Transfer Pricing – Intangibles Valuation And Tax Planning Face More Headwind

The OECD’s July 2013 revised discussion draft (“the Revised Draft”) on transfer pricing aspects of intangibles include some updates that may impact MNC’s tax planning of intangible assets (“IP”).

The Draft adopts a broad definition of intangibles and provides guidance on what is not considered intangible assets.

There was guidance on how the funding of intangible development should be remunerated based on arms’ length principles. Comparability factors to consider include the following:

•  Location savings

•  Other local market features

•  Assembled workforce

•  Multinational group synergies.

The Revised Draft adopts a more transactional approach and retains a focus on functions performed, assets used and risks assumed.

Although contractual relationships between related parties are a starting point, the location where critical functions are performed is the key.

Where the legal owner of the IP outsources most or all of the important functions to related or unrelated parties, its entitlement to any material portion of the return after compensating other parties is highly doubtful.

As many US multinational corporations (“MNCs”) have IP holding structures where the IP ownership is typically held in a low-tax jurisdiction while operational activities are conducted in other parts of the world on a cost-plus basis (such as in the form of contract manufacturing or contract R&D), the above OECD draft comments may spur some concerns for future US IP tax planning.

Specifically, the Revised Draft recognizes for the first time bearing a funding risk, without the assumption of further risk, and without control over the use of contributed funds or the conduct of funded activity, generally would entitle the funder to a risk-adjusted rate of anticipated return on its capital invested, but not more.

The Revised Draft is part of a trend of global tax authorities to address decreasing tax revenues caused by “Base Erosion Profit Shifting” (BEPS).

Tax professionals at MNCs should pay additional attention to corporate value chain analyses and establish concrete business purposes in designing their IP tax structures.