BEPS Action 8 – Transfer Pricing: Intangibles

​Definition of Intangibles

• Patents;
• Know-how and trade secret;
• Trademark, trade names and brand;
• Rights under contracts and government licenses;
• Licenses and similar limited rights in intangibles; and
• Goodwill and ongoing concern value. 
  

On the other hand, group synergies and market specific characteristics are not recognized as intangibles as they cannot be controlled by any party of the group.

Remuneration for Legal Ownership of Intangibles and Other Transactions contributed to the Value of the Intangibles

OECD stipulates that although legal rights and contractual arrangements form the starting point for any transfer pricing analysis of transactions involving intangibles, a pure legal ownership does not entitle for receiving the proceeds by exploiting the intangibles. Other group entities performing the relevant functions and assuming the relevant risks regarding the development, enhancement, maintenance, protection and exploitation of the intangibles should be remunerated for the contributions they made. Therefore, the pure legal owner without performing any key functions related to the intangibles will not be entitled to any portion of the return derived from the exploitation of the intangibles other than the arm’s length compensation, if any, for holding the title and providing the fund.

• Design and control of research and marketing programs;
• Direction of and establishing priorities for creative undertakings including determining the course of ”bluesky” research;
• Control over strategic decisions regarding intangible development programs;
• Management and control of budgets;
• Defense and protection of intangibles; and
• Ongoing quality control over functions performed by independent or associated enterprises.

Evaluation of the Intangibles

OECD states that one-sided methods including the resale price method and the TNMM, are generally not reliable methods for directly valuing intangibles as they usually allocate all residual profit, after a limited return to those providing the relevant functions, to the owner of intangibles. The selection of the most appropriate transfer pricing method should be based on a functional analysis that provides a clear understanding of the MNE’s global business processes and how the transferred intangibles interact with other functions, assets and risks that comprise the global business. The functional analysis should identify all factors that contribute to value creation, which may include risks borne, specific market characteristics, location, business strategies, and MNE group synergies and take these factors into account in determining the material contribution of each party to the creation of intangible’s value, instead of purely split only in intangibles and routine functions. As such, OECD agrees that the transfer pricing methods most likely to prove useful in matters involving transfers of one or more intangibles are the CUP method and the transactional profit split method while valuation techniques can also be useful tools.
 
On the other hand, OECD recognized that the identification of reliable comparables in many cases involving intangibles may be difficult or impossible. Under such circumstances, profit split method and/or valuation techniques may be the most appropriate TP method to set the arm’s-length price for the transactions involving intangibles. OECD reiterates that the application of the transactional profit split method should be in line with a full functional analysis that considers the functions performed, risks assumed and assets used by each of the parties over the supply chain.

• Accuracy of financial projections;
• Assumptions regarding growth rates;
• Discount rates;
• Useful life of intangibles and terminal values;
• Assumptions regarding taxes; and
• Form of payment.

OECD further stresses that a price for a transaction involving intangibles can often be identified that is consistent with the realistically available options of each of the parties. The existence of such prices is consistent with the assumption that MNE groups seek to optimize resource allocations. If situations arise in which the minimum price acceptable to the transferor, based on its realistically available options, exceeds the maximum price acceptable to the transferee, based on its realistically available options, it may be necessary to consider whether the actual transaction should be disregarded under the criterion for non-recognition, or whether the conditions of the transaction should otherwise be adjusted.

 

Pricing Guidance on Intangibles of Highly Uncertain at the Time of Transaction and Hard-to-value Intangibles

OECD states that tax authorities should recognize the mechanism which independent taxpayers might also adopt for evaluating intangibles that is of highly uncertainty at the time of the transaction, which include:
• Adopt shorter-term agreements;
• Include price adjustment clauses in the terms of the agreement;
• Adopt a payment structure involving contingent payments to protect against subsequent developments that might not be sufficiently predictable; and
• Re-negotiation of the pricing arrangements when there is changes on fundamental assumptions for the pricing.

OECD defines Hard-to-value Intangibles as those intangibles for which (i) no reliable comparables exist, and (ii) at the time the transactions was entered into, the projections of future cash flows or income expected to be derived from the transferred intangible, or the assumptions used in valuing the intangible are highly uncertain, making it difficult to predict the level of ultimate success of the intangible at the time of the transfer. OECD agrees that in these circumstances, the tax administration can consider ex post outcomes as presumptive evidence about the appropriateness of the ex ante pricing arrangements. However, in circumstances where the taxpayer can satisfactorily demonstrate what was foreseeable at the time of the transaction and reflected in the pricing assumptions, and that the developments leading to the difference between projections and outcomes arose from unforeseeable events, tax administrations will not be entitled to make adjustments to the ex ante pricing arrangements based on ex post outcomes.