TRANSFER PRICING CASE STUDIES
WORKSHOP
SAN JOSE
31 MARCH - 4 APRIL 2014
8-a. Intangibles - Basic
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The opinions expressed and arguments employed herein are those of the author and do not necessarily reflect the
official views of the OECD or of the governments of its member countries.
Importance of Intangibles
• Importance of intellectual property rights (trademarks,
patents and copyrights) to business has increased.
• ‘Key value drivers’ within international groups.
• 30% of world trade relates goods and services associated with
intellectual property.
• Intangible assets account for 50%-70% of the market value of
public companies.
• Opportunities for tax planning.
• For transfer pricing, profit potential can be more easily reallocated in the case of intangibles than production facilities.
2
Most Valuable Brand Names
(in million US$)
1.
77 839
2.
76 568
3.
75 532
4.
69 726
5.
57 853
6.
43 682
7.
40 062
8.
39 385
9.
32 893
10.
30 280
Coca-Cola brand constitutes 60% of the
market value of the company!
(Source: Best Global Brands 2012, Interbrand)
3
Transfer Pricing Aspects of
Intangibles
• Initial Discussion Draft published June 2012
• Public consultation November 2012
• Revised Discussion Draft (RDD) published July
2013
• Public consultation November 2013 in Paris
• Targeted completion by September 2014 as
part of work on BEPS
4
Basic Definition of an Intangible
“The word intangible is intended to address
something which is not a physical asset or a
financial asset, which is capable of being owned
or controlled for use in commercial activities,
and whose use or transfer would be
compensated had it occurred in a transaction
between independent parties in comparable
circumstances.”
RDD para. 40
5
Elements Required to be an
Intangible
• Capable of being owned or controlled
– Does not include local market conditions (eg good
weather; structure of market)
– Does not include MNE group synergies which are not
owned or controlled by a single member of an MNE
group
• Capable of being used in commercial activities
• Use or transfer would be compensated in
transactions between independent parties
• Not a physical asset or a financial asset
6
Types of Intangibles
• OECD TP Guidelines (Chapter VI): no definition, but a list of
commonly encountered intangibles:
COMMERCIAL INTANGIBLES:
•Used for the production of
a good or the provision of a
service.
•Business assets
transferred to customers or
used in the operation of
business (e.g. software)
TRADE (MANUFACTURING)
INTANGIBLES
E.g. patents, know-how,
designs and models
MARKETING INTANGIBLES
E.g. trademarks and trade names,
customer lists, distribution
channels, unique names,
symbols, pictures.
7
Illustrations Quiz
(not comprehensive/complete list)
Intangibles for TP
Not intangibles for TP
Patents?
Know-How / Trade Secrets?
Trademarks, Trade
Names and Brands?
Licenses and similar
limited rights in
intangibles?
Assembled workforce?
Group Synergies?
Market specific characteristics?
8
Illustrations:
Know-How / Trade Secrets
• If information or knowledge meets 4 conditions:
•
•
•
•
secret or not widely known
has commercial value
identifiable
not registered
• Value depends on confidentiality, may be protected by
• Competition law
• Employment contracts
• Economic and technological barriers to competition
9
Illustrations: Trademark
• Unique name, symbol, logo or picture (any sign, or any
combination of signs) capable of distinguishing the goods or
services
• Generally registered
• Examples are the following trademarks:
• In some countries it is sufficient to file a description or
designation of the trademark, e.g. in the United States, a lion’s
roar at the beginning of a MGM-produced film, the sound of a
Harley-Davidson motorbike.
10
Illustrations: Trade Name / Brand
Trade name
• Often name of an enterprise, e.g.
• Generally registered
Brand
• Often used interchangeably with term “trademark”
or “trade name”
• But a ‘brand’ is a combination of intangibles,
generally including a trade name, customer
relationship, reputation, goodwill
11
Example:
“Less in the business of clothes manufacturing than he
is in the business of signing his name. The company is
run entirely through licensing agreements with Hilfiger
commissioning all its products from a group of other
companies: Jockey International makes Hilfiger
underwear, Pepe Jeans London makes Hilfiger jeans,
Oxford Industries makes Tommy shirts, the Stride Rite
Corporation Makes its footwear. What does Tommy
Hilfiger manufacture? Nothing at all.”
(Naomi Klein, No Logo, London, 2000)
12
Illustrations quiz
(not comprehensive/complete list)
Intangibles for TP
Not intangibles for TP
 Patents
 Group Synergies
 Know-How / Trade Secrets
 Market specific
characteristics
 Trademarks, Trade
Names and Brands
 Assembled workforce
 Licenses and similar
limited rights in
intangibles
13
Identifying intangibles
• Intangibles can be legally protected or not
– Examples: patent / trade secrets
• They can be on the balance sheet or not
– Examples: acquired / created and capitalised / created and
expensed
• They can be remunerated or used free of charge by
other group companies (often in good faith)
• Identification and determination of ownership, and
who should be entitled to associated rewards, can be
difficult
14
To identify intangibles, a thorough
functional analysis must be performed
• It is not sufficient to rely on the balance sheet or the P&L
accounts
• “Do not forget that probably half of the companies do not
have a well-articulated procedure in place to charge other
group companies for their use of IP “
(Source: PricewaterhouseCoopers / Landwell survey of intellectual property, March 2002)
• Requires a thorough functional analysis
15
Functional analysis
• Interviews
• Historical background of the company
• Financial information released for investors
• Other publicly available information
16
Identifying intangibles
1. Review financial information
a) Balance Sheet
– Not all intangibles are recognised as intangible assets for
accounting purposes
– Must meet definition of intangible asset (identifiable,
control over a resource, and existence of future economic
benefits)
– Must meet recognition criteria
17
Identifying intangibles
b) Income Statement
 Example – Exclusive License
• License execution fee
• Royalty revenues/expenses
• Regulatory milestone payments (exclusive development
rights)
• Product milestone payments (exclusive manufacturing rights)
• Execution fees on sublicensing (right to sublicense)
 Other
• Write-down of development costs
• Impairment loss
• Amortisation expense pertaining to intangibles (e.g.
amortised development costs)
18
Identifying intangibles
c) Cash Flow Statement
– Project development costs
d) Notes to financial statements (e.g. purchase price allocations)
e) Annual reports
f) Marketing activities (brochures)
g) Internal valuation
h) Royalty / license agreements
i) Franchise agreements
j) Interviews
– Management/owners
– R & D team
19
Where intangibles are identified, they must be
taken into account:
 In the functional analysis
 In the selection of the transfer pricing method
 In the selection of the “tested party” for a one-sided method:
the less complex party to the transaction
 In the selection of uncontrolled transactions that can be used
as comparables
20
Characterisation of Transactions
• Use of intangibles in connection with sales of goods or
services
• Transfer of intangibles
– Sale of intangibles
– Transfer of rights in intangibles (eg a licence)
– Transfer of combinations of intangibles
– Transfer of intangibles in combination with other
transactions
21
Determining ownership or rights to
returns?
22
Example 1: Rights of an enterprise to share
in the return of an intangible it does not own
Company A:
Patent and trademark registrations
Country B
Company B:
R&D activities
Country A
Country C
Company C:
Marketing activities
• Legal ownership / registrations in A
• Are there situations where B and C have rights to share the
return (and if so, what is the extent of such rights)?
23
Example 2: Who is entitled to the intangible
related returns?
Parent
Development
Sub Co
Sub Co
Sub Co
Funding
IRELAND
Patent
Registration
100 m $
INDIA
Contract
R&D
24
Identification of the party(ies) entitled to
returns from intangibles
• Legal ownership or bearing of costs alone:
generally not sufficient to be entitled to all the returns
related to the intangible
• Factors to be considered:
1. Terms and conditions of legal arrangements
2. Functions, risks and costs related to intangibles
 who performs functions?
 who bears risks and costs?
 who controls the risks?
25
Examples: a developer may perform
a research activity:
• In its own name, i.e. with the intention of having full legal
and ‘economic’ ownership of any resulting intangible
• On behalf of one or more other group members under an
arrangement of contract research where the beneficiary or
beneficiaries have legal and ‘economic’ ownership of the
intangible, or
• On behalf of itself and one or more other group members
under an arrangement in which the members involved are
engaged in a joint activity and have economic ownership of
the intangible
26
Case 1: Development in its own name
(The parent company gets dividends)
R&D centre




Provides funding (finance the R&D)
Bears risks (failure)
If successful: owns intangible developed
Exploits (itself or though license out)
and gets the residual profit attributable to
the intangible
 The manufacturer gets
manufacturing reward
 The distributor gets
distribution reward
27
Case 2: Contract Research




Contract R&D
Provides funding (finance the R&D)
Bears risks (failure)
If successful: owns intangible developed
Exploit (itself or though license out)
and gets the residual profit
Foreign
IP company
 Provides no funding
 Bears limited risks (no risk of failure, only
responsible for correct performance)
 If successful: no ownership of intangible developed
 No exploitation,
 No residual profit attributable to the intangible
28
Case 3: Joint research
R&D centres
x countries
 All provide funding (finance the R&D)
 All share risks of failure
 If successful: co-ownership (generally ‘economic’)
of intangible developed
29
Case 4: Cost Contribution Arrangement
Marketing or
manufacturing
companies
 All provide funding (finance the R&D)
 All share risks of failure
 If successful: co-ownership (generally
economic) of intangible developed
R&D centre
can be
 a contract researcher,
or
 one or more of the
CCA members
30
Discussion
• These 4 scenarios have different transfer pricing
consequences.
• Assuming you are auditing a company that
performs R&D functions, how would you assess
whether it does so
– in its own capacity,
– as a contract researcher,
– through joint research, or
– as a member of a CCA?
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Valuation issues
32
Importance and difficulties of valuation
• Book value not always meaningful
• Historical costs do not necessarily represent value
• Accounting standards differ with respect to fair market
valuation and can create significant differences:
 Daimler Chrysler which had net income of USD 733 millions in 2001
according to German accounting standards had a USD 589 million loss
applying US GAAP;
 Vodafone Group PLC had a USD 10 billion loss for 2004 which became a USD
17 billion profit by applying IFRS
 Reason= different depreciation rules for intangible assets
Source: Isabel Verlinden, Axel Smits and Bart Lieben, Mastering the IP life cycle, 2005
33
OECD TP Methods
1. Comparable Uncontrolled Price Method (CUP)
 Can be used if the owner has transferred comparable
intangibles under comparable circumstances to independent
parties
 In practice it is unusual to find exact CUP for a controlled
transactions
 Other methods might have to supplement or endorse the
results of a CUP analysis
2. Resale price method
 May be used in the case of sub-licensing by the associated
enterprise to third parties
34
OECD TP Methods
3. Cost plus method?
 Caution! Cost does not necessarily reflect value
4. TNMM
 Sometimes possible to apply, e.g. owner of a
manufacturing process licenses the process to a related
party for use in a particular market
5. Profit split method
 Appropriate when the licensee contributes significant value
to the intangible
 Residual profit split method is generally more appropriate
 Other methods may also be used where appropriate
35
Main non-tax valuation methods
 Practical valuation issues:
 Heterogeneous, often unique nature of intangibles
 Estimation of the remaining useful life of the asset
 Forecast of cash flows and measure of the risk
36
Valuing a licence
 The first step is to perform a thorough comparability
analysis (9 steps). This will allow identification of:
 Type of property to be licensed (e.g. non-unique intangible
or unique intangible)
 Rights granted to the licensee
 Relative value of the rights granted
37
License of an Intangible
Example
Stainless AG
(Germany)
Creates a grease stain
remover which preserves
the colour of the clothing
Patents the invention
Licence agreement
+ technical know how
Irish
Subsidiary
Licence agreement
+ technical know how
Gone for
Always Inc (US)
38
License of an Intangible
Example (continued)
Irish Subsidiary
Gone for Always
Profile
Full-fledged manufacturer
Full-fledged manufacturer
Type of
arrangement
License + related technical
know how
License + related technical
know how
Type of license
Exclusive
Exclusive
Rights granted
Manufacture, use and sale of
products
Manufacture, use and sale of
products
Duration
Patent’s life + 20 workdays of
technical assistance
Patent’s life + 20 workdays of
technical assistance
Europe
US
Geographic scope
39
License of an Intangible
Example (continued)
Questions:
1)Are these two license agreements comparable?
2)Which are the differences that should be examined in
greater detail?
40
Considerations in valuing an Intangible
 Expected profits attributable to the technology
 Cost of developing the technology?
 Degree of protection provided under the terms of the license
as well as the length of time the protection is expected to
exist
 Terms of the transfer, including geographic limitations
 Uniqueness of the property
 Consider from the perspective of the transferee AND the
transferor
41
Use of Valuation Techniques
• Use of valuation techniques specifically approved
• No comprehensive summary of acceptable valuation
techniques
• No endorsement of particular valuation practices or
standards
• Purchase price valuations are not determinative for
transfer pricing purposes
• Techniques based on discounted value of cash flows
can be especially useful
– But with an important caveat: Assumptions underlying
application of valuation techniques must be carefully
considered. Such techniques must be applied using
assumptions that are consistent with the arm’s length
principle
42
Valuation of Intangibles
- Uncertainties  Valuation of intangibles can be highly uncertain
 What would independents have done? Possibilities:
1) Value anticipated benefits (subsequent developments are
foreseeable and predictable?)
2)
3)
4)
5)
Short term agreement
Price adjustment clause
Sliding scale royalty (royalty rates increase or decrease with sales)
Renegotiation of main contractual terms
 where major unforeseen developments, or transaction becomes
uneconomic
43
Valuation of Intangibles
- Information Requests  The following information may assist in determining
transfer price/value:
•
•
•
•
•
•
•
•
•
•
•
•
Transfer pricing agreements
Royalty/license agreements
Development/exploitation contracts
Financial statements
Forecasts/projections (e.g. royalty revenues)
Operational documents (e.g. manuals)
Registration documents (e.g. patent application)
Judicial decisions/court orders
Technology data
Product life cycle information
Development costs
Trade publications (in subject industry)
44
Transactions Involving Use But Not
Transfer of Intangibles
• General rules of Chapters I – III apply
• Intangibles are an important comparability factor
• Comparables can often be found even where
intangibles are used by one or both parties
• Where the existence of unique and valuable
intangibles makes comparability difficult,
methods not relying on comparables, including
profit splits and valuation techniques may be
necessary
45
Questions and/or
comments?