Meaning
Contractual provisions requiring the licensee to increase the royalty payment so that the net amount received by the licensor after deducting withholding taxes equals the agreed nominal amount ensure the protection of licensor margins. The royalty gross up clause is a standard element in international technology transfers where cross-border withholding taxes apply. It shifts the tax burden from the technology provider to the domestic manufacturer.
This clause must be carefully structured to comply with local tax laws.
Tax Obligation
Withholding taxes on technology imports are typically collected by local tax authorities at the point of remittance. When a royalty gross up is applied, the local licensee must calculate the additional tax based on the increased gross amount. This requirement increases the total cost of the transaction.
Contractual Clause
Payment terms must be explicitly drafted to detail how the tax adjustment is calculated and who bears the payment responsibility. Through the royalty gross up, the foreign licensor is insulated from changes in the local tax rates. The contract must specifying that the net amount remains constant regardless of future policy changes.
Tax authorities often scrutinize these clauses to ensure they do not lead to illegal tax evasion or artificial price inflation. Correct documentation is required to defend this pricing structure during audits.
Withholding Adjustment
Financial calculations must be executed correctly to determine the increased payment and avoid penalties. Implementing a royalty gross up requires the licensee to perform a mathematical adjustment that reflects the local withholding tax rate. This calculation ensures the tax department receives its full legal entitlement.
