The Municipal Court in Prague has recently issued a judgement (ref. no. 6 Af 36/2020-42 of 3 February 2022) which dealt with the interpretation of the term “beneficial owner” for the purposes of the Income Taxes Act (“ITA”) in relation to the payment of royalty fees. (Not only) companies paying royalty fees abroad under (sub)licensing agreements should take note.
The full text of judgment ref. no. 6 Af 36/2020-42 is available on the website of the Supreme Administrative Court.
The British company Avon Cosmetics Limited (the “plaintiff”) became the sole licensor of intellectual property rights within the Group and was authorised to issue sub-licences to other companies in the Group. It charged a fee for issuing a sub-licence equal to an agreed-upon percentage of net sales. However, the ownership of the property rights (including the right to conduct audits) remained with the US companies that assigned the licencing rights to the plaintiff. The plaintiff was then contractually obliged to pay fees to the assignors, which were also calculated as a percentage of net sales.
Arguments of the tax administrator and the court
The plaintiff proceeded according to Section 38nb of the ITA and applied for exemption from royalty income. However, the tax administrator denied the application. The tax administrator concluded from the contractual documentation submitted (sub-licensing agreement) that the plaintiff is not the beneficial owner of the royalty income but only an administrator or intermediary. Therefore, not all the legal conditions for granting the exemption were met. In particular, the tax administrator argued that the plaintiff did not obtain any real benefit from the royalty fees. Furthermore, the plaintiff is not authorised to freely decide on the income as it is obliged to divert it almost in full to the US companies. Under such circumstances, the amount that makes up the difference between the payments received and made, which belongs to the plaintiff, cannot be seen as royalty income but rather as a compensation for managing the payments collected for the US companies.
The Municipal Court in Prague upheld the tax administrator’s interpretation and summarised that under Czech law, an entity that merely receives royalty payments for another entity as an intermediary is not the beneficial owner. A beneficial owner can generally be understood as the entity that (i) increases its property by the income, i.e., enriches itself, and that (ii) uses such income without limitations, i.e., is not obliged to cede it to another entity.
We will see how the Supreme Administrative Court (“SAC”) will comment on the situation, as in recent years, the SAC has also dealt with a number of cases that were revolved around the definition of “beneficial owner” (see our previous articles When does the burden of proof pass to the tax administrator? or The Supreme Administrative Court’s View of Beneficial Ownership in Sublicense).
In view of the existing case law, it is therefore always appropriate to check whether the entity to which a Czech entity pays royalty fees is also the beneficial owner. As the practice and the judgement itself indicate, the tax administrator focuses on this issue and carefully examines whether the (sub)licensing agreements (or other supporting documents) suggest that the actual beneficial owner of the royalty income is, in fact, someone other than the (sub)licensor.