Transcript TRANSFER PRICING: OECD GUIDELINES

Transfer Pricing Workshop
Cairo
14-25 February 2010
Identifying Intangibles
Legal vs. Economic Ownership
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Transfer Pricing Background

OECD Transfer Pricing Guidelines,
Chapter VI, March 1996:
“Special considerations for Intangible for
Property”

Chapter VIII, August 1995:
“Cost Contribution Arrangements”

Examples in Annex (AN-15), February
1998:
“Intangible property and uncertain valuation”
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The functional analysis and
the portable profit potential
Low Added Value $
Functions
Mobile?
High Added Value $$$
Assets
Risks
Tangibles
Intangibles
Operational
Entrepreneurial
$
$$$ Mobile
$
$$$ Mobile
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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 in ‘No Logo’ London, © 2000).
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Issues for tax practitioners
and tax authorities

How to define intangibles?

How to identify intangibles?

How to determine ownership?

How to value intangibles?
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How to identify intangibles?
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Starting point will be legal and
accounting information, but…

Intangibles can be protected or not
– Examples: patent / know-how

They can be on the balance sheet or not
– Examples: acquired / created and capitalised / created
and expensed

They can be remunerated or used free of charge by
other group companies (often in good faith)

Where they are not protected and not on the balance
sheet, identification and determination of ownership
can be difficult
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To identify intangibles, a thorough
functional analysis must be performed

It is not sufficient to rely on the balance sheet

It is not sufficient either to rely on the P&L accounts (in
case the taxpayer omits to charge some valuable
intangibles used by related parties):

Risk assessment forms which are filed with tax returns
in some countries often prove insufficient in this respect
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To identify intangibles, a thorough
functional analysis must be performed

Interviews

Historical background of the company

Financial information released for investors (e.g. IPOs)
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Where intangibles are used in a controlled
transaction, they must be taken into account:
 In the functional analysis (“functions performed taking account
of assets used and risks assumed”),
 In the selection of the transfer pricing method,
 Comparable uncontrolled price
 “One-sided” methods: cost plus, resale price, TNMM
 “Two-sided” methods: profit split e.g. if both parties use unique,
valuable intangibles
 In the selection of the “tested party” for a one-sided method: the
less complex party to the transaction
 In the selection of uncontrolled transactions that can be used as
comparables (comparable means: no material difference or
differences can be adjusted in a reasonably accurate manner)
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Examples
1. A sells sport shoes with valuable trademark.
B sells similar sport shoes with no trademark.
2. X is a large retail store that purchases personal
computers for display in its stores and sale to
customers.
Y is a licensed distributor that purchases and
distributes similar personal computers, exploits the
trademark, participates in the development of new
products.
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How to determine ownership?

Economic vs. Legal ownership

Centralized vs. Distributed ownership
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Ownership
legal vs. economic

Legal ownership for registered intangibles (e.g.
registered patent, trademark, copyright)

Economic ownership: who is entitled to the
economic benefits?

For transfer pricing purposes, a party that bears the
costs and risks of developing an intangible should
be entitled to a corresponding beneficial interest,
even if it is not the legal owner of the intangible.
For transfer pricing purposes
economic ownership!
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Ownership
legal vs. economic

Reasons for taxpayers to segregate legal and
beneficial ownership:
– Handle all intangible registrations centrally
– Cost Contribution Arrangement (CCA) where economic
ownership is shared but legal ownership cannot be under
multiple names (para. 8.6 OECD TP Guidelines)

Taxpayer must provide sufficient documentation!
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Ownership
legal vs. economic

The OECD TP Guidelines recognise the difference
between legal and economic ownership, and provide
specific comments in this respect in relation to
marketing intangibles (marketing activities performed
by a party that does not own the trademark).

This will be discussed in further detail later.
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Ownership
legal vs. economic

In the treaty context, useful (although different)
notion of beneficial ownership
– For the purposes of determining treaty benefits, a conduit
company cannot normally be regarded as the beneficial
owner if, though the formal owner, it has, as a practical
matter, very narrow powers which render it, in relation to
the income concerned, a mere fiduciary or administrator
acting on account of the interested parties.
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Ownership
centralised vs. distributed

Centralised ownership
– Single company in the group owns the intangibles,
both beneficially and legally.
– License agreements with other group entities
need to determine arm´s length price
– Opportunity for tax planning
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Ownership
centralised vs. distributed

Distributed ownership
– A number of companies (operating companies) would
share ownership of intangibles on a pre-determined
basis (e.g. geographic territory or product application)
– It always involves shared beneficial ownership
– Usually take the form of CCA
– Less tax driven
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Various
intra-group
scenarios
to develop
intangibles
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A developer may perform
a research activity:

In its own name, i.e. with the intention of having legal
and economic ownership of any resulting trade
intangible,

On 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, or

On 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
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Case 1: Development in its own name
(The parent company gets dividends)
R&D centre
Korea




 The manufacturer gets
manufacturing reward
 The distributor gets
distribution reward
Provides funding (finance the R&D)
Bears risks (failure)
If successful: owns intangible developed
Exploits (itself or though license out)
and gets the residual profit attributable to
the intangible
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Case 2: Contract research




R&D centre
Korea






Provides funding (finance the R&D)
Bears risks (failure)
If successful: owns intangible developed
Exploit (itself or though license out)
and gets the residual profit
Foreign
IP company
Provides no funding (finance the R&D)
Bears limited risks (no risk of failure, only responsible
for correct performance)
If successful: no ownership of intangible developed
No exploitation,
No residual profit attributable to the intangible
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Case 3: Joint research
R&D centres
x countries
 All provide funding (finance the R&D)
 All share risks of failure
 If successful: co-ownership (generally economic)
of intangible developed
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Case 4: Cost Contribution Arrangement
Marketing or
manufacturing
companies
 All provide funding (finance the R&D)
 All share risks of failure
 If successful: co-ownership (generally
economic) of intangible developed
R&D centre
Can be
 a contract researcher,
or
 one or more of the
CCA members
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Discussion

These 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
so
– in its own capacity,
– as a contract researcher, or
– as a member of a CCA?
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Illustration: CCA among R&D Centers
R&D
R&D
Manufacturing
Manufacturing
Manufacturing
Manufacturing
Manufacturing
Manufacturing
Market
Market
Companies
Market
Market
Companies
Companies
Market
Companies
Companies
R&D
R&D
Clients
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Illustration: CCA among R&D Centers
R&D
R&D
Manufacturing
Manufacturing
Manufacturing
Manufacturing
Manufacturing
Manufacturing
Market
Market
Companies
Market
Market
Companies
Companies
Market
Companies
Companies
R&D
R&D
Clients
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Illustration: CCA among R&D Centers
R&D
R&D
Manufacturing
Manufacturing
Manufacturing
Manufacturing
Manufacturing
Manufacturing
Market
Market
Companies
Market
Market
Companies
Companies
Market
Companies
Companies
R&D
R&D
Clients
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Conclusion

Multinational enterprises have the freedom to fund and
organise the development of intangible property, subject to
– the legal form of the arrangement to be consistent with the
substance of the transaction and
– the arrangements, viewed in their totality, to be arm’s length
(see in particular whether consistent with functional analysis
and whether achieves an arm’s length allocation of risks)

Legal and economic ownership are increasingly
disconnected from the location where R&D is performed.

The location of legal and economic ownership of intangibles
developed have huge transfer pricing consequences. This
is a policy issue for fiscal attractiveness.
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Conclusion
 Decision where to locate R&D activities is
generally based mainly on non-tax factors
(e.g. skilled personnel),
although tax factors (specific tax breaks for
R&D activities) might help.
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But what are the tax factors taken into account by
MNEs when deciding to locate IP ownership?

Depreciation, amortisation of developed or acquired
intangible

Deduction of license fees

Treaty network

Withholding tax on inbound (and outbound) royalties

Tax rate on benefits from exploitation (business profits or
royalties)

Repatriation of earnings to shareholders

Future disposal of intangibles (exit scenarios)

Others (VAT, registration duties…)
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