Licensing Business“ and “Software-as-a-Service less 25% tax, on a conservative estimate of the future growth of 2% and on a discount factor of 10%.

The value assessment of the business transferred may be broken down as follows:


DKK million
Total present value of the business before the restructuring […]
- Present value of the commissionaire business - […]
- Present value of the services rendered - […]
- Present value of existing contracts - […]
- Present value of assets and liabilities not transferred - […]
Value of intangible assets […]
Tax Amortisation Benefit (“TAB”) + […]
Value of intangible assets linked to the business transferred […]


The adviser asserted three claims in his complaint filed with the Tribunal:

  1. H1 DK did not dispose of the IP in connection with the restructuring in 2010, and the adviser contested the clc claim of H1 DK being entitled to compensation due to the termination of the distribution agreement
  2. In the alternative, the adviser claimed that SKAT’s increase should be lowered to one of the amounts fixed by by the Tribunal
  3. In the second alternative, the adviser claimed that the case should be remitted to the court for rehearing

As for item 2, the representative added that SKAT had based its value assessment on Gordon’s growth model and that this model assumed that the cash flow would continuously rise by a fixed amount and that the useful life of the underlying assets was unlimited. Furthermore, if the underlying asset had an unlimited useful life, this should be taken into account with respect to the budget period or in connection with the terminal value. As for the useful life of intangible assets it was stressed that “(....) According to paragraph 2.6.4.4. of the transfer pricing guidelines, the useful life of an intangible asset is determined on the basis of all relevant facts. The useful life of an intangible asset may be affected by technological changes within the line of industry or by other factors with an impact on the relevant economic environment. In addition, legal circumstances may also affect the useful life of an intangible asset – for instance the lapse of patent rights or general contractual terms and conditions”.

The decision made by the Danish National Tax Tribunal

By way of introduction, the Tribunal noted that according to paragraphs 9.45-9.47 of the OECD Transfer Pricing Guidelines 2017, an independent distributor with a high future profit potential would not be willing to dispose of this potential profit in connection with a restructuring in return for a stable lower income without receiving some kind of compensation.

Two members of the Tribunal found that SKAT had proved that in connection with the restructuring and the company’s conversion into being a commissionaire, valuable intangible assets that should have been priced in accordance with section 2 of the Danish Tax Assessment Act and section 40(6) of the Danish Depreciation/Amortisation Act had in fact been transferred. Against this background, the Danish Tribunal found that the value of the assets should be based on SKAT’s assessment, but that the assessed value should be lowered in terms of the expected useful life – which according to the Tribunal was estimated at 10 years based on a specific evaluation of the duration of the company’s customer relationships.

However, a member was of the opinion that the case should be remitted to SKAT for a renewed value assessment of the intangible assets transferred, including the goodwill.

Baker Tilly comments

According to Baker Tilly, the decision is a textbook example of how changes to contractual terms and conditi¬ons can trigger exit taxation, as from a transfer pricing perspective, such changes often lead to intangible assets being considered assets disposed of.

In the case in question, SKAT assessed the value of intangible assets in accordance with the DCF method and followed the standard practice for doing so. Anyhow, the Tribunal still found that the methodology of SKAT needed an adjustment, as based on a specific assessment, the useful life of the intangible assets was only 10 years. Consequently, the Tribunal removed the terminal value which was often 40 to 60% of the total value. The Tribunal did not give any further elaboration of why it came to a useful life of exactly 10 years.

We are currently not aware of the Danish Tax Agency having filed an appeal against the decision. However, we expect that the decision made by the Danish National Tax Tribunal will be appealed. Especially as the reason given and the discretionary value assessment provided with respect to the value of the intangible asset seem to violate the standard valuation principles and SKAT’s practice in a number of other cases.

If the decision is not appealed, it would reflect a change of practice, as previously SKAT used to assess the value of customer relations and related goodwill based on the DCF method and apply a terminal period (value).

Contact

Please do not hesitate to contact us if you have any questions:

Michael B. Villinger, Transfer Pricing Senior Manager
mbv@bakertilly.dk І M +45 8188 8108

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