Transfer Pricing of Intangibles

In July 2010, the Organization for Economic Co-operation and Development (OECD) announced its intention to revise the transfer pricing guidelines with respect to intangibles over a series of public consultations.

Perceived as an area of high uncertainty and tax risk for multinational companies, the announcement was well received across the globe by advisors and taxpayers alike. As part of this process the OECD released a discussion draft in June 2012, setting out their conceptual view of intangibles and seeking public comment placing considerable emphasis on the identification, valuation and transfer of intangibles. Given that estimates suggest that up to 80% of the value of some multinationals lie in their intangible assets it is no surprise that globally both taxpayers and tax authorities alike are focused on this aspect of transfer pricing.

Concept

With some criticism, instead of utilizing existing legal or accounting definitions of intangibles, the OECD has sought to develop its own concept, presumably in the hope that it readily translates across multiple legal systems and accounting standards. The OECD concept defines an intangible as an asset that would not qualify as a physical asset or financial asset, but is capable of being owned or controlled for use in commercial activities. The draft uses a number of illustrations such as goodwill, patents, know-how, trademarks, etc to clarify the provisions of the concept. However, questions remain as to whether goodwill or other intangibles are separable from the business of which they are part. This has certainly always been a point of debate in the investment management industry where a brand is synonymous with particular individuals; cemented by the fact that so many businesses bear the name of their founders. A more precise definition could reduce the potential tax disputes. Importantly, the clear OECD position is that if there is something of value that would be expected to be taken into account in compensating dealings between independent parties, then it must be taken into account in a transfer pricing analysis, whether or not it is defined as an “intangible”.

Identification

The draft defines three criteria to be taken into account in determining the entitlement of the returns to intangibles: 1) the legal registrations and contractual arrangements (for example, transfers and licenses); 2) which party performs or controls the important functions and bears the risks and the various costs associated, and 3) whether services rendered in connection with developing, enhancing, maintaining and protecting intangibles are compensated on an arm’s length basis. Perhaps the key point in the analysis is that incurring costs of marketing and advertising does not necessarily mean that there is something of enduring value.

Valuation

Arguably the most contentious area is the valuation and pricing of intangibles. Intangible transactions can be relatively unique and are only rarely transferred or licensed, therefore pricing methodologies tend to focus on external comparables rather than using data for comparable uncontrolled transactions. Factors such as geographic scope, useful life and expected future
benefits should be taken into account as a comparability factor. In the investment management sector arguably the premium a manager can charge to investors compared to the average manager is indicative of the value of the goodwill in their business. The draft indicates that it is important to perform a robust comparability analysis when using information drawn from commercial
and proprietary databases. However, it calls for caution to be exercised in accepting valuations performed when determining arm’s length prices in particular for intangibles, but, where reliable data is not available, the draft gives qualified endorsement to using valuation techniques, in particular discounted cash flow, to price the transfer of intangibles.

In conclusion, the draft is definitely a step in the right direction and will present certain organizations with an opportunity to further justify pricing; however, change can be a double edged sword and tax authorities may start using the new guidance to mount an assault on existing structures that push the boundaries. When considering pricing inter group services, taxpayers should consider where the real value lies in their business, be it recognized on their balance sheet or otherwise, and whether this is accurately reflected in their pricing methodologies.

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