Transfer pricing of intangibles Valuation

Content ●Background ●Valuation methods ○Income Based ○Market Based ○Cost Based ●Changes in new BEPS

What is an Intangible? ●Not a physical or financial asset ●Can be owned or controlled ●Use would be compensated between independent parties

Valuation ●Recognition differs between accounting and transfer pricing purposes ●Hard to value due to missing manufacturing costs ●Derives value from its projected use -> future income generated ●Guidance in BEPS 2015 ●Arm's length principle

Valuation methods Income Based Methods Market Based Methods Cost Based Methods

Income Based Methods Future cash flows attributable to intangibles are projected and discounted to the present to establish fair value Major weakness: estimating future cash flows Methods: Profit Split, Incremental Cash Flow, Price Premium

Income Based Example: Profit Split ●More as a principle than method by itself ●Splitting profits from intangible assets between divisions ○contribution to joint earnings

Income Based Example: Price Premium Theory: an intangible can warrant a price premium over and above a generic product In practice: how much more you can charge for a bike with a Batman logo on it compared to the same bike without the logo original price premium price of Batman bike

Market Based Methods Comparable transactions are found and fair value is established based on them Major weakness: often comparable transactions are not available Methods: Comparable Uncontrolled Transaction, Relief from Royalty

Example: Relief from Royalty Theory: a hypothetical royalty that a company would be willing to pay for the intangible in an uncontrolled transaction In practice: a royalty that the company would be willing to pay for the use of the Batman logo on bikes to a third party (a non-group company)

Cost Based Methods Two methods: Reproduction Cost, Replacement Cost Estimates the value of an intangible based on the current cost to replace/reproduce the intangible Major weakness: does not take into account future potential May be used in valuation of early-stage technologies or workforce

Changes of intangibles’ valuation In 2015 OECD issued guidance on transfer pricing of intangibles under BEPS Clearer definition of intangibles Ownership of intangibles Conditions related to arm’s length and comparative analysis of intangibles

Conclusion ●Main purpose is to estimate value for transactions based on intangibles to use that in aggressive tax planning and/or diminish the risk of legal offences ●Valuation of intangibles is problematic area of transfer pricing ●Valuation process (purpose & identification -> method selection -> analysis -> value of intangible) ●Income based methods most useful in practice