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Adecco Intercompany Royalty Litigation: CUP v. TNMM

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Swiss multinational employment service provider Adecco recently prevailed in a case brought by the Danish tax authority (Skattestyrelsen or SKAT) challenging the 2% sales royalty paid by Adecco affiliate in Denmark for the use of various intangible assets, including trademarks and know-how.

The arguments put forth by the taxpayer and SKAT represented the classic tension between market versus profits-based approaches to evaluating arm’s length royalties. The 3-2 split decision and SKAT’s less-than-comprehensive analysis in its argument also may have left room for the possibility that a more robust analysis could have led to a different result.

SKAT’s Case for TNMM

In defending its intercompany royalty rate, Adecco presented evidence from Adecco licenses to third party franchisees, which represented an internal application of the Comparable Uncontrolled Price (CUP) approach, as well as an external CUP evidence. Tax authorities in Norway and Sweden accepted the taxpayer’s defense of its intercompany royalty rate, but the Danish tax authority  asserted that the losses during the 2006 to 2009 period implied that no royalties should be paid under the arm’s length standard.

SKAT rejected the external application of CUP, arguing that because it was based agreements in the U.S. employment services market, there were comparability differences where the profit potential for these third-party U.S. agreements were higher than for the controlled transaction. SKAT also asserted that there were significant comparability differences between the controlled transaction and the third-party franchise agreements including the fact that the Danish licensee incurred significant marketing expenses.

SKAT’s primary argument is that a third party would not agree to persistent losses by paying royalties in addition to bearing the marketing expenses. SKAT argued that the Swiss parent should have either compensated the Danish affiliate for these marketing expenses or agreed to a lower royalty rate. SKAT compared the operating losses as a percent of sales for the Danish affiliate to the operating margins for certain third-party entities, which is an application of the Transactional Net Margin Method (TNMM).

The Case for CUP

The taxpayer countered this ex post profitability analysis by noting the “Strawberry Strategy.” The Danish affiliate in 2005 was considered the leading employment staffing company in Denmark and this strategy was initiated to expand its operations to more cities and to more sectors. The strategy was expensive and did not generate the results that Adecco originally expected. As such, projected profits were not realized and in fact the Danish affiliate incurred losses.

The court decision provides more details with respect to the positions of the taxpayer and the tax authority and the court’s reasoning in its decision, but most notable in this context was that the court found the taxpayer’s application of CUP more convincing than SKAT’s profits-based analysis. Its notes that the CUP method is considered the most reliable method; that SKAT had neither performed its own arm’s length analysis nor proposed what the royalty rate should have been; and that SKAT had not provided relevant differences between the Danish market and the markets of the comparables.

While SKAT may have interesting observations with respect to comparability differences between the controlled transaction and the third-party franchisee agreements, TNMM alone was not a convincing position. A more compelling profits-based analysis would have evaluated the expected benefits and costs for this Strawberry Strategy.


Oct 2019, High Court, Case No SKM2019.537.OLR

Published on Jul 29, 2020 10:18:45 AM

Harold McClure has over 25 years of transfer pricing and valuation experience. Dr. McClure began his transfer pricing career at the IRS and went on to work at several Big 4 accounting firms before becoming the lead economist in Thomson Reuters’ transfer pricing practice. Dr. McClure received his Ph.D. in economics from Vanderbilt University in 1983.
He can be contacted at: hmcclure@edgarstat.com