- Posted by jbehrendt on May 3, 2009
Very often, companies are creating valuable brands over time. In accounting terms, this means not much as long as the company is not sold - it is considered to be a self-created immaterial asset, which is not allowed to be recorded in the balance sheet. When the company is sold, and when the buyer pays more then the book value of the company's assets (which hopefully is the case), either the brand is valued separately, and recorded as a derivative immaterial asset in the balance sheet of the purchasing company, or it becomes part of the goodwill purchased from the acquiring company, which is calcuated as the difference between the purchasing price and the price of the assets purchased.
But even without selling the company, the value of its own brands may become relevant the moment a restructuring takes place, and the business starts using a structure comprising of different legal entities. For tax purposes, every legal entity forms a separate taxable unit, and the tax authorities have a strong interest in keeping the tax base of every company as intact, and as high, as possible. Contracts between different companies in one group, even if finally belonging to the same owners, have to be defined as if agreed upon between third parties ("arm's length principle") in order to avoid hidden profit transfers between different legal entities endangering the taxable income of each unit. This becomes especially true if non-domestic or tax-exempted companies are part of the circle, the famous issue of international transfer pricing.
Over time, however, tax authorities become more sophisticated, therefore not only checking intra-group transfers between internationally linked companies but between domestic companies as well, since otherwise tax reductions (e.g. because of using hidden profit transfers in order to make use of otherwise unusable losses) may take place by using domestic companies as well. The normal "punishment" in case proper transfer pricing did not take place is to consider the payments made to be hidden profit transfers, for which the respective profit taxation is applied - sometimes several years backwards.
For self-created brands used within a more complex group structure, this causes significant problems. The moment the internal brand is used by different companies within the group, it is to be treated as it would have been the case between third parties. This means that the owner of the brand has to set up a license agreement with the user of the brand, and a detailed contract needs to be set up in which it is defined who is responsible for legally defending the brand, doing market research, invest in the further development of the brand, etc.etc. In connection with carve-outs, further questions arise, since brands belonging to the business carved out should be transferred as well to the new legal unit in order to preserve tax neutrality of the transaction, which may mean an - unintended - transfer of assets worth millions of dollars.
For the group, this means some questions to be addressed and answered:
- Who should be the legal owner of the brand - or the brands - within the group? Does it make sense to set up a separate company only being responsible for the internal brands, in order to avoid unintended brand transfers during restructuring measures?
- Is the legal owner (who normally registers the brand, and is owner of the trademark) the beneficial owner (economic owner) of the brand as well, or did another unit within the group spend all the money for further promoting the brand?
- Who are the users of brands within the group, and what are exactly there rights - do they have exclusive or nonexclusive usage rights, is it limited to a certain region or not, does it contain only a certain combination of words, or, if it contains pictures or logos, which pictures or logos are protected?
- Who is responsible for further investments in the brand, the owner of it, or the user?
- Last not least, what is an appropriate license fee (which can be more or less anyting between 1% and 10% of the related turnover) which should be paid?
The consideration of continously paid license fees and its effects on the income statements of the related companies can change the picture about advantages and disadvantages of certain target structures significantly. The same is true for the possible transfer of significant asset values related to brand transfers within a group. Any restructuring project including a legal restructuring in a group where significant and so far unrecognized brand values may exist therefore needs a throughout analysis and consideration of its related problems - otherwise the tax inspector may do the analysis.