Facts

The US multinational ran a number of operating companies in Europe including Germany. In distribution, the operating companies worked as buy-sell entities. In production, they purchased input materials and managed inventory and logistics. The operating companies used necessary intellectual property rights (patents, know-how, brands, etc.) under a non-exclusive license agreement extended by a US affiliate.

Already before the establishment of the principal structure, a French operating company exercised important management functions also in relation to the German operative companies, such as strategy definition, investment and product portfolio management, medium- and long-term production and capacity planning, central negotiation of procurement contracts and key account management. These management activities were rendered on the basis of service agreements.

As from 2011, a Swiss principal company took over the management functions from the French affiliate and engaged European operating companies as contract or toll manufacturers and as limited risk distributors. Manufacturers were remunerated on the basis of cost plus, distributors of TNMM.

Two payments were made on entry into the principal structure:

• A transfer package payment for the assumed transfer of functions, compensating for reduced profit expectations, and
• a compensation for early termination of the IP license agreement.

The technical approach taken by the court is virtually identical with the approach in its previous, first exit tax decision dated 16 March 2023. The tax court analyzed:

• First, whether a constructive dividend had been realized by the transfer of a business opportunity.
• Second, whether a taxable transfer of functions had been performed.

The court did not see the transfer of a business opportunity. In its judgment, the tax office could not show a concrete business opportunity that had been transferred. The court explicitly stated that the (limited) reduction of the function and risk profile of the German companies and the ensuing reduction of profit expectations did not represent a concrete business opportunity. The premature termination of the IP license agreement was not deemed a constructive dividend, since it had been fairly compensated.

The court further denied a transfer of functions since no tangible or intangible assets and no business opportunities or other benefits had been transferred by the German operating companies to the Swiss principal. In this context, the court noted that no inventory and no tangible assets had been transferred. The court also found that the consent by the German operating companies to the premature termination of the IP license agreements did not represent the transfer of an intangible asset. Further, no customer base was transferred.

Some conclusions and recommendations

• The decision refers to the statute as before 2022. As from 2022, the conditions for a taxable transfer of functions have been loosened, and a taxable transfer can occur even when no asset is transferred. Nevertheless, one may assume that also under current law, no transfer of functions would have to be taxed.
• The tax court uses the same, restrictive concept of business opportunity and other benefits for purposes of a constructive dividend and of the transfer of functions analysis as it had in its previous exit tax decision dd. 3/16/2023, in which we represented the taxpayer.
• As encouraging the decision is from the perspective of taxpayers, one should note that the key managerial functions were not moved out of Germany, but rather from France to Switzerland, and this played a part in the court's exit tax analysis.
• The court has confirmed that the consent to premature termination of the license agreement by the licensees did not represent the transfer of an intangible asset. This is an unsurprising, but helpful clarification.
• The payment of a transfer package apparently did not make a difference. Neither did it improve the tax audit defense position, nor did it impact the court decision: Notwithstanding the initial payment, the German tax administration raised an exit tax adjustment. In court, the payment of the transfer package did not play a decisive role for the denial of a transfer of functions. Now, one may speculate whether the taxpayer should pursue a refund of the tax paid on the initial transfer package.

German version