Several different situations can arise in the taxation of licence fees or franchise fees.
35% Taxation
Licence fees are taxed at 35% where a company pays a licence fee to a foreign company based in a country that has not concluded a double taxation treaty (e.g. Hong Kong or an offshore jurisdiction). In that case the licence fee is a tax-deductible expense, but the company must pay withholding tax of up to 35% on it – far more than the standard income tax rate.
10% Taxation
Licence fees are taxed at 10% where a company pays a licence fee to a foreign company based in a country that has concluded a double taxation treaty (e.g. EU member states or the USA). In that case the licence fee is a tax-deductible expense, but the company must usually pay withholding tax of 10% on it – less than the standard income tax rate.
10% Taxation
Licence fees are taxed at 0% where a company pays a licence fee to a foreign company that holds at least a 10% stake in it (i.e. the two are linked as parent and subsidiary) and is based in an EU member state. In that case the licence fee is a tax-deductible expense and the company does not have to pay withholding tax on it. Where companies from different countries are linked by ownership, however, the issue of transfer pricing arises, meaning that the amount of deductible expenses is capped. For related companies there is a well-known rule for setting licence fees – the classic 25% Rule in valuing IP. Under this rule, the licence fee should amount to 25% of the company’s gross profit. It is, however, only a rule of thumb: several US court rulings have already rejected it, and numerous articles dispute it, since every trademark or patent is different and specific, and its value cannot be generalised. If related companies do not wish to follow this rule, they should set the licence fee at the market price that would apply between unrelated parties. This would require valuing the trademark, which can be done in various ways – for example, on the basis of future income, costs incurred or comparison with other trademarks.
Licence fees are also taxed at 0% where a company pays a licence fee to another domestic company. In that case the licence fee is a tax-deductible expense and the company does not have to pay withholding tax on it.
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