Transfer pricing: Focus on marketing intangibles

Income earned from intangible property such as trademarks or brands is one of the most challenging issues in transfer pricing (TP).
Transactions involving the licensing of trademarks are common amongst multinational enterprises and these pose challenges in terms of the valuation of the trademark and remuneration of the trademark owner.

Indeed TP audits that have been undertaken by tax authorities have focused on royalty payments made by local subsidiaries to related parties for the use of trademarks.
Taxpayers are finding that defending such payments is no walk in the park, particularly where the local subsidiary is also incurring Advertising, Marketing and Promotional (AMP) expenditure on the trademark.

In such cases, the tax authorities have argued that local AMP expenditure adds value to the trademark and as such, the local subsidiary should be compensated for this either in form of reduced royalty payments, no payment at all or by charging a fee.
This is on the basis that significant AMP expenditure leads to the creation of a marketing intangible or economic ownership of the trademark by the local subsidiary as the AMP investment leads to the trademark becoming more recognisable and valuable in the marketplace.

There is no doubt that the AMP spend benefits the local subsidiary as it often leads to increased revenue generation as a result of increased brand awareness.

However, there needs to be a balance between how much the local entity spends on AMP versus the functions, risks and costs incurred by the trademark owner, particularly where the local entity is also paying a royalty to the trademark owner for the use of the trademark.
A good illustration of marketing intangibles is the US GlaxoSmithKline (GSK) case. The issue was whether the value of a drug, Zantac, was derived from Research and Development undertaken by GSK UK, the owner of the Zantac trademark, or by marketing activity undertaken by GSK US in the US market. GSK US was the distributor of the Zantac drug whose trademark was legally owned by GSK UK.

GSK US invested heavily in the marketing of the drug, which became a success in the US, while also making royalty payments to GSK UK .
The US tax authority successfully argued that GSK US was not entitled to deductions for the royalty payments as it had become the economic owner of the marketing intangible by virtue of its significant AMP expenditure.

A settlement was reached last year in which GSK US agreed to pay $3.4 billion in taxes.
Let’s make it more practical and assume that our very own Movit Uganda is a subsidiary of US based cosmetic giant – Movit Inc. Let’s also assume that Movit Inc owns the MOVIT trademark and enters into an agreement with Movit Uganda by which Movit Uganda will pay Movit Inc a royalty representing 3 per cent of gross revenue from sales of products bearing the MOVIT name.

A new fragrance, Movit Perfume is going to be launched and Movit Uganda has planned a promotion across all major towns featuring top local artists to introduce Movit perfume to the public. This will cost of Shs150 million.

The product becomes a great success and grosses Shs10 billion in its first year. Going by the agreement, Movit Uganda is required to pay 3 per cent of this (Shs300 million) to Movit Inc. The TP issues would be – who is the “owner” of the Movit Perfume brand?
What has Movit Inc done to warrant Shs300 million? Who is taking the risk regarding Movit Perfume? What was the nature of the AMP expense – was it routine or non routine?
This is what Movit Uganda would need to do.

• Analyse the agreement and the nature of rights obtained, functions, risks and expenditure relating to marketing activities.
• Consider the nature of AMP expenditure being incurred e.g. whether it has an enduring effect on the trademark
3. Consider the level of local AMP versus that of Movit Inc
• Assess whether Movit Uganda ought to pay a royalty or should be compensated by Movit Inc e.g. by way of a mark up on its AMP expenses.

Crystal Byaruhanga Kabajwara
Manager, Transfer Pricing
PwC Uganda