It has almost been a year since we informed you about another ruling dealing with the interpretation of the “beneficial owner” term in the case of royalty fees. It was a judgment of the Municipal Court in Prague in the case of Avon Cosmetics Limited (“Avon UK”). Now, in its ruling ref. no. 4 Afs 63/2022 dated 21 February 2024, the Supreme Administrative Court (“SAC”) confirmed the conclusions of both the Municipal Court and the tax administrator.
Avon UK sought exemption from withholding tax on income derived from royalty fees pursuant to Section 38nb of the Income Tax Act. However, the tax administrator denied the request as, in their opinion, not all legal conditions for such exemption were met. Specifically, Avon UK (as the beneficiary) did not prove to be the beneficial owner of royalty payments for which the exemption was requested. This stance was also upheld by the Municipal Court, as detailed in our previous article.
In terms of arguments, both the Municipal Court and the tax administrator based their conclusions on the following findings: Within the group, Avon UK became the exclusive holder of licence rights to the intellectual property and was authorised to grant sublicences to other companies within the group; however, property rights remained in the ownership of American companies and Avon UK was contractually obliged to pay fees for the licenced rights to those companies. In fact, Avon UK collected royalty fees from the individual companies within the group in the amount of 6% of their net sales and, subsequently, paid royalty fees of 5.68% of net sales to the American companies for the same licenced rights. According to the tax administrator’s opinion, based on the contract concluded with the American companies, Avon UK has contractually agreed to transfer the majority of accepted royalty fees to another entity (approx. 95% of royalty fees collected from other entities in the group) and therefore cannot be deemed the beneficial owner of the royalty fees.
The case proceeded to the SAC, which decided in line with the Municipal Court’s conclusions. According to SAC’s opinion, there existed an implicit contractual obligation on the part of Avon UK to transfer the majority of its income from royalty fees to another entity, as inferred from the circumstances of the contractual relations and the interconnectedness of both types of payments (licence and sub-licence).
Thus, in its ruling ref. no. 4 Afs 63/2022, the SAC confirmed the conclusion of the Municipal Court stating that Avon UK does not meet the definition of the beneficial owner of the royalty fees collected from the individual companies within the group. From an economic point of view, Avon UK does not derive real benefit from the accepted royalty fees. The company cannot decide freely on the use of these financial resources and cannot utilize or consume them without constrains. This is because, based on the licence contract, it is obliged to transfer the majority of the collected royalty fees to the US companies.
The ruling confirms the consistent practice and approach of the Czech administrative courts and the tax administrator to these issues. Unfortunately, in the given case, certain objections and arguments remained unresolved, as the SAC considered them not being presented during the proceedings and legal action (but only in the cassation complaint). It remains uncertain whether these would have had an impact on the assessment of the given case.
As this case and other foreign judgments (to which the judgment refers; unfortunately, not always in detail) show, the theoretical concept of beneficial ownership is quite difficult to handle in a globalised economy. While we cannot foresee the future development of interpretation and case law in this area, we recommend when entering into agreements, both the transaction itself and the broader context should be assessed.
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