Danish Tax Tribunal Rules on WACC in IP Transfer Valuation, Rejects Lower Discount Rate for Routine Functions

A recent Danish Tax Tribunal case addressed the valuation of intellectual property (IP) transferred from a Danish principal entity to a new group principal during a restructuring. Post-transfer, the Danish entity became a routine service provider.

The taxpayer valued the transferred IP using a Discounted Cash Flow (DCF) method, deducting the estimated value of its future routine functions from the total enterprise value. The tax authorities disputed this adjustment, arguing the routine functions were overvalued.

Key Tribunal Findings:

1. DCF Method Accepted: The Tribunal affirmed the DCF method as appropriate for valuing transferred IP.

2. Routine Functions Have Value: It agreed that the continuing routine functions retained by the transferor held measurable value.

3. Critical Issue - Single WACC Applied: The Tribunal's central ruling was that a single, high Weighted Average Cost of Capital (WACC) of 20% must be applied to both the consolidated business cash flows and the projected cash flows from routine services. It rejected the taxpayer's use of a lower WACC (8%) for the routine functions.

4. Rationale for High Routine WACC: The Tribunal emphasized that the routine entity's cash flows were not economically independent. Its revenues were entirely dependent on the group's success (single-customer risk) and its service contracts were terminable at short notice (90 days), negating the assumption of low-risk, perpetual cash flows. Therefore, its risk profile aligned with the overall group, justifying a similarly high discount rate.

Outcome: Using the lower WACC had artificially inflated the value attributed to routine functions, thereby understating the residual value of the transferred IP. The adjustment effectively reallocated significant value (2.5x) back to the IP.

Key Takeaway: Taxpayers must exercise caution when applying a reduced WACC to routine entities in such valuations. Tax authorities will scrutinize deductions for routine functions. Robust documentation is required to justify a lower discount rate by demonstrating that the routine entity's risks are genuinely insulated from group risks through long-term, protective contracts. Otherwise, authorities may impose the group's higher WACC, significantly increasing the calculated value of transferred IP and potential tax liabilities.