The area of intangibles in the context of transfer pricing has long been regarded as one of the major battlefields by tax authorities and multinational enterprises world-wide and has resulted in some of the most prominent international court cases on transfer pricing, such as the GlaxoSmithKline case in the US, which, with a purported settlement amount of US$4bn is widely regarded as the largest transfer pricing case ever settled.
From a South African perspective, transfer pricing in the context of intangibles has always been a hot topic, particularly due to the additional complexity added through the South African Reserve Bank’s policy of not allowing the transfer of intangible property developed in South Africa to any non-South African related party.
In the context of the major revision of the Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations ("the Transfer Pricing Guidelines") by the Organisation for Economic Co operation and Development ("the OECD") in July 2010, transfer pricing pertaining to intangibles was identified as one of the key areas of concern, due to insufficient international guidance in particular on the definition, identification and valuation of intangibles for transfer pricing purposes.
While many of the issues addressed in the 2010 revision of the Transfer Pricing Guidelines are relevant to intangible transactions, Chapter VI of the Transfer Pricing Guidelines, which contains special considerations for Intangible Property, and Chapter VIII, which contains guidance on cost contribution arrangements, date back to previous revisions of the Transfer Pricing Guidelines in 1995 and are, therefore, in need of updating to be in line with today’s business environment and transfer pricing practices.
OECD project on transfer pricing and intangibles
The OECD has acknowledged the need for an update of Chapters VI and VIII and, accordingly, the OECD’s Committee on Fiscal Affairs, on 25 January 2011, approved the scope of its new project on the transfer pricing aspects of intangibles. This work will be carried out by Working Party No. 6 on the Taxation of Multinational Enterprises, through a Special Session on the Transfer Pricing Aspects of Intangibles set up for this purpose ("WP6 TPI"). It is important to note that WP6 TPI is open to all interested member countries and those non-member countries with observer status in Working Party No. 6, such as South Africa.
Scope of the project
According to the scoping document released by the OECD on 27 January 2011, the focus of WP6 TPI will be on the following aspects:
The development of a framework for the analysis of intangible related transfer pricing issues, similar to the multi-step framework developed for conducting a comparability analysis set out in paragraph 3.4 of the Transfer Pricing Guidelines. The intention is not to develop a prescriptive process, but rather to provide a typical, non-compulsory process, the use of which will be regarded as an accepted code of practice.
The definitional aspects relating to the scope of Chapters VI and VIII of the Transfer Pricing Guidelines, including the relevant factors that should be considered in whether or not an intangible is used or transferred and if so, how it should be remunerated at arm’s length;
The WP6 TPI will also focus on certain specific issues involving intangibles, such as research and development activities, the differentiation between intangible transfers and services, the correct identification and valuation of marketing intangibles, cost contribution agreements, or the right of an enterprise to share in the return from an intangible, where it is not the legal owner of the intangible but might have some form of economic ownership of the intangible.
Last but not least, the scope of the project also includes the development of further guidance regarding the valuation of intangibles. In this regard, it is not expected that any specific new guidance on the selection and the application of the five OECD recognised transfer pricing methods (that is, the comparable uncontrolled price (CUP) method, the cost plus and resale price methods, the transactional net margin method (TNMM) and the profit split method) in the context of intangibles will be developed, as the Fiscal Committee is of the view that the guidance in Chapters I and III on comparability is broadly adequate and sufficient for the application in the context of intangibles. Instead, the WP6 TPI will consider the extent to which financial valuation methods and in particular the Discounted Cash Flow method should be given greater recognition in the Transfer Pricing Guidelines.
Exclusions from the Scope
It is important to note that the scope of the project only relates to the examination of transfer pricing aspects of transactions involving intangibles between associated enterprises (i.e. in the context of Article 9 of the OECD Model Tax Convention) and will not include a discussion of intangible dealings or the attribution of economic ownership of intangibles to a permanent establishment in the context of Article 7. The issues of intangible dealings in the context of the attribution of profits to permanent establishments were resolved in the 2008 & 2010 OECD Reports on the Attribution of Profits to Permanent Establishments and it is not the intention of the WP6 TPI to reopen any of these issues.
In line with the standard OECD approach, WP6 TPI will invite business representatives in its discussions and it is the intention to release a discussion draft for public comment by the end of 2013.