Part 1 – Introduction to BEPS for IP professionals
The focus on IP related issues is becoming increasingly more relevant as our economy is changing to become more digital and knowledge based. More are realising the potential of their intangibles and what commercial gains can be won if managed properly. The possible threats and costly consequences if ignored are also becoming evident in both large and small companies. A contributing factor to the latter is how IP is becoming a main character in the world of TAX through Base Erosion and Profit Shifting (BEPS).
BEPS is a practice enabled by, among other things, discrepancies in tax laws combined with aggressive tax planning by MNEs. The result is double non-taxation and reduced tax rates. The Practice is affecting development rates as it reduces tax revenues for certain countries.
The BEPS project is an effort to keep up with the dynamic market and knowledge base economy by the Organisation for Economic Co-operation and Development (OECD) countries. The result is a set of guiding action plans with different ways to tackle the problem of BEPS. Out of the 15 actions, action 8-10 of the report deal with Transfer Pricing (TP) and intangibles. More information about the different actions can be found here http://www.oecd.org/ctp/beps-actions.htm
Transfer Pricing is how goods and services are priced when they occur within an MNE group. An intra group transaction should be treated according to the arm’s length principle. The problem of adopting this principle when it comes to intangibles is the difficulty to define intangibles and how and when they are transferred. The previous guidelines have put an emphasis on legal ownership of intangible assets and this has resulted in the possibility to artificially shift profits through contractual arrangements like remuneration schemes and royalties.
In the new guidelines a mere legal ownership will not, on its own, justify any returns. The profits rendered from intangibles should rather be allocated based on what value contribution functions a group member and what risk they take in relation to the intangible asset and the transaction. The definition of intangibles is also broadened and a guide of how to deal with Hard to Value Intangibles (HTVI) has also been included.
The guidelines aim to improve the understanding on intangible assets and how they should be considered for the purpose of determining the correct pricing method and under what conditions the transaction occurs. For any large MNE the work in untangling these relationships will be vast and from an IP perspective several questions arise:
- What are the main difficulties MNEs will experience as they start to unravel their IP ownership structures?
- What resources and systems must be implemented in order to cope with the demand of clearly articulating their IP, rights to IP and how it is transferred?
- The identification of risk assumption in relation to IP will be different in regard to what value contributing functions are undertaken, how is this practically operable when the understanding of IP is limited in the group?
Although there is a large risk of making errors when transfer pricing and aligning business and operations to the new BEPS regulations, there is also a lot to be gained in improving one’s understanding and controlling of IP.