Print Edition
September 2010 
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Transfer Pricing Of Intangible Assets |
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Pauline Renaud, August 2010 |
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Valuing intangible assets such as trademarks, copyrights and patents for tax purposes can prove to be a complex task. It is often difficult to estimate the cost of development and resulting profits and to analyse the correlation between the two. Nonetheless, the intangible nature of IP rights makes them easily movable and creates the potential for valuable tax planning and profit maximisation. Transferring intellectual property between subsidiaries in different countries, for example, allows a company to reposition cash. But transfer pricing of intangible assets bears some risks as it can lead to valuation disputes between tax authorities in the jurisdictions concerned.
In recent years, intangibles related to marketing and technology have become crucial sources of value and of competitive distinctiveness and now play a greater role in a company’s profitability. “Today’s world, with ever reducing differences in availability of routine factors of production, is evidenced by highly increasing level of competition in every field.
In such a situation, intangible assets can enable their economic owner to survive, thrive or even succeed,” explains Kunj Vaidya, an associate director at PricewaterhouseCoopers. “Research has proved that intangible assets comprise, on an average, nearly 75 percent of a company’s value.” Given these improving results, there has been, over the last few years, a shift away from physical assets, whose returns are eroding, to IP assets, given the easier access to information across global markets.
The growing importance of intangibles is also due to third-party providers serving an increasingly large portion of the supply chain. “While traditional businesses tended to rely heavily on the effective use of their equipment and other tangible assets to cut costs and enhance their competitiveness, recent advancement of information technology and globalisation of the world economy has paved the way for businesses to create new markets using information, knowledge and other intangible assets,” says Sai Ree Yun, a partner at Yulchon. “During this process, many enterprises were able to develop brand-name recognition, a valuable asset based on which they were able to gain and maintain a competitive advantage in the market.” He adds that these factors combined with the advent of active research on the valuation of intangible assets in the 1990s caused intangibles to emerge as key value drivers for many multinational enterprises.
Valuation issues
But given the nature of IP assets, difficulties can arise when seeking to value them for tax purposes. Lack of external comparables along with uncertainty about the future make accurate valuations a challenge in most cases. “Intangibles are, somewhat by definition, unique,” says Nathaniel Carden, a partner at Skadden, Arps, Slate, Meagher & Flom LLP. “Therefore, it is often difficult to use broader economic and transactional data to assess their value, since direct comparables often do not exist. Also, no company seems to believe that its ability to create value is attributable to just one intangible. Consequently it can be very difficult to disaggregate the value created by specific intangibles,” he adds. Analysing the link between the cost of developing an intangible asset and the resulting profits is indeed almost impracticable. Also, tax authorities may have a different view than that of the company regarding the future returns of a specific intangible.
Difficulties and risks are usually greater in cross-border situations, as the notion of value can differ substantially from one country to another. “The different rules affecting the profit attributable to intangible assets, useful economic life and capital costs in the home country and each host country render accurate valuation of intangible assets even more difficult,” says Mr Yun. “But generally speaking, transfer pricing methods widely used for valuation of intangible assets worldwide can be classified as market-based pricing, cost-based pricing, and discounted cash flow methods.” Joint ownership of IP across different countries can make valuation even more complex from an operating perspective. But cost-sharing agreements – which allow the parties to the agreement to attribute proportional share of costs relating to the development of intangible property based on their anticipated share of the benefits to be derived from that property – are usually considered to be one response to such challenges. Besides cost-sharing arrangements, ownership transfers and licensing of intangible assets are two other instances that involve transfer pricing.
With adequate planning, transfer pricing of intangible assets to low-tax jurisdictions can help in the effective allocation of functions and risk within a multinational enterprise and can reduce their worldwide tax exposure. “It is common for companies to centralise their intangible assets in a low-tax jurisdiction. Given the current global tax scenario it has become increasingly important to ensure economic substance in the central group entity where the intangible asset resides to achieve an optimal global tax position for the group. Transfer pricing beautifully achieves both these goals in one go. Since the valuation of any intercompany transaction, including transfer of intangible assets, is based on the arm’s length principle, the resulting valuation by definition finds its foundation in the underlying functions, risks and assets employed,” says Mr Vaidya. Also, a company may centralise its ownership of intangible assets so that the payments made to subsidiaries for these assets can offset current losses.
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