Swedish Tax Agency wins case regarding TP and intangible assets

On 10 April 2024, the Swedish Administrative Court of Appeal in Stockholm (the Court) decided a case concerning the Swedish adjustment principle in Chapter 14, Section 19 of the Swedish Income Tax Act, overturning a ruling of the Stockholm Administrative Court. The case before the Court concerned whether the review should be limited to the actual contractual terms or whether other circumstances between related parties should also be taken into account.

The case concerned Meda AB, the Swedish parent company of an international pharmaceutical group, and its subsidiary in Luxembourg (LuxCo).

LuxCo has made four acquisitions of intellectual property rights in the pharmaceutical industry from third parties. Following the acquisition, LuxCo entered into licensing and distribution agreements with Meda AB. LuxCo received a residual profit from the ownership of the acquired intangible assets, while Meda AB, together with other group companies, received fixed routine fees for services provided in connection with the intangible assets.

The Swedish Tax Agency (STA) argued that the contractual provisions contained in the intra-group agreements did not reflect the actual transactions between LuxCo and Meda AB (the Parties) because they failed to take into account the actual decision-making process and risk allocation between the Parties in the four acquisitions of intangible assets.

STA also questioned whether the terms of the agreement accurately reflected the actual transactions between the parties because they failed to take into account the actual allocation of risk during the four acquisitions.

In addition, STA argued that LuxCo should not receive any part of the residual profit as the legal owner of the intangible assets, but should instead be compensated for the provision of intra-group administrative services with an appropriate net cost plus and risk-free return on the investments it made. As a result, STA attributed 60% of the residual profit to LuxCo Meda AB and 40% to other group companies due to their strategic influence on acquisitions.

Meda AB argued that the assessment under the adjustment rule can only be based on the actual meaning of the contractual terms. According to Meda AB, taking into account anything other than the actual terms that applied between the Parties would be contrary to the wording of the adjustment rule. Meda AB considered that the calculation made by the STA was not based on any objective basis and argued that the calculation was completely arbitrary and based on generalisations.

The Court emphasised the importance of considering all relevant circumstances when reviewing related party transactions under the corrective principle. The Court followed the STA’s line of reasoning that LuxCo acted as the formal contractual party in the acquisitions of intangible assets, while Meda AB controlled the most material risk – namely the acquisition risk in all four acquisitions through the performance of functions performed by Meda AB – and made the actual decisions regarding the acquisitions.

The Court found that the terms agreed between the Parties were not based on fair market value and that an independent party would not have agreed to such a division of results. Therefore, there was a basis for adjusting Meda AB’s results in accordance with the adjustment principle.

The Court accepted STA’s calculation of the compensation to be allocated to LuxCo and the profit allocation method used to allocate the residual profit to Meda AB. The Court was of the opinion that the compensation to LuxCo was based on a reasonable market price. As regards the profit allocation method, the Court found that transactions between related parties may involve unique contractual relationships and business arrangements that have no equivalent in the market. The Court found that it was unreasonable to expect STA to provide evidence of market conditions and prices in such a situation.

Meda AB appealed against this decision, but the Supreme Administrative Court refused to grant permission for the appeal.

Meda AB is one of several Swedish groups affected by the STA’s post-BEPS rationale that the entity exercising “risk control” should receive economic returns from the intangible assets (IP) rather than from the legal owner. The common denominator is that the STA bases its assessment primarily on Chapter 1 of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations and the concepts of risk control and risk-free return rather than a civil law assessment.

The decision of the Supreme Administrative Court to refuse leave to appeal means that there is still no ruling of the Supreme Administrative Court. Consequently, there is no clear legal precedent for the STA’s approach to the influence of control over risk in assessing contractual terms between related parties; in particular, how the concept of control over risk is applied more as a profit allocation mechanism in itself.

STA’s latest trends regarding the economic ownership of legacy IP are something that companies designing new operating models should keep in mind, especially in terms of reporting lines and decision-making processes.