Presentation on theme: "Transfer Pricing Case studies Workshop SAN Jose 31 March - 4 APRIL 2014 8-a. Intangibles - Basic OECD freely authorises the use of this material for."— Presentation transcript:
1 Transfer Pricing Case studies Workshop SAN Jose 31 March - 4 APRIL 2014 8-a. Intangibles - BasicOECD freely authorises the use of this material for non-commercial purposes. All requests for commercial uses of this material or for translation rights should be submitted toThe 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.
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 83976 56875 53269 72657 85343 68240 06239 38532 89330 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 2012Public consultation November 2012Revised Discussion Draft (RDD) published July 2013Public consultation November 2013 in ParisTargeted 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 controlledDoes 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 groupCapable of being used in commercial activitiesUse or transfer would be compensated in transactions between independent partiesNot a physical asset or a financial asset
7 Types of IntangiblesOECD 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) INTANGIBLESE.g. patents, know-how, designs and modelsMARKETING INTANGIBLESE.g. trademarks and trade names, customer lists, distribution channels, unique names, symbols, pictures.
8 Illustrations Quiz (not comprehensive/complete list) Intangibles for TPNot intangibles for TPPatents?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 knownhas commercial valueidentifiablenot registeredValue depends on confidentiality, may be protected byCompetition lawEmployment contractsEconomic 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 servicesGenerally registeredExamples 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 registeredBrandOften 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 TPNot intangibles for TPPatentsGroup SynergiesKnow-How / Trade SecretsMarket specific characteristicsTrademarks, Trade Names and BrandsAssembled workforceLicenses 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 notExamples: patent / trade secretsThey can be on the balance sheet or notExamples: acquired / created and capitalised / created and expensedThey 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 investorsOther publicly available information
17 Identifying intangibles Review financial informationBalance SheetNot all intangibles are recognised as intangible assets for accounting purposesMust meet definition of intangible asset (identifiable, control over a resource, and existence of future economic benefits)Must meet recognition criteria
18 Identifying intangibles Income StatementExample – Exclusive LicenseLicense execution feeRoyalty revenues/expensesRegulatory milestone payments (exclusive development rights)Product milestone payments (exclusive manufacturing rights)Execution fees on sublicensing (right to sublicense)OtherWrite-down of development costsImpairment lossAmortisation expense pertaining to intangibles (e.g. amortised development costs)
19 Identifying intangibles Cash Flow StatementProject development costsNotes to financial statements (e.g. purchase price allocations)Annual reportsMarketing activities (brochures)Internal valuationRoyalty / license agreementsFranchise agreementsInterviewsManagement/ownersR & D team
20 Where intangibles are identified, they must be taken into account: In the functional analysisIn the selection of the transfer pricing methodIn the selection of the “tested party” for a one-sided method: the less complex party to the transactionIn 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 servicesTransfer of intangiblesSale of intangiblesTransfer of rights in intangibles (eg a licence)Transfer of combinations of intangiblesTransfer of intangibles in combination with other transactions
23 Patent and trademark registrations Example 1: Rights of an enterprise to share in the return of an intangible it does not ownCompany A:Patent and trademark registrationsCountry ACountry BCountry CCompany B:R&D activitiesCompany C:Marketing activitiesLegal ownership / registrations in AAre 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? ParentDevelopmentSub CoSub CoSub CoFundingINDIAIRELAND100 m $PatentRegistrationContractR&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 intangibleFactors to be considered:Terms and conditions of legal arrangementsFunctions, risks and costs related to intangibleswho 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 intangibleOn 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, orOn 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 centreThe manufacturer getsmanufacturing rewardThe distributor getsdistribution rewardProvides funding (finance the R&D)Bears risks (failure)If successful: owns intangible developedExploits (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 developedExploit (itself or though license out)and gets the residual profitForeignIP companyContract R&DProvides no fundingBears limited risks (no risk of failure, only responsible for correct performance)If successful: no ownership of intangible developedNo 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 failureIf successful: co-ownership (generally ‘economic’)of intangible developed
30 Case 4: Cost Contribution Arrangement R&D centreMarketing ormanufacturingcompaniescan bea contract researcher,orone or more of the CCA membersAll provide funding (finance the R&D)All share risks of failureIf successful: co-ownership (generally economic) of intangible developed
31 DiscussionThese 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 soin its own capacity,as a contract researcher,through joint research, oras a member of a CCA?
33 Importance and difficulties of valuation Book value not always meaningfulHistorical costs do not necessarily represent valueAccounting 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 IFRSReason= different depreciation rules for intangible assetsSource: 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 partiesIn practice it is unusual to find exact CUP for a controlled transactionsOther methods might have to supplement or endorse the results of a CUP analysisResale price methodMay be used in the case of sub-licensing by the associated enterprise to third parties34
35 OECD TP Methods Cost plus method? TNMM Profit split method Caution! Cost does not necessarily reflect valueTNMMSometimes possible to apply, e.g. owner of a manufacturing process licenses the process to a related party for use in a particular marketProfit split methodAppropriate when the licensee contributes significant value to the intangibleResidual profit split method is generally more appropriateOther methods may also be used where appropriate35
36 Main non-tax valuation methods Practical valuation issues:Heterogeneous, often unique nature of intangiblesEstimation of the remaining useful life of the assetForecast of cash flows and measure of the risk36
37 Valuing a licenceThe 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 licenseeRelative value of the rights granted37
38 License of an Intangible Example Licence agreement + technical know howStainless AG (Germany)Irish SubsidiaryCreates a grease stain remover which preserves the colour of the clothingPatents the inventionLicence agreement + technical know howGone for Always Inc (US)Gone for Always Inc (US) is an independent party38
39 License of an Intangible Example (continued) Irish SubsidiaryGone for AlwaysProfileFull-fledged manufacturerType of arrangementLicense + related technical know howType of licenseExclusiveRights grantedManufacture, use and sale of productsDurationPatent’s life + 20 workdays of technical assistanceGeographic scopeEuropeUS3939
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 technologyCost 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 existTerms of the transfer, including geographic limitationsUniqueness of the propertyConsider from the perspective of the transferee AND the transferor41
42 Use of Valuation Techniques Use of valuation techniques specifically approvedNo comprehensive summary of acceptable valuation techniquesNo endorsement of particular valuation practices or standardsPurchase price valuations are not determinative for transfer pricing purposesTechniques based on discounted value of cash flows can be especially usefulBut 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 uncertainWhat would independents have done? Possibilities:Value anticipated benefits (subsequent developments are foreseeable and predictable?)Short term agreementPrice adjustment clauseSliding scale royalty (royalty rates increase or decrease with sales)Renegotiation of main contractual termswhere major unforeseen developments, or transaction becomes uneconomicSee explanation in paras OECD TP Guidelines43
44 Valuation of Intangibles - Information Requests - The following information may assist in determining transfer price/value:Transfer pricing agreementsRoyalty/license agreementsDevelopment/exploitation contractsFinancial statementsForecasts/projections (e.g. royalty revenues)Operational documents (e.g. manuals)Registration documents (e.g. patent application)Judicial decisions/court ordersTechnology dataProduct life cycle informationDevelopment costsTrade publications (in subject industry)44
45 Transactions Involving Use But Not Transfer of Intangibles General rules of Chapters I – III applyIntangibles are an important comparability factorComparables can often be found even where intangibles are used by one or both partiesWhere the existence of unique and valuable intangibles makes comparability difficult, methods not relying on comparables, including profit splits and valuation techniques may be necessary