Turkey – Before Challenging “Embedded Royalties” in Transfer Prices of Tangible Products, It Is Necessary to Think Twice

1. Introduction

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

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

This approach raises two fundamental questions:

1. Transfer pricing question: Under the OECD Transfer Pricing Guidelines 2022 (OECD TPG), is it correct to treat an implicit return for intangibles (for example, trademarks) embedded in transfer prices as a separate royalty?
2. Treaty/WHT question: Even if part of the profit economically relates to intangibles, does that automatically mean that there is a “royalty payment” within the meaning of domestic law and tax treaties?

Given that Turkish legislation and practice refer to the OECD TPG as a key interpretive source, these questions should be analysed carefully before accepting an “embedded royalty” theory. In particular, the OECD framework does not support a blanket presumption that every cross‑border sale of branded goods contains a separable, WHT‑able royalty component.

2. OECD TPG: Trademarks Do Not Automatically Require a Separate Royalty

2.1. Marketing intangibles and embedded value

Chapter VI of the OECD TPG 2022 distinguishes marketing intangibles (such as trademarks, brands, trade names and customer lists) from trade intangibles (such as technology, patents, know‑how). In discussing marketing intangibles, the OECD expressly recognises that:

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

Paraphrasing the OECD’s 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.

In other words, return on marketing intangibles can legitimately be embedded in the transfer price of goods. The OECD does not require that this embedded return be carved out and priced as a standalone royalty in all cases.

2.2. Accurate delineation and “single transaction” character

The OECD TPG emphasise the concept of accurate delineation of the actual transaction; based on the contracts and conduct of the parties:

• The controlled transaction is properly delineated as a single purchase of goods;
• The Turkish distributor’s overall margin is in line with independent distributors of similar branded products; and
• There is no separate contractual royalty;

then, under OECD standards, there is no separate “royalty transaction” to be identified and priced. The foreign supplier earns its return (including on its intangibles) within the overall margin on product sales.

Economically, it is true that part of the foreign supplier’s margin may relate to its IP (trademarks, technology, know‑how, etc.). But:

• Legally and for treaty purposes, the payment is still a payment for goods.
• The OECD TPG do not require that such a bundled price be split into an artificial “goods” component and a “royalty” component where independent parties also transact on a bundled basis.

Accordingly, the automatic identification of an “embedded royalty” in the transfer price, and its subjection to WHT, goes beyond the OECD transfer pricing framework.

3. From TP to WHT: When Is There a “Royalty Payment”?

The OECD TPG primarily deal with the allocation of profits among associated enterprises. They do not directly govern withholding tax. However, they inform the characterisation of transactions, which in turn is crucial for WHT.

For WHT to apply to a portion of a payment as “royalty”, two conditions must generally be met:

1. The relevant domestic law or tax treaty defines “royalty” in a way that covers the specific payment; and
2. Factually and legally, that portion of the payment is consideration for the use of, or the right to use, intellectual property (for example, trademarks, patents, know‑how), rather than consideration for goods.

If, following OECD guidance:

• The accurately delineated controlled transaction is a single sale of goods;
• The comparability analysis shows that the Turkish distributor’s margin is arm’s length; and
• There is no contractual royalty obligation,

then there is neither a separate royalty transaction nor a royalty payment in treaty terms. The foreign seller simply earns business profits from the sale of goods.

Turkish practice that systematically re‑characterises part of a price for goods as a royalty—without contractual basis and without a separate DEMPE‑based intangible transaction—sits uneasily with both the OECD TPG and typical treaty definitions of royalties.

4. Risk of Double Taxation and Inconsistency

A further concern is the risk of double taxation and inconsistency between jurisdictions.

If Turkey:

• Re‑characterises part of the payment as a royalty and applies WHT; while
• The counterparty jurisdiction treats the full amount as business income from the sale of goods (not a royalty),

then the same income can be taxed twice: once as business profits abroad, and once as a royalty in Turkey (with limited or no relief if the other state does not recognise a royalty).

This outcome conflicts with the OECD’s fundamental objectives to:

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

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

• Creates a high risk of double taxation;
• Is not aligned with transfer pricing standards applied by many of Turkey’s treaty partners; and
• Undermines the OECD‑based transfer pricing environment that Turkey has committed to.

5. Benefit Test, Rights in Intangibles and Limited‑Risk Models

5.1. No royalty without transfer or grant of rights

The OECD TPG distinguish clearly between:

• Situations where an intangible is used in providing goods or services, but no rights are transferred or granted; and
• Situations where the distributor obtains a right to exploit the intangible (licence, sub‑licence, etc.).

Where a supplier uses its own intangibles to produce goods or provide services, but does not grant the distributor  any right to use or exploit those intangibles, there is no transfer of rights and therefore, under OECD logic, no royalty. The distributor simply pays for the product or service.

This is fully consistent with typical treaty definitions of royalties, which focus on payments “for the use of, or the right to use” IP. If no such right is granted, the payment is not a royalty.

5.2. Limited‑Risk Distributor (LRD) models

In a classic Limited‑Risk Distributor (LRD) model:

• The Principal is the economic owner of the business and of the relevant intangibles (including trademarks, technology, marketing intangibles).
• The LRD performs routine distribution functions and earns an arm’s‑length, limited return (for example, a routine operating margin).

Under this model:

• The LRD does not acquire or control the Principal’s intangibles.
• The LRD may use the brand in its limited capacity as distributor, but this use does not mean that it owns or economically exploits the IP.
• From a TP perspective, the LRD’s routine margin already reflects its contribution; requiring an additional royalty payment would contradict the arm’s length principle.

Similarly, where an entity in Turkey performs significant DEMPE functions (development, enhancement, maintenance, protection, exploitation) relating to intangibles, the appropriate reward for these functions should be reflected in its margin or profit allocation, not via an artificial royalty carved out of product prices. Charging an additional royalty in such cases would be inconsistent with the value chain and functional analysis.

6. Case Law Illustration: The “Pepsi” Case

Although fact patterns and legal frameworks differ by jurisdiction, the logic of certain court decisions is instructive. In the well‑known Pepsi case, the Supreme Court held that:

• The price paid for the concentrate was payment for the concentrate and nothing else.
• The arrangement reflected arm’s length dealings between unrelated parties.
• The absence of a separate royalty was consistent with market practice under the franchise‑owned bottling model used by PepsiCo.

The court thus rejected the idea that part of the product price should be re‑cast as a royalty where independent parties had agreed on a single bundled price and no explicit royalty existed.

This reasoning is fully aligned with the OECD TPG’s recognition that:

• Independent parties often structure branded product arrangements without a separate trademark royalty; and
• It is inappropriate to re‑characterise such arrangements ex post when the transfer price and margin are arm’s length.

7. Conclusion

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

• The use of group trademarks in distribution does not automatically require a separate royalty.
• Where the accurately delineated transaction is a single sale of goods, and the distributor’s margin is arm’s length, the return on intangibles may legitimately be embedded in the product price and margin.
• Re‑characterising part of a purchase price as a royalty without contractual, commercial or functional basis is inconsistent with OECD TP principles and significantly increases the risk of double taxation.

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

• The single transaction nature of their cross‑border distribution and procurement arrangements; and
• The treatment of payments as consideration for goods (business profits) rather than as royalties subject to WHT, provided that:
• The transfer prices are demonstrably arm’s length,
• DEMPE functions and value creation are properly documented, and
• There is no separate contractual or factual transfer of rights in intangibles.

In light of the OECD‑based framework and the risk of double taxation, it is indeed necessary to “think twice” before challenging transfer prices of tangible products on the basis of presumed “embedded royalties”.