Global Tax Alert | 21 January 2014

Spanish Central Tax Court re-characterizes price under procurement contracts as a deemed royalty and denies use of "secret comparables"

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Executive summary

The Spanish Central Tax Court issued a resolution dated 3 October 2013 where it re-characterizes part of the consideration agreed upon between unrelated parties for procurement services as a deemed royalty payment, subject to withholding tax, and disallows the use of the so-called “secret comparables” as a valid valuation method, under applicable transfer pricing rules.

Detailed discussion


The factual background of the Tax Court's decision is summarized as follows:

  • The Spanish taxpayer (SpainCo) entered into separate contracts with two nonresident unrelated entities, the main features of which were as follows:
  • Under the first contract, SpainCo undertook to prepare the beverages using ingredients which could only be acquired from the nonresident unrelated entities, and to package and distribute them in the Spanish market.
  • Under the second contract, SpainCo was granted the right to use brands, labels, designs, packages and other intangible assets of the foreign unrelated entity, in the context of the above-referred distribution and sales process, for no consideration.
  • The Spanish tax authorities understood that there was only one complex and mixed-purpose contract with each of the nonresident entities, which included the right to use the intangible assets (trademark). Thus, the part of the price paid by SpainCo to each of the nonresident entities under the first contract (procurement) that remunerated the right to use the trademark should be characterized as a royalty payment, subject to Spanish withholding tax.
  • To quantify the deemed royalty payments the Spanish tax authorities used a set of comparables, without disclosing data from the companies used to the taxpayer.

Recharacterization of the consideration paid under the procurement and distribution contracts as royalty income

Under Spanish Nonresidents' Income Tax Law the supply of services which generate Spanish-sourced income are deemed to be remunerated and Spanish General Tax Law provides that tax obligations must be based on the true legal nature of the fact, act or business carried out, regardless of the form or name given by the parties to the same.

Based on the above rules, the Tax Court understands that a detailed analysis of the contracts should be performed to determine if the use of the brand by SpainCo should be remunerated, regardless of the fact that the contracts explicitly establish that the Spanish entity should only compensate the nonresident entities for the acquisition of the ingredients and not for the use of the brand itself. The Court concludes that these payments should be partially re-characterized as royalty income based on the following arguments:

  • SpainCo was authorized to produce and commercialize the beverages in the Spanish market and also to prepare, package, distribute and sell the same under the brand owned by the nonresident entities; and
  • Although the ingredients had an economic value themselves, the sale of the beverages under a certain well-named brand had a very significant added-value for SpainCo which increased the turnover of the Spanish entity.

In addition to the above, the Tax Court makes reference to the 2010 OECD Transfer Pricing Guidelines under which the compensation for the use of intangible property may be included in the price charged for the sale of goods and also to the OECD Commentaries to article 12 (royalties) of the OECD Model Convention.

Valuation methodology used by the Spanish tax authorities

To determine the part of the consideration which should be re-characterized as royalty income, the Spanish tax authorities requested information from other Spanish entities in the beverage distribution industry. Based on the data provided, the tax authorities determined the percentage of the price that should be considered as royalty income and subject to Spanish withholding tax. No data on the companies used as comparables was disclosed to the taxpayer on the basis that such data should be kept confidential.

The Spanish Tax Court understands that this lack of disclosure leads to a situation where the taxpayer is unable to properly defend its position.


The criteria followed by the Tax Court regarding the re-characterization of the contracts should be taken into consideration especially by multinational groups selling products in Spain where a substantial part of such sales may be connected with the trademark (as evidenced, for instance, in the cost of publicity of the trademark in Spain), whether or not there may be an intra-group agreement for the use of the trademark (or, conceivably, other intangible assets) in place. The transfer pricing documentation and the tax residence of the owner, among other parameters, will determine the potential cash-out tax exposure of the taxpayer. A case-by-case analysis should be made to all similar structures already in place, as well as to any further related planning, considering, in any event, the fact that this resolution has been issued by a tax court, not a court of justice (but there is at least one court case ruling, in a comparable situation, in the same direction).

The criterion set by the Tax Court confirms that the use of “secret comparables” may jeopardize the defense rights of the taxpayer. This criterion has already been utilized by this same court in the resolution issued on 5 September 2013 (R.G. 3780/11), although both cases do not have identical factual backgrounds.

For additional information with respect to this Alert, please contact the following:

Ernst & Young Abogados, Madrid
  • Laura Ezquerra
    +34 91 572 7570
  • José Luis Gonzalo
    +34 91 572 7334
  • Maximino Linares
    +34 91 572 7123
Ernst & Young LLP, Spanish Tax Desk, New York
  • Cristina de la Haba
    +1 212 773 8692

EYG no. CM4120