Intangibles in the World of Transfer Pricing

Actions 8 to 10 of the BEPS Project aim to develop rules to prevent the erosion of tax bases and the shifting of profits through the movement of intangibles within multinational groups. This chapter addresses the definition of intangibles and outlines the identification of intangibles. It analyzes the relevance of legal protection and its validity for a transfer pricing analysis. Lastly, as intangible asset assignment or license contracts have a mixed nature that also encompasses the provision of services, we will mention aspects that help differentiate them.

The ownership of an intangible asset is of particular importance for a transfer pricing analysis because ownership defines to a significant extent the allocation of profits of a multinational group to the individual companies and to the countries these companies are located in. According to national and international tax laws, different types of ownership exist that have to be considered. German tax law distinguishes between legal and economic ownership, which is mainly relevant for tax accounting. From an OECD and transfer pricing perspective, the notion of functional ownership is the main standard for the allocation of profits resulting from intangible assets. The functional owner of an intangible asset, who is entitled to the residual profits in connection with the asset, is determined on a functional approach that is based on the development, enhancement, maintenance, protection, and exploitation (“DEMPE”) of that asset. Any transfer pricing planning that involves intangible assets, therefore, has to start with the determination of the legal, economic, and functional owner of the intangible assets.

Globalization, along with increased digitalization, often leads to the need for business restructurings of multinationals, in particular with regard to consolidation of the group’s intangibles for a number of reasons. Connected with this need, different questions arise from a business perspective as well as from a tax perspective. This chapter will outline the various aspects of an IP migration from different angles and highlight typical IP migration models seen in practice. Further, the history and recent developments on an international level with regard to the competition between tax systems for IP will be outlined as well as typical limitations and drawbacks.

This chapter provides an overview of empirical studies that analyze the potential profit shifting and tax avoidance of multinational firms using IP. First, we present evidence for profit shifting with additional research that directly studies the structures that are used to shift profits from high to low tax jurisdictions. Second, we present evidence on the geographical allocation of IP. These studies investigate whether tax incentives and profit shifting opportunities associated with IP determine the assignment of IP such as patents and trademarks.

This chapter deals with the specific characteristics of the mid-market sector and its impact on the transfer pricing of intangibles. The specifics of mid-market enterprises are outlined as an introduction. Based on this, internationalization strategies and how intangibles are dealt with in the mid-market sector are discussed and explained from a transfer pricing perspective. Finally, an illustration of the impact of mid-market characteristics on the determination of transfer prices for intangibles within a factual arm’s length test and within a hypothetical arm’s length test is given. Moreover, the problems and valuation issues are discussed and guidance is offered on how to deal with them in practice.

In the knowledge-based economy, the intangibles of firms have become the most important strategic resources and key drivers of firm value and business success. Traditional financial disclosures are no longer sufficient to convey a firm’s wealth-creation potential to stakeholders. Instead, intellectual capital reports have gained increasing importance to ensure transparency and reduce information asymmetries. Tax departments rely on these reports as a starting point for the identification and valuation of intangibles that are relevant for the transfer pricing process. This chapter provides a comprehensive overview of a firm’s opportunities for reporting intangibles internally and externally. It also includes a description of suitable tools for internal reporting, such as an intellectual capital statement, and explains the German reporting regulations for intangibles as well as further approaches to voluntary external disclosure of intangible values.

Purchase price allocations (PPAs) primarily serve for valuing tangible and intangible assets that result from acquisitions. Even though the values derived for the assets can generally not be used directly for transfer pricing purposes, public information available on purchase price allocations is of interest and may be used for valuing intangibles for transfer pricing purposes. To this end, in addition to a brief theoretical summary of PPAs and their implementation, we have conducted an empirical study based on published data from 631 large corporate transactions. Besides analyzing PPAs by industry, this chapter also provides a qualitative assessment of the most important value drivers per industry.

Strong brands are the result of brand value creation within a company. Established brands may lead to higher market share, higher sales volumes, and higher price margins for the respective product or service. In this chapter, we analyze the sources of brand value creation from a functional perspective, both for B2C and B2B markets. We also show that the functions of reducing information cost and risk have a positive impact on the decision of a customer to purchase a product or service by reducing uncertainties in the decision-making (evaluation) process. In addition, the function of symbolic meaning can increase the perceived value of a product or service from a customer’s point of view. Moreover, we provide practical examples of each of these functions.As understanding a brand and its creation is fundamental for valuing intercompany transactions that concern the transfer or use of brands, this chapter outlines the basics of brands and the differences between B2B and B2C by reference to marketing literature. An understanding of the brand concept is prudent for identifying relevant DEMPE functions that are performed by related parties and is helpful to comprehend intercompany transactions related to brands, such as licensing. This basic understanding helps in finding, setting, and defending arm´s length prices for such transactions.

Valuation is a measuring process because in so doing an empirical relation (e.g., an intangible value) is assigned a numerical relation (e.g., a monetary unit). The question arises about what a good valuation or measuring process is. This chapter outlines the concept of narratives and numbers. It shows that a good valuation requires both an accurate numerical process, i.e., the calculation part, as well as a convincing narrative that puts the calculation into context. A good valuation defined by numbers and narrative also needs to be documented. This chapter shows the link between narratives, numbers, and notes with typical assessment criteria for a measuring process: validity, reliability, and objectivity. This chapter concludes with a description of the documentation requirements of a valuation for transfer pricing purposes according to OECD principles.

This chapter provides an overview of how a license model can be determined in line with the arm’s length principle. For this purpose, the parameters that need to be considered when structuring a license system are presented. The overview in this chapter includes fixed and flexible license schemes. Regarding flexible license schemes, the possible license bases and rates are discussed. To determine license rates, the respective transfer pricing methods are examined, with a focus on the external CUP approach. Finally, empirical observations on license arrangements between third parties are presented, including insights from a database analysis and from license contracts analyzed in recent license rate benchmark studies.

Outsourcing of R&D tasks to specialized legal entities within a multinational enterprise is a commonly observed practice. This chapter discusses contract R&D setups, a popular method for aligning a transfer pricing structure with intercompany R&D outsourcing. This chapter describes the core features of contract R&D structures and establishes that in a typical setup the principal entity should be in control of all value-adding strategic functions and bear all material R&D risks. However, the contract R&D service provider’s role should be limited to routine functions and it should bear only limited risks. Such a setup typically entitles the R&D principal to directly own any intangibles resulting from successful R&D activities and to capture all returns that are generated based on these intangibles. This chapter also discusses the implications of new OECD recommendations on the arm’s length profit attribution and describes commonly observed pitfalls related to contract R&D.

Research and development cost contribution arrangements (“R&D CCA”) are a commonly used setup for implementing complex R&D projects within multinational groups from a transfer pricing perspective. This chapter starts by describing the advantages and disadvantages of R&D CCAs. Then we describe the criteria for membership in an R&D CCA and how these have narrowed as a result of the OECD BEPS project. To perform the activities of an R&D CCA, the participants contribute R&D efforts and resources, as well as existing intangibles. These contributions need to be valued and as necessary balanced. Further valuations and balancing payments become necessary when participants enter the R&D CCA later on or leave before the project is complete. We guide the reader through all these stages and describe the relevant regulatory background. At each stage, we illustrate these regulations with a practical example of an R&D CCA.

In light of BEPS discussions and digitalization of the economy in recent years, taxpayers and tax authorities are increasingly interested in using the value creation of a group’s entities to estimate the respective profit allocation. In this context, the Transactional Profit Split Method (“TPSM”), one of the transfer pricing methods available in the OECD Transfer Pricing Guidelines, plays an increasingly important role in discussions about arm’s length profit allocations. However, the application of the method is often challenging in practice. This chapter first summarizes the most recent guidance published by the OECD and the EU Joint Transfer Pricing Forum. Reflecting this guidance, we have compiled a practitioner’s checklist for the application of TPSM. Finally, based on the outcome of two Advance Pricing Agreements between the relevant tax authorities of different jurisdictions, this chapter illustrates examples of reasonable considerations with respect to the parameters of a profit split that have been mutually accepted amongst various tax jurisdictions.

Arm’s length comparison is the guiding principle for transfer pricing purposes. In cases of valuations that are performed based on other standards, such as the fair market value, it is questionable to what extent such values can be considered to have an arm’s length nature in intercompany sales or licenses of intangibles. This chapter compares the arm’s length principle with fair market value. It demonstrates that they follow quite different principles. The fair market value has a rather objective perspective, whereas the arm’s length principle takes subjective aspects into consideration that results in a two-sided approach. As such, there is a gap between both standards, which might lead to different results. The magnitude of this gap depends on the specific facts and circumstances. Acceptance of a valuation that is based on fair market value (or other standards) depends on the underlying assumptions. This chapter outlines possible amendments to existing valuations that would lead to a better fit with the arm’s length standard and could even close the gap.

Following the market approach, the value is determined based on analyses of pricing information of assets that are either identical or at least comparable. Depending on whether the pricing information relates to identical or comparable assets, the pricing information is either directly applied or first standardized and then applied to the asset to be valued.Typical advantages that are quoted in the context of the market approach relate to its direct connection to (observable) market activity and the minimal mathematical effort required to perform the valuation analysis. However, the inherent uniqueness of intangible assets and the fact that intangible assets are typically transferred in combination with other assets or liabilities limit the applicability of this approach.

The relief-from-royalty approach is based on the idea that the fair value of an intangible asset equals the present value of the cost savings realized by the owner of the asset that result from not having to pay royalties for the use of the intangible asset to another party. In order to determine the cost savings, a hypothetical royalty rate has to be calculated for the subject asset, based on market comparable royalty rates. As it is less complex and highly transparent in terms of calculation and input parameters the relief-from-royalty approach is a valuation method that is commonly used in practice for the fair value assessment of brands and trademarks, patents, software, and databases. However, since it is largely dependent on market comparable royalty rates, it is essential to apply detailed plausibility and reconciliation considerations in order to derive reliable fair value results.

The multi-period excess earnings method (MEEM) is one of the income-oriented approaches for determining the fair value of intangible assets. In contrast to other income approaches, MEEM is designed to be applied only to the most relevant intangible asset with respect to cash flow generation. MEEM addresses the fact that in general assets generate cash flow only in conjunction with other assets. The method operates under the assumption that an entity has only this particular asset, while all others—referred to as contributory assets—are leased from external sources for which fictitious expenses are charged. Often such leading intangible assets are customer-related assets, in-process research, and development (IPR&D), or already developed technologies and trademarks. This chapter gives a brief overview of the practical implications of MEEM and guides the reader through the method’s parameter specifications.

The incremental cash flow method, also referred to as the “with or without method”, determines the value of an asset by comparing cash flow streams of an entity or the business holding the asset under review with what the cash flow streams of the same entity or business would be without the asset. The difference between these two cash flows is attributed to the asset under review and this provides a basis for determining its value. As the value of a specific asset is based on future income streams, the incremental cash flow method is classified as an income approach.

The cost approach indicates an intangible asset’s value by considering its replacement or reproduction cost, relying on the economic premise that a prudent investor would pay no more for an asset than the cost to acquire an asset of equal utility. As one of three generally accepted and commonly applied approaches for the valuation of intangible assets (Chartered Global Management Accountant [CGMA], Three Approaches to Valuing Intangible Assets, 2012), the cost approach is applied the least frequently—because it is considered the least representative of an asset’s future economic benefits. In common practice, the cost approach is typically applied as a method of last resort, when other methods are not feasible, when market participants could reproduce an asset of substantially similar use without restrictions or significant time delay (IVSC, Valuation Approaches and Methods. London, 2016), or as a means of validating the plausibility of valuation estimates that are generated by other valuation approaches. The cost approach is typically applied for the valuation of a workforce—a key component of a firm’s goodwill and a crucial input for the income approach to valuing intangibles. The most commonly applied cost approach methods for the valuation of intangible assets are the reproduction cost method and the replacement cost method, both of which have special characteristics with respect to tax treatment and the treatment of obsolescence charges.

The valuation of intangibles is discussed in the literature and by practitioners for transfer pricing purposes, whereby the emphasis is very often placed on deriving and determining the capitalization rate and selecting the method. One rarely finds, however, any comprehensive discussion on the assessment of the planning calculations in the literature. This is especially surprising as planning data has a significant influence on the results of the valuation. This chapter provides an overview of plausibility checking of planning data and the requirements associated with this. The considerations of the OECD on ex post adjustments of ex ante values are also presented in this connection.

The discount rate is a crucial factor for valuing intangibles and needs to be considered in most of the approaches described. This chapter outlines how the discount rate can be calculated. In particular, it explains how the weighted cost of capital (“WACC”) is determined. WACC is typically applied when discounting cash flows with DCF models. The CAPM model is used to calculate the cost of equity, which along with the cost of debt is required to calculate the WACC.

Even though several countries have accepted the BEPS results as part of the inclusive framework, its implementation into local legislation varies. For that reason, taxpayers should not shape their analysis of intangibles solely on OECD guidance, it is also necessary to consider the relevant local legislation. Besides countries belonging to the inclusive framework, taxpayers also need to factor in developments in leading global economies such as India and China, which vary significantly from the OECD consensus. The following sections provide an overview of local legislation in more than 20 countries. The country chapters each have a similar structure and reflect local legislation, court decisions, best practice for the valuation of intangibles, and further related aspects, such as the depreciation of intangibles. In addition, a section by Patrick Wittgenstein outlines recent developments with regard to intangibles at the Court of Justice of the European Union.

In Austria, the arm’s length principle is implemented in several provisions of the (corporate) income tax law. Whereas Section 6 item 6 Austrian Income Tax Act (ITA) generally implements the arm’s length principle for cross-border transactions between related parties, Section 8 para 1 and para 2 Austrian Corporate Income Tax Act (CITA) concerning hidden capital contribution and hidden profit distribution specify that transactions between corporations and their shareholders have to be at arm’s length terms to be recognized for tax purposes. Whereas in cross-border transactions, the tax administration generally refers to Section 6 item 6 ITA when assessing transfer prices as primary adjustment, Section 8 paras 1 and 2 might give rise to secondary adjustment.

The tax law in Belgium does not define an intangible property for tax (transfer pricing) purposes. Intangible property is considered to be part of the intangible (fixed) assets of a company and as such, the definition of intangible fixed assets in Belgian accounting law can be used for reference purposes.

The control of transfer pricing in Brazil was initiated by the enactment of Federal Law 9,430/1996 (in force as of January 1, 1997). In Brazil, the transfer pricing regime is applicable to cross-border transactions that take place, inter alia, between:

There is no specified framework for intangible properties (IP) in Canadian tax law other than the general provisions applicable to various types of property. Canada’s transfer pricing regime abides by the arm’s length principle. In its application of the arm’s length principle, Canada generally follows the OECD Guidelines.

The Chinese Enterprise Income Tax Law (“EIT Law”) and its Implementation Regulations specify the general tax treatment of intangibles from the tax perspectives of the People’s Republic of China (“PRC”), including descriptions of intangibles, methods to be adopted in computing the taxation basis, and amortized expenses calculations, etc.

The countries covered in this section are Kenya, Uganda, Tanzania, Ethiopia, and Rwanda. Transfer pricing is relatively new for these East African countries compared to developed countries. Kenya was the first country in the region to introduce transfer pricing in 2006. Due to the sparse nature of their TP provisions, the transfer pricing regulations that do exist in the region rely heavily on international best practice and the OECD Guidelines.

The French legal framework for transfer pricing is contained in a core substantive rule and several material rules governing the documentation requirements.

Germany demands the use of the arm’s length principle in Section 1 of its Foreign Tax Act (“Außensteuergesetz—AstG”). It outlines a hierarchy of methods with a preference for the comparable uncontrolled price method, the cost-plus method, and the resale minus method. Only in cases where there is no reliable comparable third-party data available to apply one of these standard methods, the transactional net margin method or the profit split method can be applied. If those are also not applicable, the taxpayer needs to apply what is termed a hypothetical arm’s length test. This method assumes a hypothetical bargain is struck between a seller and buyer and with reference to economic methods determines the minimum ask price and the maximum bid price for a particular good or service. Two prudent independent business managers are assumed and the midpoint of this price range constitutes the default value. Arguments for other points within this spread can be provided when such a figure is more likely than the midpoint. The hypothetical arm’s length test was introduced as part of Germany’s “company tax reform,” and is applicable for financial years that started after December 31, 2007.

Ghana published its Transfer Pricing Regulations (L.I. 2188) in July 2012. The regulations were made by the Minister of Finance as empowered by the Internal Revenue Act 592 of 2000, as amended (“IRA”). In 2015, the IRA was repelled by the Income Tax Act, Act 896 (ITA).

Transfer pricing provisions were introduced by the Indian Finance Act (“IFA”), 2001. These provisions are broadly aligned with the OECD Guidelines on transfer pricing. Over the years, the Indian Government has taken various steps to streamline the provisions further; with an objective to follow international best practices. India has shown an inclination to adopt the principles outlined in the BEPS Action Plans. Some of the Indian provisions mirror BEPS guidelines to a large extent. Specific mention may be made of developments with regard to research and development (R&D) contracts—discussed later in this chapter.

In Italian practice, the valuation of intangible property (“IP” or “intangible assets”) may involve operational as well as accounting and tax aspects. From an operational perspective, the appraisal of intangibles may be needed, or just opportune, to integrate economic and financial indicators concerning a company’s business performance and to express a clearer view of how such performance is affected by the exploitation of intangible assets. Such a need or opportunity may emerge both in non-recurring transactions (mergers, de-mergers, transfers of businesses, sales or exchanges of shares, etc.) and in routine operations of companies that heavily rely on IP as a key factor for the creation of added value.

Transfer pricing (“TP”) regulations were introduced in Mexico more than 20 years ago by the Mexican Income Tax Law. Even though it is no longer new to the Mexican taxation scene, it is true that tax collection for TP was only incipient during the first years of the existence of these obligations. That has definitely changed in recent years. Today, TP in Mexico is one of the most important and hot issues on the taxation agenda, not only for the tax authorities but also for taxpayers.

In line with global trends, the regulatory landscape in the Middle East region is evolving at a fast pace, and therefore, transfer pricing (“TP”) is becoming increasingly relevant. As a regional overview, the countries in the region can be categorized as follows:

The primary legal framework for transfer pricing in Nigeria is the Income Tax (Transfer Pricing) Regulation 2018 (“TP Regulations”). The TP Regulations were made in exercise of powers conferred on the Minister of Finance by the Federal Inland Revenue Service (Establishment) Act 2007.

In general, Polish transfer pricing (“TP”) regulations follow the OECD Transfer Pricing Guidelines after BEPS (including the introduction of Action 13 documentation requirements into Polish rules). The arm’s length principle based on the OECD Model Tax Convention and the TP documentation standards are reflected in Polish law. There are Advance Pricing Arrangements (“APA”) available in the form of unilateral, bilateral, or multilateral agreements. The avoidance of double taxation is provided for under Mutual Agreement Procedures governed by Double Tax Agreements. Within the European Union, the EU Arbitration Convention is available for intercompany transactions.

Key intangible property aspects are regulated by the Russian Civil Code.

The Spanish case is no exception to the controversy regarding the concept of intangible assets, as there is no unanimous definition of intangible assets that allows a clear and objective idea of their limits. Indeed, the concept and scope of the definition of intangible may vary, depending on whether seen from an accounting, legal, or tax perspective. The following is a brief description, based on these perspectives of the ways an intangible can be identified according to Spanish legislation.

The arm’s length principle is regulated by Sweden’s Income Tax Act (“inkomstskattelagen” in Swedish in Chapter 14, Sections 19 and 20. Section 19 provides the legal basis for imposing the arm’s length principle on transactions between associated enterprises and states that the income of a business should be increased when income has been reduced due to conditions in intra-group transactions that independent businesses would not have agreed upon.

The UK transfer pricing legislation, which can be found in the Taxation (International and Other Provisions) Act 2010 (“TIOPA 2010”), Part 4, requires that any provision made by a transaction (or series of transactions) between connected persons be made on an arm’s length basis, as would have been made between independent enterprises. The legislation does not directly stipulate how the arm’s length provision should be established and instead requires that it “be read in such manner as best secures consistency” with the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (“OECD Guidelines”) and the OECD Model Tax Convention on Income and on Capital, as covered in other chapters. At the time of writing, the 2017 version of the OECD Guidelines, published by the OECD on July 10, 2017, should be used for interpreting UK transfer pricing (“TP”) laws. This includes the approach to the transfer pricing of hard-to-value intangibles (“HTVI”) that is contained in the OECD Transfer Pricing Guidelines, Chapter VI Section D.4.

The Court of Justice of the EU (“CJEU”) has become a major standard setter in EU tax matters. Intangible property (“IP”) is often regarded as an important driver of today’s multinational firms, in particular with respect to their tax planning activities. The present analysis focuses therefore on court cases of the CJEU that deal with IP and taxation. Using CJEU’s database, this chapter identifies relevant case law and subject matters (such as denial of R&D tax benefits for activities in other EU Member States, exit taxation, and abusive practices) in the area of direct taxation and VAT, and examines whether there is a tendency in judgments of the CJEU with regard to IP and taxation. In his results, the author observes some deviating tendencies, depending on the subject matter. Overall, the CJEU case law on IP and taxation appears to have become consistent over time, but rather more restrictive from a taxpayer’s point of view.

The collection of tax at source prevents foreign businesses from evading tax on revenues in the source country. This is particularly relevant for inland cases of restricted tax liability. Moreover, withholding tax at the source makes it possible to enforce legal obligations across the board. Types of revenue that are typically subject to withholding tax are investment income and royalties. Very wide variations exist worldwide for national withholding tax rates on investment income and royalties. Therefore, double taxation treaties and the EU regulatory framework seek to restrict any excessive national taxation at source. In practice, however, the initial deduction often exceeds the provisions in the double taxation treaty or EU regulations. Therefore, as a first step, it is necessary to compare the conditions of the treaties and regulations with national tax relief rules. As a second step, any remaining double taxation of royalties by both the countries of residence and source is recovered, either by exemption (exemption method) or by imputation (tax credit method). The detailed practical examples in this chapter describe this two-stage procedure and conflicts of qualification that frequently occur in practice with the interpretation of the treaties.

This chapter deals with civil law aspects of intangible assets, i.e., intellectual or industrial property (IP) rights, by outlining (i) the categories of IP rights recognized by civil law, (ii) the extent to which the exclusivity of such IP rights is secured, and (iii) what the legal requirements and practical implications of their development, transfer, and licensing are. This chapter uses German law as a basis and offers only a few contrasting glances into other jurisdictions to illustrate some of the existing variety.

This chapter provides an overview of M&A transactions, including crucial process-related points of interest and the technical ratio between due diligence findings, structuring criteria, and necessary safeguards in the purchase agreement. It introduces typical tax issues that relate to IP, provides selected practical examples and discusses how to deal with them; especially concerning the negotiation of the purchase agreement, bearing in mind the potential transaction risks arising from IP. The chapter concludes by illustrating the increasing relevance of recent developments concerning IP transactions, e.g., patent/innovation box regimes.

This chapter describes the treatment of intellectual property under customs law, and the interaction between customs and transfer pricing. The reader is first introduced to the basics of customs law and customs valuation. The governing principles and valuation methods are explained. It is then discussed under what circumstances royalties, license fees and the transfer of ownership of an intellectual property right are subject to customs duties. Subsequently, it illustrates what potential significance transfer pricing has for the customs treatment of transactions between related parties. The reader learns to what extent transfer pricing documentation can be helpful for customs purposes. Finally, it sets out the preconditions for the eligibility of transfer pricing methods and transfer pricing documentation for customs valuation.