In the regular framework of the operations of the main multinational companies, one of the most important aspects is the development and exploitation of trademarks, which for tax purposes are considered intangible assets.
Indeed, in many multinational companies, a brand is the product itself and, therefore, practically represents the image that the company conveys to the market. A brand can even represent one of the most valuable assets within a company; think Coca-Cola, Corona, Facebook, Subway, Colgate, among others.
In recent years, it has become a recurring practice for several companies to enter into trademark licensing agreements between their related parties, which is logical for companies that own certain trademarks to be able to operate efficiently in other countries. For purposes of the foregoing, in accordance with Article 179 of the Income Tax Law, related parties should be understood as the case in which one of the companies participates directly or indirectly in the management, control or capital of the other, or when a person or group of persons participates directly or indirectly in the management, control or capital of such companies.
Through trademark licensing, many companies can effectively operate and exploit their trademarks through a related company that is resident in another jurisdiction, which administratively represents greater effectiveness and lower cost in their regular operations.
Up to this point, it is very reasonable to consider trademark licensing as a normal and even positive activity for companies; the problem arises when the structure and requirements given to trademark license agreements do not comply with applicable tax provisions. In this regard, we have observed that, in practice, at the time of entering into a trademark license agreement, companies enter into it free of charge and only comply with the obligation (in force until November 2020) that such agreement be registered before the Mexican Institute of Industrial Property, in order to comply with the requirements established in the Federal Law for the Protection of Industrial Property.
As it is a trademark to be exploited by a “sister” company, the multinationals consider that it is not necessary to establish an amount corresponding to the payment of royalties for the exploitation of the trademarks. However, the fact that the license of use is entered into between related parties does not imply that the transaction can be agreed for free.
In the case of transactions between related parties, it should be remembered that there are transfer pricing provisions, within which the Arm’s Lenght principle prevails, established by the Organization for Economic Cooperation and Development (OECD). This principle basically refers to the fact that, in transactions between related parties, they are obliged to operate as they would between independent companies, under conditions and at values established by the market.
Thus, in transfer pricing matters, it will be logical to state that a trademark license agreement between related parties simply cannot be entered into for free.
To make the above more evident and what the Arm’s Length principle refers to, let us imagine that Coca-Cola allows a Mexican company that has no relationship with the Coca-Cola companies to use and exploit the “Coca-Cola” trademark, so that said company sells its own cola soft drink. It is absurd that, being Coca-Cola a brand worth approximately $35.4 billion dollars, said company allows the Mexican company to use its brand free of charge, when the Mexican company will obtain an obvious benefit from the exploitation of said brand. It is illogical to think of this option, so the same should apply to transactions between related parties.
Under such considerations, the related parties will not only have to enter into their trademark license agreements agreeing on a consideration for such use, but such consideration will have to be adjusted to market values, considering a real valuation of the trademark, at the time the rights of use and exploitation of the trademark are being granted. The type of consideration that is given for the use and exploitation of a trademark is usually under the concept of royalties.
If the consideration is not agreed at market value, in the event of a review by the tax authorities, the tax authorities may carry out the following actions:
i) A readjustment of the margins of the consideration that should correspond for the transaction, established at market value. Even if any payment had been made that differs from market values, the tax authority could consider that the tax paid as a consequence of the agreed consideration was not effectively paid and that, in addition, the payments made for royalties would not be considered deductible.
ii) Likewise, tax credits could be determined for the omissions derived from the payment of income tax and value added tax for the payment of royalties, in addition to fines, updates and surcharges derived from the lack of timely payment.
This analysis will not detail how the value should be determined or the transfer pricing methods that could be used, but is only intended to convey the relevance of trademark license agreements between related parties being entered into at market value. In view of the foregoing, the following is an analysis of the income tax and value added tax implications attributable to the payment and income from royalties for the grant of a license to use trademarks.
A) Income tax treatment of licenses for the use of trademarks
In income tax matters, it will be necessary first to distinguish the tax residence of the related party owning the trademark and, on the other hand, the country of residence of the company that will use and exploit, under the license granted to it, a trademark.
Under the assumption that the owner of the trademark is a resident of Mexico and the person who will use the trademark is a resident abroad, the income tax treatment will be relatively simple, i.e., for the resident in Mexico, the payment received for royalties will be considered as income that must be accrued to the rest of the income received in the current fiscal year.
On the other hand, if the owner of the trademarks is a resident abroad and the royalty payment is received by a Mexican resident or for the use of the trademarks in Mexico, Title V “On Residents Abroad with Income from a Source of Wealth Located in Mexican Territory” will be applicable for tax payment purposes.
According to the text of Article 167 of the aforementioned Law, the payment of royalties will be taxable for the foreign resident when the goods for which the royalties are being paid are used in Mexico or when such royalties are paid by a Mexican resident. Therefore, by provision of the Income Tax Law, even if the royalty payment is made by a resident abroad to another resident abroad, as long as the trademarks are used in Mexico, the royalty payments arising from the use of the trademarks in Mexico will be considered as taxable income for the owner of the trademarks.
The concept of leverage in Mexico, more than something theoretical, is a logical concept, based on the premise that a brand will be leveraged in a certain place, through its promotion or diffusion in that place, with the intention of encouraging sales in that same market.
In the event of any of the foregoing assumptions, royalty payments arising from their use in Mexican territory, or from a resident in Mexico, will be subject to a tax rate of thirty-five percent (35%). Such tax will be paid by means of withholding, in the event that the payment is made by a resident in Mexico or, in the case of a payment made by a resident abroad, by taking advantage of the trademarks in Mexico, the payment will be made by means of a tax return filed by the resident abroad, within fifteen (15) days following the day in which the payment is made.
It is important to mention that in tax matters, Mexico has entered into various agreements to avoid double taxation and combat tax evasion, which could be applied in the event that the owner is a resident abroad or in Mexican territory. What is relevant for purposes of the application of the treaty will be the country (other than Mexico) involved in the transaction and whether there is a treaty in force with that country.
If there is an agreement in force, it would be possible for the owner of the trademarks that will receive the royalty payment to suffer a lower withholding than the one established in the Income Tax Law. By way of example, Mexico currently has in force the “Agreement between the Government of the United Mexican States and the Government of the United Kingdom of Great Britain and Northern Ireland to Avoid Double Taxation and to Prevent Fiscal Evasion in Income Tax and Capital Gains Tax Matters”. Article 12 of the Convention states that, in the case of royalty payments, such payments may be subject to taxation both in the country in which the royalty payment is made (or in which the goods are used) and in the country in which the trademark owner is resident.
However, the article is clear in establishing that, if the payment of royalties is taxed in the country where the trademarks are used or of which the person making the payment is a resident, the tax may not exceed ten percent (10%) of the amount agreed as consideration.
In the specific case, if a foreign resident receives royalty payments with source of wealth in Mexico, the thirty-five percent (35%) withholding rate established in Article 167 of the Income Tax Law will be reduced to a maximum rate of ten percent (10%), while in the country of which the foreigner is a resident, the income may be taxed according to the rate or tariff applicable in its local legislation.
Therefore, it will be vital to identify the tax residence of the parties involved in the trademark license transaction, in order to validate whether or not it is possible to apply a treaty to avoid double taxation and, therefore, reduce the withholding tax rate applicable in Mexico.
B) Treatment of licenses for the use of trademarks for value added tax purposes
In terms of value added tax, both the import and export of intangible goods are taxable activities. The applicable rate and the treatment of royalty payments will depend on the place of residence of the parties to the trademark license agreement. However, the tax base will be based on the value of the royalties to be paid, hence the importance that for purposes of such tax, it is also considered a consideration at market value.
In this regard, Article 24 of the Value Added Tax Law establishes that goods are considered to be imported when the temporary use or enjoyment in Mexican territory of intangible goods provided by residents abroad is granted.
In such case, the applicable rate shall be the general rate of sixteen percent (16%). However, in this case, the phenomenon of virtual VAT occurs, which allows the tax that should have been paid in connection with the transaction to be credited practically automatically.
On the contrary, in the event that the owner of the trademarks is a resident for tax purposes in Mexico and the license of use is granted to a resident abroad, it will be considered as an export of intangible goods, and therefore such transaction will be taxed at a zero percent (0%) rate, in accordance with article 29, section III of the Value Added Tax Law. In this respect, the resident in Mexico must transfer the value added tax to the resident abroad and, upon receipt of the royalty payment, must pay the tax to the tax authority.
In conclusion, the first and most important step that must be complied with by companies that are members of the same group, is that at the time of entering into a trademark license agreement with any of their related parties, they agree to pay royalties at market value, in order to comply with transfer pricing provisions.
Once this has been done, an analysis of the parties involved must be made, as well as the place of use of the right to use the trademarks, with the intention of verifying in a concrete manner the implications of such operation.
The tax practice of Acedo Santamarina, S.C. actively participates in advising companies on the appropriate structure of this type of operations. If you have any questions, please contact us at the following e-mail address:
Luis Shahid Kanchi Gómez lkanchi@acsan.mx
