On April 10 2024, the Swedish Administrative Court of Appeal in Stockholm (the Court) decided in a case regarding the Swedish correction rule in Chapter 14, Section 19 of the Swedish Income Tax Act by overturning the ruling of the Stockholm Administrative Court. The matter before the Court was whether a review should be limited to the actual contractual terms, or if other circumstances between related parties should also be considered.
The case involved Meda AB, a Swedish parent company in an international pharmaceutical group, and its subsidiary in Luxembourg (LuxCo).
Background to the case
LuxCo had made four acquisitions of pharmaceutical intellectual property rights from external parties. Post acquisition, LuxCo entered into licensing and distribution agreements with Meda AB. LuxCo had received the residual profit from the ownership of the acquired intangibles, while Meda AB, along with other group companies, had received a stipulated routine compensation for the services performed related to the intangibles.
The Swedish Tax Agency (STA) argued that the contractual terms in the intragroup agreements did not reflect the actual transactions between LuxCo and Meda AB (the Parties) because they did not consider the actual decision making and the risk allocation between the Parties in the four acquisitions of the intangibles.
The STA also questioned whether the contractual terms accurately reflected the actual transactions between the Parties, as they did not consider the actual allocation of risk during the four acquisitions.
Furthermore, the STA argued that LuxCo should not receive any part of the residual profit as the legal owner of the intangibles but should, instead, be compensated for providing intragroup administrative services with a corresponding net cost-plus and a risk-free return on the investments they had made. As a result, the STA attributed 60% of LuxCo’s residual profit to Meda AB and 40% to other group companies due to their strategic influence in the acquisitions.
Meda AB argued that an assessment under the correction rule can only be based on the actual meaning of the contractual terms. According to Meda AB, considering anything other than the actual terms that have applied between the Parties would be contrary to the wording of the correction rule. Meda AB believed that the calculation made by the STA was not based on any objective basis and argued that the calculation was entirely arbitrary and based on generalisations.
The Court’s decision
The Court emphasised the importance of considering all the relevant circumstances when reviewing transactions between related parties under the correction rule. The Court followed the STA’s line of argument that LuxCo acted as a formal contractual party in the acquisitions of the intangibles while Meda AB controlled the most significant risk – namely, acquisition risk in all four acquisitions through the execution of functions performed by Meda AB – and made the actual decisions of the acquisitions.
The Court found that the agreed terms between the Parties were not based on fair market value, and that an independent party would not have agreed to such an allocation of results. Therefore, there was a basis for adjusting Meda AB’s results under the correction rule.
The Court accepted the STA's calculation of the compensation that should be allocated to LuxCo and the profit split method used in allocation of the residual profit to Meda AB. The Court opined that the compensation for LuxCo had been based on a reasonable market price. Regarding the profit split method, the Court stated that in transactions between related parties, there may be unique contractual relationships and business arrangements that do not have any counterparts in the market. The Court concluded that it is not reasonable to expect the STA to provide evidence of market-based conditions and pricing for such a situation.
Meda AB appealed the decision, but the Supreme Administrative Court denied leave to appeal.
KPMG's comment
Meda AB is one of several Swedish groups affected by the STA's post-BEPS rationale that the entity exercising ‘control over risk’ should receive economic returns from legacy intangible property (IP), rather than the legal owner. The common thread is that the STA mainly bases its assessment on Chapter 1 of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations and the concepts of control over risk and risk-free return instead of a civil law assessment.
The Supreme Administrative Court’s decision not to grant leave of appeal means that there is still no ruling from the Supreme Administrative Court. Consequently, there is no clear legal precedent on the STA's approach to the impact of control over risk in assessing the contractual terms between related parties; specifically, as to how the concept of control over risk is applied more as a profit allocation mechanism in itself.
The recent trend from the STA regarding economic ownership of legacy IP is something that companies should be aware of when designing their new operating models, particularly in terms of reporting lines and decision-making processes.
