Demystifying Transfer Pricing of Intangibles: Challenges and Solutions

Introduction Transfer pricing involving intangibles is one of the most complex areas in international taxation. Multinational enterprises (MNEs) heavily depend on intellectual property (IP) and other intangible assets such as patents, brands, and technological know-how, which are difficult to value due to their non-physical nature. Ensuring proper transfer pricing of intangibles is critical for compliance and to avoid disputes with tax authorities.

Understanding Intangibles Intangible assets are non-physical elements that contribute to a company’s value and competitive advantage. These assets include:

• Patents: Legal protections for inventions.
• Trademarks: Unique symbols or signs distinguishing products or services.
• Copyrights: Protections for original works of authorship.
• Technological Know-how: Proprietary production processes or technical knowledge.
• Goodwill: Value derived from reputation, customer loyalty, and brand recognition.

Valuing these assets is challenging as they are often unique and lack direct market comparables, unlike tangible goods.

Steps in Examining Intangibles To address the complexities of intangible asset valuation, the following steps are recommended:

1. Identify Intangibles and Associated Risks: It is crucial to identify the intangible assets and evaluate the economically significant risks involved in their development, enhancement, maintenance, protection, and exploitation (DEMPE).

2. Determine Legal Ownership: Reviewing legal agreements like registrations or licenses is essential to identify the legal owner of the intangible asset.

3. Map Out Functions, Assets, and Risks: Recognize the parties responsible for the DEMPE functions and assess their contribution in terms of assets, functions, and risks.

4. Align Conduct with Contracts: Ensure that the behavior of the involved parties aligns with the contractual terms. Any discrepancies between conduct and contract need to be addressed.

5. Evaluate Controlled Transactions: Controlled transactions related to the DEMPE functions must be identified and analyzed to ensure consistency with the legal ownership and contributions of each party.

6. Set Arm’s Length Prices: Finally, arm’s length pricing should be determined to ensure fair compensation for the contributions, based on functions performed, assets provided, and risks assumed.

Challenges in Valuing Intangibles Several key challenges emerge when valuing intangibles:

1. Identification and Classification: Companies may struggle to correctly identify all relevant intangibles, leading to disputes or misclassifications.

2. Applying the Arm’s Length Principle: Due to the unique nature of intangibles, comparable independent transactions may not exist, complicating the application of arm’s length pricing.

3. Valuation of Emerging Technologies: In industries such as biotech or software, rapid technological advancements complicate forecasting future revenue, making valuation difficult.

4. Risk Allocation: Determining which entity within the group should bear the risks and rewards tied to the intangible’s development is a major issue, especially in cost-sharing arrangements.

5. IP Migration and BEPS Concerns: Multinationals often transfer intellectual property to low-tax jurisdictions through cost-sharing agreements, raising concerns about Base Erosion and Profit Shifting (BEPS).

OECD Guidelines and Best Practices The OECD BEPS Action Plan, particularly Action 8, provides comprehensive guidance on transfer pricing for intangibles, emphasizing alignment with value creation. The guidance is particularly helpful for the valuation of hard-to-value intangibles (HTVI). MNEs should develop robust transfer pricing documentation, explaining how intangibles were valued, which includes financial forecasts and risk assessments.

Additionally, Advance Pricing Agreements (APAs) can help mitigate risks, offering pre-emptive agreements with tax authorities on transfer pricing methods, thus reducing the likelihood of future disputes.

Conclusion Navigating the complexities of transfer pricing for intangibles requires careful attention to legal ownership, risk allocation, and compliance with international guidelines. Developing strong documentation and considering APAs can help multinationals mitigate the risks of disputes and ensure compliance with global standards.

For MNEs dealing with transfer pricing of intangibles, adopting a strategic and compliant approach is essential for managing tax liabilities and maintaining transparency in cross-border operations