BEPS Action Plan 8: Transfer pricing of intangibles

SUITS THE C-SUITE By Deonah L. Marco-Go

Business World (03/02/2015 – p.S1/5)

(Second of two parts)

IN LAST WEEK’S column, we discussed Action Plan 8 of the Base Erosion and Profit Shifting (BEPS) report issued by the Organization for Economic Co-operation and Development (OECD), on the revisions to the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (2010) (the “2010 OECD TP Guidelines”) on intangibles. We discussed the amendments to Chapter I and II, which added areas where comparability issues may arise and other methods to be revisited. We also started with the amendments for Chapter VI, which covered the definition of intangibles and the ownership and transactions involving intangibles.

We will continue with the other amendments to Chapter VI of the 2010 OECD TP Guidelines.

IDENTIFYING TRANSACTIONS INVOLVING INTANGIBLES

In addition to identifying with specificity the intangibles involved in a particular transfer pricing issue, and identifying the owner of such intangibles, it is necessary to identify and properly characterize the specific controlled transactions involving intangibles at the beginning of any transfer pricing analysis.

The guidelines identified and differentiated two general types of transactions, which are:

1) Transactions involving transfer of intangibles or rights in intangibles; and
2) Transactions involving the use of intangibles in connection with sales of goods or performance of services.

The first type involves the transfer of all rights or only limited rights in the intangible. The second type involves controlled transactions where intangibles are used, but no transfer of the intangibles or rights in the intangibles takes place.

The guidelines discussed some of the specific features of intangibles that should be taken into consideration in conducting a comparability analysis, such as exclusivity and duration of legal protection.

Controlled transactions involving intangibles which are exclusive in nature, such that the legal owner may exclude others from using the intangibles, are comparable to uncontrolled transactions involving exclusive intangibles as these transactions may involve market advantage which is not present in transactions involving non-exclusive intangibles.

The duration of legal protection also affects the comparability analysis. An example provided is when two otherwise comparable patents will not have equivalent value if one expires at the end of one year while the other expires only after ten years.

Other features discussed were: geographic scope; useful life; stage of development; rights to enhancements; revisions and updates; and expectation of future benefit.

SUPPLEMENTAL GUIDANCE ON TRANSFER PRICING METHODS

Depending on the facts, any of the five OECD transfer pricing methods may be the most appropriate transfer pricing method in case of transfer of intangibles or rights in intangibles. However, according to the guidelines, the Comparable Uncontrolled Price method and the transactional profit split method are likely to prove useful in case of transfer of intangibles or rights in intangibles.

The use of other alternatives, such as valuation techniques, is also recognized as a useful tool. The guidelines further discussed the application of income-based valuation techniques, especially valuation techniques premised on the calculation of discounted value of projected future income streams, or cash flows derived from the exploitation of the intangible.

Depending on the facts, valuation techniques may be used as part of one of the five OECD transfer pricing methods or as a tool that can be usefully applied in identifying arm’s length price.

The guidelines also emphasized that it does not intend to set out a comprehensive summary of the valuation techniques. It also does not intend to endorse or reject one or more sets of the valuation standards utilized by professionals.

SUPPLEMENTAL GUIDANCE FOR TRANSACTIONS WITH INTANGIBLES

Where intangibles are present, the transfer pricing analysis must carefully consider the effect of the intangibles involved on the prices and other conditions of controlled transactions. Whether the intangible involved is unique and valuable should be taken into consideration in conducting comparability analysis. Similar to the discussion earlier in case of transfer, it is also important to clearly and distinctly identify the intangible involved in cases of transactions which do not involve transfer of intangibles.

ARM’S LENGTH PRICING WHEN VALUATION IS HIGHLY UNCERTAIN

The BEPS Action Plan suggests that this is one area for future BEPS related work. As of the time of the report, the wording of the 2010 OECD TP Guidelines has been retained. However, it is expected that substantial work will be done on this chapter this year.

With the effectivity of the Philippine Transfer Pricing Guidelines or Revenue Regulations No. 2-2013, which is largely based on the OECD TP Guidelines, businesses should be aware of the BEPS work on intangibles. Although some sections have not yet been finalized, the report may already serve as a useful tool in determining the likely approach of the OECD on transfer pricing issues on intangibles.

Deonah L. Marco-Go is a Tax Senior Director of SGV & Co.