1. Transfer Pricing Case studies Workshop SAN Jose 31 March - 4 APRIL 2014
8-a. Intangibles - Basic
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2. 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 re- allocated in the case of intangibles than production facilities.

3. Most Valuable Brand Names (in million US$)
77 839
76 568
75 532
69 726
57 853
43 682
40 062
39 385
32 893
30 280
(Source: Best Global Brands 2012, Interbrand)
Coca-Cola brand constitutes 60% of the market value of the company!

4. 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

5. 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

6. 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

7. 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.

8. 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?

9. 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

10. 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.

11. Illustrations: Trade Name / Brand
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

12. 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)

13. 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
- In cases where a structural advantage or material synergistic benefit or burden can be clearly identified and is attributable to deliberate concerted group actions, a comparability adjustment is likely to be warranted. (para20 of RDD)
- Where (such) a transfer of know-how or other intangibles results from the transfer or secondment of employees, the redulting transfer of know-how or other intangibles should be separately analysed under the provision of Chapter VI and an appropriate price should be paid for the transferred know-how or other intangibles. (para17 of RDD)

14. 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

15. 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

16. Functional analysis Interviews Historical background of the company
Financial information released for investors
Other publicly available information

17. Identifying intangibles
Review financial information
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

18. Identifying intangibles
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)

19. Identifying intangibles
Cash Flow Statement
Project development costs
Notes to financial statements (e.g. purchase price allocations)
Annual reports
Marketing activities (brochures)
Internal valuation
Royalty / license agreements
Franchise agreements
Interviews
Management/owners
R & D team

20. 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

21. 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

22. Determining ownership or rights to returns?

23. Patent and trademark registrations
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 A
Country B
Country C
Company B:
R&D activities
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)?

24. Example 2: Who is entitled to the intangible related returns?
Parent
Development
Sub Co
Sub Co
Sub Co
Funding
INDIA
IRELAND
100 m $
Patent
Registration
Contract
R&D

25. 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:
Terms and conditions of legal arrangements
Functions, risks and costs related to intangibles
who performs functions?
who bears risks and costs?
who controls the risks?

26. 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

27. Case 1: Development in its own name
(The parent company gets dividends)
R&D centre
The manufacturer gets
manufacturing reward
The distributor gets
distribution reward
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

28. Case 2: Contract Research
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
Contract R&D
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

29. 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

30. Case 4: Cost Contribution Arrangement
R&D centre
Marketing or
manufacturing
companies
can be
a contract researcher, or
one or more of the CCA members
All provide funding (finance the R&D)
All share risks of failure
If successful: co-ownership (generally economic) of intangible developed

31. 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?

32. Valuation issues

33. 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 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

34. OECD TP Methods 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
Resale price method
May be used in the case of sub-licensing by the associated enterprise to third parties 34

35. OECD TP Methods Cost plus method? TNMM Profit split method
Caution! Cost does not necessarily reflect value
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
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

36. 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

37. 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

38. License of an Intangible Example
Licence agreement + technical know how
Stainless AG (Germany)
Irish Subsidiary
Creates a grease stain remover which preserves the colour of the clothing
Patents the invention
Licence agreement + technical know how
Gone for Always Inc (US)
Gone for Always Inc (US) is an independent party 38

39. License of an Intangible Example (continued)
Irish Subsidiary
Gone for Always
Profile
Full-fledged manufacturer
Type of arrangement
License + related technical know how
Type of license
Exclusive
Rights granted
Manufacture, use and sale of products
Duration
Patent’s life + 20 workdays of technical assistance
Geographic scope
Europe US 39 39

40. License of an Intangible Example (continued)
Questions:
Are these two license agreements comparable?
Which are the differences that should be examined in greater detail? 40

41. 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

42. 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

43. Valuation of Intangibles - Uncertainties -
Valuation of intangibles can be highly uncertain
What would independents have done? Possibilities:
Value anticipated benefits (subsequent developments are foreseeable and predictable?)
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
See explanation in paras OECD TP Guidelines 43

44. 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

45. 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

46. Questions and/or comments?