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Does the separate agreement help to mitigate withholding tax on royalty?

PAYMENT OF SERVICES, including royalties, to non-Thailand residents who do not carry on business in Thailand is subject to a 15 per cent withholding tax (WHT) under Section 70 of the Thai Revenue Code (TRC ).

This 15 per cent WHT is generally exempted under various tax treaties if it can determined to be a payment for a service other than a royalty. It is common that a licence agreement for the use of intellectual property (IP) which is royalty income will be entered separately from a service agreement so that WHT shall only be deducted from the licence fee for the use of IP. The payment under the service agreement should not be subject to WHT if the relief can be claimed under the tax treaty. However you should be aware that WHT cannot be mitigated by simply having a separate agreement.

To learn more about the Thai Revenue Department's (TRD) view on this subject, we refer to the recent Supreme Court decision, no 13993/2555, with T Company as the plaintiff and the TRD as the defendant. In this Supreme Court decision, T Company, the Thai subsidiary of a Netherlands company, entered into two agreements with its parent company in the Netherlands (NV Company). The first agreement is a "licensing agreement" for the use of the parent company's trademark and related know-how, from which T Company deducted WHT upon the payment of the licensing fee to NV Company. The second agreement is an "offshore service agreement" for the provision of services, including consulting and training, in various business aspects, such as procurement, budgeting, system and controls, security, fire and environment management. Within this framework, T Company agreed to pay a fixed monthly fee plus a variable fee based on its revenue. T Company did not deduct WHT on the payment of the service fee under the offshore service agreement because it claimed an exemption under the tax treaty between Thailand and the Netherlands. The TRD assessed the WHT on the fixed fee paid on the ground that such payment was made for the use of technical information concerning industrial and commercial experiences, which falls under the terms of a royalty.

The two factors which formed the TRD's conclusion and which we can extract from this case are namely the fixed fee arrangement and the scope of services. The TRD took a view that the fixed fee arrangement was similar in substance to a royalty payment, which is generally paid with no reference to the volume or degree of the services rendered. In addition, the fixed fee under the offshore services agreement was high compared to the licensing fee paid under the licensing agreement and so the TRD believed that the fixed fee was also paid for the use of IP and related know-how.

The TRD lost this case because the Supreme Court ruled that the fixed fee was not paid as a royalty but rather paid for general services, which are not subject to the WHT under the tax treaty between Thailand and the Netherlands. The decision was made on the grounds that the plaintiff could manage to prove that the actual services provided by NV Company were general administrative services as opposed to any type of royalty. Although the scope of services as indicated in the offshore service agreement included services that required special or unique knowledge from NV Company, which should be regarded as royalty, but in reality no such service was rendered and the TRD did not challenge otherwise. The plaintiff was able to substantiate and satisfy to the court that the actual services received under the offshore service agreement were in the nature of general services available in the public sphere, which did not require special knowledge or industrial expertise from NV company, and the agreement did not contain a confidentiality clause, which is normally required in a royalty agreement. In addition, the plaintiff was able to |provide evidence to support that |the related know-how required for |the business was received from a |third party service provider who had special knowledge and expertise in this industry and for which the separate fee was paid. Thus the plaintiff did not require such know-how or industrial expertise from NV Company. In addition, the plaintiff was able to demonstrate that the fixed fee paid was commensurate with the general services received and was within the range paid by other companies for similar services.

The lessons learnt from this case are that a business has to be prepared to substantiate the actual services received and demonstrate that the pricing arrangement is commensurate with the actual services received. Although it is possible to win on the substance of actual services, it is still time-consuming if there is a dispute with the TRD. It would be best if a business reviews the scope of services hired and ensures that it does not include within the scope and fees any services which could lead to a classification as a royalty. Those which may be considered a royalty should be detailed in a separate service agreement.

Benjamas Kullakattimas is Tax partner in charge, KPMG Phoomchai Tax Ltd.

This information is intended as a general guide only. Tax law is complex and professional advice should be taken before acting on the information provided.


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