The taxation of transactions involving intangible assets (either by licence of use or directly by their transmission) is possibly the OECD's biggest concern on transfer pricing and international tax at the moment. Action Group 8 was tasked with developing guidance on the transfer pricing aspects of intangibles.

Definition

According to the OECD guidelines, the term "intangible" refers to those non-physical or financial assets to be disposed of or controlled for use in commercial activities, transfer or whose use should be compensated as if it occurs between nonrelated parties.

Action Plan 8 develops standards to prevent BEPS as a result of intragroup transfer of intangibles with the following implications: 

  • Adopt a comprehensive and clear definition of "intangible".
  • Ensure that the benefits associated with the transfer and use of intangible assets are properly allocated according to value creation.
  • Develop transfer pricing rules or special measures for the transfer of difficult-to-value intangibles.
  • Provide updated guidance in cost contribution agreements.

Special Measures Under Consideration

Alongside revised guidance on transfer pricing and intangibles, the following special measures will be considered: 

  • Difficult-to-value IP. Provide tax administration with authority to apply rules based on real results ("according with income" standards)
  • Financial returns. Limit the return of entities that provide only financing services. Treat such entities as lenders rather than equity investors.
  • Mandatory sharing of benefits. Apply quotas/profit split to capital gains of certain transfers of difficult-to-value IP.
  • Capitalisation. Implement Article 7 on attribution of profit to subsidiaries regulations (asset and risk allocation through the "Significant People Function" for situations involving excessive capitalisation of low-function entities).

Key Issues Addressed in the Revised Guidance

OECD has also provided guidance in relation to intangibles, brief details of which are set forth below:

Chapter I 

  • Location savings. Should not be considered an intangible, but prices should be based on comparable transaction in the local market. When such comparable cannot be identified, comparability adjustments may be necessary.
  • Uniquely assembled workforce. Transfers should not necessarily require a payment, but any know-how, saving time and associated costs (or any detrimental effects) should be reflected in the price according to the "arm's length" principle.
  • Synergies. Compensation is appropriate only when there is "a deliberately concerted action of the group" which provides material advantages. The benefits should be allocated based on the contribution to the creation of synergy savings.

Chapter VI

  • Intangibles continue to be classified either as "marketing" or "trading" intangibles, although it is clear that the classification of an intangible does not affect the required analysis level of transfer pricing.
  • A functional analysis must be performed in order to understand how an intangible interacts with other functions, assets and risks of MNEs; therefore an analysis made from a single perspective cannot reliably value a transaction involving an intangible.
  • Legal ownership alone does not confer any right to retain ultimately any return on the intangible. Also, the intangible's financing developed in isolation is likely to result in a level of return on financing other than "return on equity".
  • It is possible that a dealer could increase the value of an intangible, in which case the nature of the costs and the substance of the (future) rights of the relevant part should be reviewed.
  • In general, no payment should be made simply for using the trademark of the group. Any consideration paid should reflect the functions, assets and risks assumed by the user of the trademark in the improving value of the trademark in their jurisdiction.

Intangibles Developed by Employees

In relation to intangibles developed by the employees themselves, the following should be taken into account:

  • Design and control of marketing and research programs.
  • Priorities setting and management for creative companies, including determining the course of a "blue-sky" investigation or a basic research.
  • Control over strategic decisions in relation to development of intangibles.
  • Significant decisions on the defence and protection of intangibles.
  • Management and control of budgets.
  • Quality control of functions undertaken by others.

Studies

The studies are focusing on the following issues: 

  • Intangibles based in workforce: Comments on the organised workforce, consideration of the right to use intangible assets of temporary employees.
  • Developed IP against acquired IP: New distinction between "intangible internally developed" and "intangible fully developed and currently exploitable".
  • Ex ante analysis: The new definition includes a distinction between ex ante and ex post.
  • Important functions: New list of important functions to be done/controlled by the owner.
  • Price analysis: Potential for using an analysis not based on comparable (profit split, valuations, etc.) in the absence of comparable observations.

Tax Authority Activities

Areas in which more tax authority activity is expected include: 

  • Rates of input and output royalty payments.
  • Price of franchise rights in which the business model is well established.
  • Existence of royalties for the group name.
  • Level of local marketing expenses incurred by distributors.
  • Valuation of intangibles transferred within the group.
  • Group's synergies captured by a centralised entity.
  • Return level where the owner of intangible outsources a significant part of this development activity to related parties.
  • Comparability where "local market characteristics" influencing prices are observed.
  • Movements of workforce—groups and individuals who could transfer know-how.

Conclusions

The application of these regulations must overlap with a multitude of domestic tax regulations by governments that obviously seek greater economic and tax efficiency of investments globally. In view of the results of the action plan, it is clear that the OECD is not seeking a radical change in the rules governing international taxation but pursues the inclusion of numerous modifications and adjustments which may have a significant impact on the taxation of multinational companies. Further developments may be forthcoming, as the reports issued to date contain a reference to the future evolution of the outstanding areas and are, therefore, preliminary.