DHL - international transfer pricing wake-u call.
DHL started as a domestic courier service in 1969 and, by the early 1990s, had expanded to be the leading global service. By 1990, the legal structure was a brother-sister relationship with a U.S. corporation (DHL) and a Hong Kong corporation (DHLI). Although DHL created the U.S. domestic infrastructure of captive and third-party couriers, DHLI created this network in numerous locations outside the U.S. All worldwide subsidiaries and third-party couriers were required to use the DHL trade name.
Promoting Brand Name
To promote the DHL trade name, DHL spent approximately $150 million within the U.S.; DHLI spent approximately $380 million outside the U.S. between 1982 and 1992.
During the 1970s and 1980s, DHLI registered the DHL trade name in many foreign jurisdictions outside the U.S. During this time, there were no royalties between DHLI and its foreign subsidiary/third-party network, nor were there any such payments between DHLI and DHL. Further, there was no transfer of the DHL trade name to DHLI to enable the latter to register the trade name in foreign jurisdictions.
By 1992, various third parties purchased a controlling interest in DHLI for $450 million. As part of this transaction, DHLI agreed to purchase the DHL trade name for $20 million, DHL reserved the right to use its own name for 15 years on a royalty-free basis, and, after 15 years, DHL agreed to pay a royalty of 0.75% of its revenue.
In terms of the DHL trade name, the IRS attacked these royalty-related transactions as follows:
* DHL should have charged DHLI a royalty prior to the sale of its name. The Service asserted that, had the royalty been paid, it would have amounted to $80 million.
* In terms of the DHL trade name sale, the sale price was increased from the $20 million that had been agreed to by the parties to $600 million.
In the ensuing Tax Court litigation on the $80 million royalty issue, DHL introduced evidence that, in its dealings with third-party agents, the DHL trade name was used on a royalty-free basis. In lieu of cash royalties, DHL argued, it received noncash value in the form of enhancement to the image of its global network.
Despite this argument, the Tax Court agreed with the IRS. Thus, no matter how good the argument, royalty-free licenses are always suspect in the U.S. tax system and face challenges despite third-party royalty-free arrangements.
As for the trade name sale, the Tax Court adopted an interesting approach that can serve as a beacon for service companies. In litigation, the Service backed down from $600 million to $300 million transfer price for the trade name. In principle, the Tax Court agreed with a $300 million value. However, rather than place the entire value on the trade name, it made a radically different allocation. It valued the DHL trade name in the U.S. at $50 million, the DHL trade name in foreign jurisdictions at $50 million and all other intangibles (e.g., global network, global infrastructure and global goodwill) at $200 million.
In reaching this allocation, the Tax Court disagreed with valuing the trade name by including goodwill or other intangibles associated with the name, noting that DHLI was responsible for developing the network infrastructure and foreign component of the name. Implicit in the court's decision is that DHL was not the owner of the network or of any intangibles beyond the DHL name. Thus, the other intangible value should not get bundled with the trade name.
The Tax Court's decision can be expanded to other situations in which related parties can reduce the transfer price for a trade name by:
* Isolating from the trade name other intangible assets, such as customer lists, supplier relationships, patents, workforce and networks.
* Determining, in terms of each intangible asset, which related party incurred development costs and risks, held a protectable interest, had access to the benefits or could convince a third party to "buy in."
Many of these issues can now be resolved via a cost-sharing agreement under which the related parties can, in advance, agree to share the development costs commensurate with the benefits to be derived. These arrangements can alleviate transfer-pricing adjustments for royalties and do away with unnecessary sale transactions.
Finally, a properly documented cost-sharing agreement can eliminate the U.S. transfer pricing penalties.
FROM BILL ZINK, CPA, CHICAGO, IL
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|Publication:||The Tax Adviser|
|Date:||Feb 1, 2000|
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