Transfer Pricing Aspects of Intangible Property (IP)

1. Transfer Pricing Aspects of Intangible Property (IP) Dr. Vikram Chand Executive Director, International Tax Education, University of Lausanne vikram.chand@unil.ch

2. Transfer pricing for IP – Key questions • What is the significance of IP • What is the definition of IP and how do you identify if intangibles exist • Who is the owner of IP • What are the common IP transactions within a MNE • How do you determine the ALP for IP transactions

3. Significance of intangibles

4. Signifiance of intangibles • Main force of economic activity and growth • Gives an MNE a competitive edge • Do a comparison between the following products with and without the brand name • Gucci • Rolex • Question – Will you pay the same for the product without the brand name? • Premium profit is always attributable to the IP

5. Forbes – World’s Most Valuable Brands Source: http://www.forbes.com/powerful-brands/list/#tab:rank, accessed 21 December 2015

6. Definition and identification of intangibles

7. What is an_intangible? » no physical or financial asset owned or controlled « » compensated

8. Definitionof IP • Marketing intangibles are • Trademarks (eg - The Pepsi and Mc Donalds Logo) • Trade names ( eg - Microsoft Inc, CNN) that aid in the commercial exploitation of a product or service • customer lists (eg- client contacts of a bank) • distribution channels (eg - sourcing contracts for raw materials) • unique names, symbols, or pictures that have an important promotional value for the product concerned Trade intangibles are: • Patents (eg - Zantac by Glaxo) • Know-how and secrets: (eg -The Coke formula) • Designs (eg - Aviator sunglasses ) • Models ( eg - Credit scoring in the financial services industry) used for the production of good or the provision of a service • as well as intangible rights (eg - engineering drawings, computer software) that are themselves business assets transferred to customers or used in the operation of a business What about • Rights under government licences (exploitation of a gold mine) • Limited rights in intangibles (sub licences) • Goodwill (reputational value) • Group synergies (borrowing or purchasing power) • Market features (location savings)

9. Identification of intangibles • Starting point willbelegal and accounting information such as legalagreements, annual reports, inter companycontracts etc. However, • Intangibles can be protected or not • They can be on the balance sheet or not • Where they are not protected and not on the balance sheet, identification and determination of ownership can be difficult • To identify intangibles, a thoroughfunctionalanalysis must beperformed to identify the parties responsible for DEMPE functions • Interviews • Historical background of the company • Financial information released for investors (e.g. IPOs)

10. Ownership of intangibles

11. Contractual arrangements are silent: Ownership of IP for transfer pricing purposes • FP, a foreign corporation, is the registered holder of the ‘Sushi’ trademark in Country A. FP licenses to its Country B subsidiary, B Sub, the exclusive rights to manufacture and market products in the Country B under the ‘Sushi’ trademark •  As a result of its sales and marketing activities, B Sub develops a list of several hundred creditworthy customers that regularly purchase ‘Sushi’ trademarked products • Neither the terms of the contract between FP and B Sub nor the relevant intellectual property law specify which party owns the customer list. Who do you think is the owner of the customer list?

12. Economic ownership • OECD work on Intangibles • Intangible related returns should be allocated among entities based on the functionsperformed, assetsused, and risksassumed in the: • Development; • Enhancement; • Maintenance; • Protection; and • Exploitation of intangibles • Focus on economicownership as opposed to legalownership

13. The IP Funding case • Facts: • Co A, a leading pharmaceutical company, infuses funds via equity and debt in the groups principal entity • The principal entity enters into a research and development contract with Co B. The contract stipulates that Co B shall be entitled to a service fee, on a cost plus basis, for the R&D related work it performs. All IP emanating from Co B’s research shall legally belong to the principal entity • The principal entity is set up in a low tax jurisdiction. Furthermore, that entity employs five employees. These employees are in charge of IP administration • The actual conduct indicates that the senior management of Co B are taking the important strategic decisions related to the design and direction of the R&D program and the related budgets (financial decisions) • Issue: • According to Australian TP rules, can the IP be allocated to the principal for TP purposes? If no, why? Who bears the development risk? Co A State A Is IP and corresponding future royalty income allocated to this entity? Principal State B Is IP and corresponding royalty income allocated to this entity? Australia Co B

14. IP related transactions

15. IP transactions within a MNE with intangibles • Transactions involving transfer of intangibles or rights in intangibles • Transfer of intangibles or rights in intangibles (license or sale) • Transfer of combination of intangibles (the pharma example) • Transfer of intangibles or rights in intangibles in combiation with other business transactions (the franchise example – Mc Donalds or Subway) • Transactions involving the use of intangibles in connection with sale of goods or performance of services (no transfer of intangibles) – car manufacturer example

16. Determining the arm’s length price

17. Exclusivity Comparability factors Rights to enhancements, revisions and updates Stage of development Other factors may be important in specific cases Geographic scope Expectation of future benefits Risks associated with the intangible Useful life

18. Methods to beapplied • The OECD TP guidelines outline the following methods for dealing with intangibles: • The Controlled Uncontrolled Price (CUP) Method for transactions involving sale/license of intangibles • The Profit Split method (PSM) for transactions involving unique intangibles • The use of valuation techniques

19. Case study – Internal and External CUP • CASE STUDY ON COMPARABILITY

20. Hard to value intangibles • Facts: • Co A, a software company operating in the American Market, funds and carries out all related software research and development activities. The entity has 5000 technical employees • IP Co (Irish subsidiary) also carries out software related R&D activities. IP Co A has 500 technical employees • In year N1, Co A transfers the rights to a partially developed software (“version 1”)to the IP Co. Based on an independent valuation report, the sale price is fixed at USD 10 million (ex ante) • While determining the transfer price, the valuators expected that only 1 million products, from exploitation of the IP (when it is fully developed), will be sold. This was assumed without a detailed analysis • In year N2, IP Co enhances the software (“version 2”) and in year N7 it sells 10 million products from exploitation of the IP • It is the normal practice of independent parties in this industry to agree on “price adjustment” clauses to take into consideration unexpected benefits. The related party agreement does not include that clause • Issue: • Is the consideration of USD 10 million at arms length? • OECD: Further guidance expected Co A Sale Capital gains USA Ireland IP CO