Turkey-Before challenge the Embedded Royalty in Transfer Prices of tangible products, that is why it is needed to think twice!

In recent audits, Turkish tax authorities have increasingly argued that:

• The transfer price of imported goods (or intra‑group services) includes an “embedded IP royalty” (e.g. for trademarks/brands), and therefore
• Part of the payment for goods/services should be re‑characterised as a royalty subject to Turkish withholding tax (WHT) under:
• Corporate Tax Law,
• Income Tax Law (Articles on royalties), and
• Applicable Double Tax Treaties (royalty articles).

This approach raises two core questions:

1. From a transfer pricing perspective: Is it correct under the OECD Transfer Pricing Guidelines 2022 to treat an implicit return for intangibles (e.g. trademarks) embedded in transfer prices as a separate royalty?
2. From a treaty/WHT perspective: Even if some profit economically relates to intangibles, does that automatically mean there is a “royalty payment” within the meaning of tax treaties?

Using the OECD TP Guidelines 2022 – which Turkish legislation and practice refer to as a key interpretive source – we may discuss following pillars when considering the paradox.

• OECD guidance expressly recognizes that no separate royalty may be payable for trademarks where the brand value is embedded in prices and margins.
• The mere existence or use of a trademark does not itself create a royalty obligation.
• Consideration for intangibles can be embedded in the price and is then analysed at the transaction level, not re‑characterised as a separate royalty.
• For WHT purposes, a payment must be legally and economically characterized as a royalty; a simple margin embedded in the price of goods is not a royalty.

Based on OECD TP guideliness Trademarks Do Not Automatically Require a Separate Royalty. OECD TP Guidelines 2022 – Chapter VI (Intangibles) distinguish “marketing intangibles” such as trademarks, brands and trade names from trade intangibles (technology, patents, etc.). In discussing marketing intangibles:

• The OECD explicitly recognizes that independent distributors of branded products often do not pay a separate trademark royalty.
• Instead, the value of the brand/trademark is reflected in:
• The purchase price of the product, and/or
• The distributor’s gross or net margin.

Paraphrased OECD position (Chapter VI – around paras. 6.80–6.100):

The fact that a distributor uses a group trademark or trade name does not automatically mean that a separate royalty would be payable at arm’s length. In arrangements between independent parties, it is common that no explicit trademark royalty is charged. The value of the marketing intangible may be reflected in the pricing of the goods and in the distributor’s margin

Therefıore, the OECD framework does not support a presumption that every cross‑border sale of branded goods necessarily contains a separate royalty that should be carved out and subjected to WHT. Rather, it recognizes that in many arm’s‑length situations, no stand‑alone royalty exists.

The OECD TP Guidelines are primarily about allocation of profits among associated enterprises, not about withholding tax. However, they guide the characterisation of transactions. For WHT to apply to a portion of a payment as “royalty”, two conditions generally must hold:

1. The relevant tax law or treaty defines “royalty” in a way that covers the payment; and
2. Factually and legally, that portion of the payment is consideration for the use of IP (e.g. trademark) rather than consideration for goods.

If, following OECD guidance:

• The accurate delineation of the controlled transaction is a single purchase of goods,
• The comparable analysis shows that the overall margin of the Turkish distributor is in line with independent distributors of similar branded goods, and
• No separate contractual royalty exists,

then, by OECD standards, there is no separate “royalty transaction”. Instead, the foreign seller earns its return, including any return on intangible property, through the overall gross margin on product sales.

• Economically: part of the foreign supplier’s margin may reflect returns on its IP (including trademarks, know‑how, etc.).
• Legally and for treaty purposes: the Turkish payment remains a payment for goods, not a royalty.
• OECD TP explicitly does not require splitting that payment into “goods” and “royalty” components where independent parties also transact on a bundled basis.

Therefore, automatically identifying an “embedded royalty” within the transfer price and subjecting it to WHT goes beyond the OECD TP framework and beyond typical treaty definitions of royalties.

Avoiding double taxation and inconsistency

An additional issue arises: if Turkey re‑characterises part of a payment as royalty and applies WHT, while the counterparty jurisdiction treats the full amount as business income from the sale of goods, the result is double taxation.

The OECD’s underlying objective is to:

• Avoid double taxation through consistent characterisation and allocation of income.
• Respect arm’s‑length outcomes where tested and documented.

A Turkish practice of systematically carving out uncontracted, unpriced “embedded royalties” from goods payments:

• Creates a high risk of double taxation.
• Is not supported by transfer pricing standards followed by Turkey’s treaty partners.
• Undermines the OECD‑based TP environment Turkey has committed to.

Benefit Test, LRD Models, Transfer of Rigths and so on

As expalined; as long as the transfer prices are arm’s  length, it is not apporpiate to reclassy a trancsation from tangibel products to a royalty which results in double taxation.  There are also similar cases of which is well know as Pepsi case. In this case, the Supreme Court has found taxpayer the price paid for the concentrate was for the concentrate and nothing else

• the scheme was the product of arm's length dealings between unrelated parties
• the absence of a royalty was a market standard practice under the franchise-owned bottling operation model adopted by PepsiCo/SVC.

In addition,  based on OCED TP Guideliness, there areexplict examples when the Intangibles are used in the provision of services or products, however there is not any transfer of rigths. When there is not any transfer of rigths, there is no royalty payment.

For instance, in a Limited Risk Distributor model, the economic owner of the business is the Principaş entity and LRD itssef does not use and benefit the Intangilbe Property of Principal. Therore claming that a LRD must pay royalties contaddicts with arm’s length pricnciple. In addition for entites which perform DEMPE functions, paying an additional royalty in the form of transfer prices of products also contracidt with value chain and functional analysis.

7. Conclusion

The OECD Transfer Pricing Guidelines 2022, which Turkey endorses as a key interpretive framework, provide strong support for the position that:

• Use of group trademarks in distribution does not automatically require a separate royalty;
• Re‑characterising part of a purchase price as a royalty without contractual or commercial basis is inconsistent with OECD TP principles and risks double taxation.

Accordingly, the recent Turkish tax authority practice of systematically claiming that transfer prices include a WHT‑able “embedded IP royalty” is difficult to reconcile with the OECD 2022 Guidelines. Turkish taxpayers can legitimately rely on these OECD principles to defend:

• The single‑transaction nature of their distribution arrangements, and
• The treatment of cross‑border payments as consideration for goods (business profits) rather than royalties subject to Turkish withholding tax.