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Scoping of Transfer Pricing Aspects of Intangibles
In most cases their creation requires a lot of resources and capital investment through a long period of time, incurring other costs related to their legal protection and response to subsequent challenges from other market players.
For multinationals such circumstances often make it necessary to develop these type of assets via several companies within the same group, since a single entity cannot by itself bear all the costs, thus raising several issues affecting:
- the ownership of the intangible property created
- the valuation of the efforts made by the participating entities
- the price to be paid as a compensation by the entities using the IP created.
For so-called ―soft intangibles, MNEs operate with decentralised structures where intangible property is developed spontaneously, as a consequence of sharing ideas and experiences by employees located in different jurisdictions and working for different entities of the same MNE. What's more MNEs may develop increasingly sophisticated operating structures whereby the ownership of those assets is held by one company which licenses its use to other group entities. This practice is usually aimed at achieving greater economic and organisation efficiency, although it often incorporates significant tax planning opportunities.
This may give rise to a number of cross border transactions relating to the creation and use of IP assets within MNEs, and the way in which they are implemented in practice. This has a clear impact on the determination of the arm's length remuneration for the companies involved as it may be affected by the fact that it may be difficult, if not impossible, to identify similar transactions between unrelated parties, especially given the specific nature of this type of assets.
Although these issues may seem evident, it is worth considering them as a starting point in order to establish the framework in which the OECD should carry out the work to be performed on the transfer pricing aspects of intangibles. In their latest comment Taxand's Global Transfer Pricing Team recommend the following in their response to the OECDs scoping of transfer pricing aspects of intangibles:
- Clearer and more explicit definition of intangibles
Recognition of different categories and types of intangibles should be the foremost and basic requirement that OECD should address. Current OECD TP Guidelines only provide a general definition of traditional intangibles for example patents and trademarks.
- Guidance on determining life and decay of different categories of intangibles
Regardless of how the intangible asset is being used in an intercompany transaction, in order to establish an arm‘s length intercompany charge, understanding the life and decay of the intangible asset is paramount.
- Distinguishing the ownership of intangibles
Determining the ownership of an intangible in a transfer pricing analysis is needed to determine which party is entitled to income in a transaction (i.e. both earnings and losses) attributable to the intangible. This can be distinguished between legal and economic ownership of intangibles.
- Guidance on use of transfer pricing methods for establishing arm's length remuneration
Generally transfer pricing methods for establishing arm‘s length remuneration fall into two categories: transactional based methods and profit based methods. While there can be clear cut rationale for using one versus the other, often reliance on some combination of the two is required. In cases where the two types of methods provide vastly different results, placing heavier reliance on one versus the other is critical in establishing a result that is deemed to be arm‘s length.
- Sales and Marketing intangibles
Sales and marketing intangibles have been a focal point of discussions between tax officers‘ and MNCs world over. Detailed guidance is required on activities which give rise to creation of marketing intangibles and clarification should be provided on treatment of marketing expenditure. Specific guidance should be provided to distinguish between routine and non-routine expenditure / services incurred in relation to advertisement and sales promotion activities.
- Transfer of intangibles
When identifying arrangements made for the transfer of intangibles or assessing if they are embedded intangibles or package deals and if there's an intercompany assignment of employees it would be useful if the OECD Guidelines could provide more guidance on these topics.
- Guidance on benchmarking
The transfer pricing methods described in the OECD Guidelines are general in their application and not specifically written for intangibles. However, among the transfer pricing methods mentioned, the CUP, TNMM and profit split method are most commonly applied when determining the arm‘s length price of intangibles. Little guidance can currently be found in the OECD Guidelines on the selection of transfer pricing methods for intangibles. No guidance is provided on the benchmarking process after a transfer pricing method is selected.
- Distinction between platform intangibles and future iterations of current exisiting intangibles
Generally speaking, a platform intangible is one that is anticipated to contribute to the development of future intangibles. When evaluating compensation for use of general intangibles, distinctions must be made between core platform intangibles that are further built upon and the future iterations of new intangibles that make use of the original platform intangibles.
- Arrangments made for the transfer of intangible property and determination of an arm's length remunderation
In practice, the way in which an intangible asset is transferred (or its use licensed) may have an impact on the arm's length price to compensate its holder, regardless of how the payment is implemented (upfront vs. payment periodic royalty).
- General guidelines to conduct audits relating to intangible property
Recently, tax administrations seem to be increasingly focused on conducting audits relating to the transfer or use of intangible property in MNEs. Although the OECD Guidelines include some paragraphs providing general guidance for tax administrations to assess whether an arm‘s length value has been applied when there is a high uncertainty at the time the transaction is done, a more in-depth analysis should be made and further guidance be provided in connection with some issues which may be critical when auditing these types of transactions involving IP.
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