Royalties

In common with other tax administrations, we have been spending more time on issues involving the inbound licensing of intangibles.

The following checklist might be useful to companies involved in licensing arrangements with offshore associates:

1. Is there an up-to-date licensing agreement in place?
2. Does the agreement clearly identify the intangible property being supplied and accurately reflect the commercial arrangement for the New Zealand market, or is it merely a standard document used in many markets?
3. Does the intangible property add significant and substantial value to the New Zealand business operations taking into account existing valuable goodwill, monopoly position, local know how or other domestic intangibles?
4. If a royalty is paid for the use of the intangible property, has a standard global/regional rate been used or has the rate been customised to the circumstances of the New Zealand business?
5. Some activities of the licensee may not require use of the intangible property - have these been excluded from royalty computations?
6. Has the 25% rule been used as a cross-check? (Note: 25% of earnings before interest, tax and royalties is generally considered towards the top end of sums payable to a licensor absent unusual circumstances.)
7. If royalties are high relative to earnings derived from the intangible property, has consideration been given to renegotiating the terms of the license? If not, why not?
8. For annual royalty payments of $1 million or more, is transfer pricing documentation available to support the royalties charged?
9. Has non-resident withholding tax been deducted and at the correct rate?
10. Has any additional assistance been provided from offshore in connection with the supply of scientific, technical or commercial knowledge or information? (Such assistance may also be subject to non-resident withholding tax).

Remember, it is the responsibility of local management to ensure a company's transfer prices are in accordance with the arm's-length principle. Where substantial royalties are incurred to offshore associates, we suggest you seriously consider the possibility of working cooperatively with us and obtaining an advance pricing agreement.

"The 25% rule"

Licensing practitioners regularly consider the 25% rule at least as an indication of the order of magnitude of where their negotiations should focus. A variety of courts, including the US Courts of Claims, have endorsed the use of the 25% rule in litigation contexts. Professional advice received by Inland Revenue is to the effect that the 25% rule is common practice in New Zealand.

Residual profit split

Tax authorities often use a residual profit split methodology for computing appropriate royalty levels. Essentially this methodology is applied to the licensee (as the tested party) and attributes to that party a routine profit for the type of operation which it undertakes plus some appropriate share of the residual profit. The remaining profit is then treated as the royalty to be paid to the licensor. The starting point to splitting a residual profit is a 50/50 approach and there needs to be robust support for any departure from that outcome.

Date published: 02 Dec 2010

Back to top