DEMPE -A New Taxation Concept for Income related to IP Rights
DEMPE is an acronym for a new taxation concept for income from IP rights which has been developed by the OECD in 2017 as part of the anti-BEPS action items. DEMPE stands for Development, Enhancement, Maintenance, Protection, Exploitation.
DEMPE describes the various stages between the development and the exploitation of intangibles. The so-called DEMPE concept provides new criteria for allocating profits from IP rights among group companies resident in different countries. Thus, DEMPE requests corresponding adaptations of currently existing cross-border IP holding structures and IP licensing structures for making the best use of this new trend. DEMPE offers (i) new opportunities to avoid withholding taxes, license barrier rules and the documentation requirements regarding the so-called nexus approach as well as (ii) additional depreciations in India at least in case of inbound licensing structures. Finally, DEMPE is in line with current OECD standards and ‑ subject to the details of its transformation into Indian and foreign domestic law ‑ a comparably reliable basis for IP driven intra-group business transactions across the border.
Does this sound to be too good to be true? If you think so, the following comments might attract your attention.
The DEMPE concept provides for criteria by which the overall IP related profits can be allocated according to the respective economic contribution of each group company involved in an intra-group IP related business transaction across the border. Thus, it should interfere neither with the concept of beneficial ownership nor with the concept of legal ownership of IP rights.
Against this background, existing IP licensing structures currently in place which face challenges because of withholding taxes, license barrier rules, non-deductibility of license payments tax wise, differing tax treatments in India and abroad, etc. could be improved by adapting to the new DEMPE concept. In detail:
With respect to a foreign IP licensor which licenses its IP rights to an affiliated Indian licensee (‘inbound structure’) a DEMPE compliant structure could be a foreign IP holding company, which transfers its IP rights to its Indian group company against an at-arm’s-length remuneration to be paid by the Indian group company. The Indian group company instructs the former IP holding company (new servicer) with as much DEMPE functions as possible, which the Indian group company pays an adequate service fee for. This service fee needs to be calculated pursuant to the at-arm’s-length principle and needs to reflect the DEMPE criteria undertaken by the servicer and the new Indian IP holding entity. This means that the service fee is the higher, the less DEMPE functions are rendered by the new German IP holding entity. In India, the service fee to be paid by the new Indian IP holding entity to the foreign servicer is not subject to any withholding tax or limitations on the tax deductibility of the fees. Even better from the perspective of the Indian entity, probably such inbound transfer of functions from the former foreign IP holding company to the Indian group company might even be qualified as a transfer of functions from abroad to India ‑ would result in additional depreciations in India for the new Indian IP holding entity.
With respect to a Indian IP holding company which licenses its IP rights to an affiliated foreign licensee (‘outbound structure’), the DEMPE concept offers attractive possibilities, too. The Indian transferor realises a taxable sales gain from the transfer of its IP rights against an adequate remuneration. Immediate taxation of the benefits of selling IP rights might be avoidable, if certain requirements are met; instead, taxation might be spread over a longer period of time. Depending on the scope of the DEMPE-like services rendered by the Indian company as the new servicer, the Indian company generates additional service fees taxable in India which, however, are not subject to foreign withholding taxes, limited tax deductibility, etc. The respective fee amount for the services of the Indian company depends on what kind of functions the Indian company continues to render in India and which DEMPE functions shall be rendered by the foreign IP holding entity. Please note that stopping some of the DEMPE functions by the Indian entity could result in a transfer function taxation in India. In India, this results in an additional income taxation of the the India company with respect to the future profit potential of the transferred functions which are not any longer rendered by the Indiancompany. This risk could be kept under control by leaving the core DEMPE functions with the transferring Indian company. Thus, at the end of the day, the DEMPE concept might offer an attractive exit strategy for IP rights from India to a more attractive foreign IP holding jurisdiction.
Fulfilling the DEMPE criteria requires respective substance at the servicer’s place. A letter box company as servicer would not work from a Indian perspective. The transfer pricing documentation of both the servicer and the IP holding entity should describe in detail what entity undertakes which of the DEMPE functions. Although one should expect that the respective domestic tax authorities involved will follow individually optimised interpretations of the DEMPE criteria for sake of protecting their domestic tax revenue, the range of possible interpretations seems to be limited as the OECD approach forms the fundamental basis for all these individual interpretations. This offers the taxpayer a comparably reliable and defendable line of arguments against the respective tax authorities in India and abroad. Continuing with the license structures currently in place, however, leads to up-the-hill battles with German and foreign tax authorities as ignoring the DEMPE criteria is an invitation to all tax authorities involved to challenge the taxpayer’s profit allocations in India or abroad.