Litigation - Russia

As market relations and business contacts between Russian and foreign companies continue to develop rapidly, the use by Russian legal entities of trademarks owned by foreign companies is being increasingly scrutinized by the courts.

In Western European jurisdictions, parent companies which own trademark rights commonly license the use of such trademarks to manufacturers in their groups. In Russia, many companies which use trademarks in their business activities are not manufacturers, but rather licensees which grant the right to use the trademark to another company under a sub-licensing agreement. 

At the end of 2007 the Supreme Arbitrazh Court upheld lower court decisions in a case concerning the tax liability of a company which had treated licence fees that it paid for the use of trademarks under assignment agreements as a deductible expense.

The ruling concluded an almost year-long dispute involving one of the largest beer wholesalers on the Russian market about a tax audit during which the tax authorities discovered that the company had improperly understated its taxable profit by deducting licence fees paid to foreign owners of trademarks for brands of beer. The tax authorities found that the company was liable for unpaid profit tax and value added tax plus interest and penalties - a total of Rb660 million.

According to the Tax Code, tax-deductible expenses must be:

• incurred for a legitimate reason; 
• economically justifiable;
• supported by documentary evidence; and 
• incurred in connection with commercial activity.

During the case it was established that between 2002 and 2004 the company had a licensing agreement with a group of foreign organizations which entitled it to use the trademarks of several brands in return for licensing fees of between 4% and 10% of its income from products under the trademarks. In addition, the company concluded a sub-licensing agreement with one of Russia's largest breweries, allowing the brewery to use the trademarks and requiring the brewery to pay a sub-licensing fee of 0.1% of its income from the relevant products.

The Supreme Arbitrazh Court and the lower courts held that on the basis of this arrangement, the sub-licensing fees were unjustifiably low and the wide margin between the licensing and sub-licensing fees therefore violated tax law. In addition to the courts' conclusion that the deductions were not economically justifiable, the courts considered it significant that both the licensee and the sub-licensee had been founded by the same legal entity, which had effective control over both, and that this relationship was likely to have influenced the terms of the trademark licensing and sub-licensing agreements.

The decisions of the courts in this case have since been followed by the tax authorities in similar cases. For example, tax proceedings related to the payment of trademark licensing fees have been initiated by the tax authorities against a Russian company in an international group which is one of the world's leading producers of household chemicals and toiletries.

Russian law enforcement and court practices in the area of licensing and sub-licensing are still developing; thus, it is essential to consider carefully the legal and tax consequences of assigning the right to use trademarks within a group of companies.