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Nov 14, 2012 - Intangibles: the relevance of property law definitions, accounting definitions .... Richard GINSBERG, Can
PROGRAMME PUBLIC CONSULTATION ON TRANSFER PRICING DISCUSSION DRAFTS 12-14 NOVEMBER 2012 OECD CONFERENCE CENTRE 2 RUE ANDRÉ PASCAL, PARIS 16TH, FRANCE

MONDAY 12 NOVEMBER 08:30-09:30

REGISTRATION

09:30-10:00

OPENING REMARKS AND GROUND RULES Speakers: Michelle LEVAC, Chair of Working Party No. 6 William MORRIS, BIAC

10:00-11:00

I: DISCUSSION DRAFT ON TRANSFER PRICING SAFE HARBOURS Speakers:

Page No.

Patricia LEWIS, Caplin & Drysdale............................................................................................................... 6 - The general approach of the Discussion Draft - The usefulness of bilateral safe harbours Michael HECKEL, True Partners Consulting - The optional nature of safe harbours for taxpayers and the provisions on rebuttable presumptions; - The specific OECD proposals for bilateral MOUs An THEEUWES, Tax Executives Institute ................................................................................................... 10 - The usefulness of bilateral safe harbours; and - The proposed guidance on unilateral safe harbours 11:00-11:30

Refreshment Break

11:30-13:00

II: SECRETARIAT REQUEST FOR COMMENTS ON TIMING ISSUES Speakers: Duncan NOTT, BDO .................................................................................................................................... 14 - The arm’s length price-setting and the arm’s length outcome-testing approaches; - The need for further direction on year-end adjustments or “true ups” Brigitte BAUMGARTNER, Plansee Group Services GmbH ...................................................................... 19 - The relative merits of the arm’s length price-setting and the arm’s length outcome-testing approaches Matthew WALL, MDW Consulting Inc. ...................................................................................................... 24 - The determination of transfer prices when valuation is uncertain - Paragraphs 171 – 178 of the Discussion Draft and Examples 20 – 22 Jutta MENNINGER, BSH/PwC ................................................................................................................... 31 - The determination of transfer prices when valuation is uncertain

13:00-14:30

Lunch break

Page 1 of 180

MONDAY 12 NOVEMBER (CONT’D)

14:30-15:15

III: GENERAL DEFINITIONAL APPROACH FOR INTANGIBLES Speakers: Jennifer RHEE, Richter Consulting ............................................................................................................. 38 - The definition of intangibles in Section A of the Discussion Draft Vanessa DE SAINT BLANQUAT, MEDEF ............................................................................................... 45 - General definitional approach for intangibles Anne QUENEDEY, SALANS ...................................................................................................................... 49 - Intangibles: the relevance of property law definitions, accounting definitions and separate transferability

15:15-16:00

IV: CATEGORIES OF INTANGIBLES Ronald VAN DEN BREKEL, Ernst & Young ............................................................................................. 54 - The usefulness of the concept defined as “D.1. (vi) Intangibles” Wendy NICHOLLS, Grant Thornton UK ................................................................................................... 60 - Should the Discussion Draft distinguish between Routine vs. Unique and Valuable Intangibles?

16:00-16:30

Refreshment Break

16:30-18:00

V: TREATMENT OF GOODWILL AND WORKFORCE IN PLACE Speakers: Caroline SILBERZTEIN, Baker & McKenzie ............................................................................................. 65 - The treatment of goodwill (and related examples in the Annex) Agata UCEDA, International Tax Centre, Leiden ....................................................................................... 70 - The treatment of goodwill (and related examples in the Annex) Laurence DELORME, A3F ......................................................................................................................... 74 - The Discussion Draft provisions on assembled workforce

Page 2 of 180

TUESDAY 13 NOVEMBER

09:30-10:15

VI. DOES THE DISCUSSION DRAFT FOCUS TOO HEAVILY ON RESTRAINING ABUSIVE BEHAVIOUR? Speakers: Georg GEBERTH, BIAC ............................................................................................................................. 79 - Does the Discussion Draft focus too heavily on restraining abusive behaviour? James PHILLIPS........................................................................................................................................... 83 - Does the Discussion Draft focus too heavily on restraining abusive behaviour?

10:15-11:00

VII: DOES THE DISCUSSION DRAFT PLACE TOO MUCH EMPHASIS ON PROFIT SPLIT APPROACHES? Speakers: Gary SPRAGUE, Treaty Policy Working Group ......................................................................................... 88 - Does the Discussion Draft place too much emphasis on profit split approaches? Arnaud LE BOULANGER, CMS Bureau Francis Lefebvre ....................................................................... 93 - Does the Discussion Draft place too much emphasis on profit split approaches?

11:00-11:30

Refreshment Break

11:30-13:00

VIII: INTANGIBLES: ENTITLEMENT TO INTANGIBLE RELATED RETURNS Speakers: Alison LOBB and John HENSHALL, Deloitte ........................................................................................... 98 - The treatment of risk and control of risk, including the consistency of the draft with Chapter IX of the TPG Linda FERNANDEZ, Transfer Pricing Discussion Group ....................................................................... 103 - The general usefulness of the intangible related return concept and its definition

13:00-14:30

Lunch

14:30-16:00

IX: INTANGIBLES: ENTITLEMENT TO INTANGIBLE RELATED RETURNS (CONTINUED) Speakers: Catherine SCHULTZ, National Foreign Trade Council ........................................................................... 108 - The role of registrations and contractual arrangements; - Disregard of transactions, registrations and contracts Kate NOAKES, Fidal International Direction .......................................................................................... 111 - Compensation for marketing activities performed by associated enterprises related to the development, enhancement, maintenance or protection of Intangibles, including examples 3 through 8 Ian BRIMICOMBE, AstraZeneca .............................................................................................................. 114 - Entitlement to intangible related returns: The importance of performance of important functions and control

16:00-16:30

Refreshment Break

Page 3 of 180

TUESDAY 13 NOVEMBER (CONT’D)

16:30-18:00

X: OPTIONS REALISTICALLY AVAILABLE AND PERSPECTIVES OF THE PARTIES Speakers: Isabel VERLINDEN, PriceWaterhouseCoopers ....................................................................................... 130 - Options realistically available and perspectives of the parties and example 19 Carol Doran KLEIN, USCIB ..................................................................................................................... 136 - Options realistically available and perspectives of the parties and example 19 Patrick BRESLIN, Bates White, LLC ........................................................................................................ 140 - Options realistically available and perspectives of the parties and example 19

WEDNESDAY 14 NOVEMBER

9:30-11:00

XI: INTANGIBLES: USE OF FINANCIAL VALUATION TECHNIQUES Speakers: Jochem QUAAK and Dick DE BOER, Duff & Phelps .............................................................................. 145 - The relevance of accounting valuations and purchase price allocations for transfer pricing purposes Richard GINSBERG, Canadian Institute of Chartered Business Valuators ............................................. 150 - Use of financial valuation techniques and expressly adopting a standard of value Emmanuel LLINARES, NERA Economic Consulting ............................................................................... 161 - Use of financial valuation techniques for transfer pricing purposes

11:00-11:30

Refreshment Break

11:30-12:45

XII: DETERMINING ARM’S LENGTH ROYALTY RATES FOR LICENSING TRANSACTIONS Speakers: Brian CODY, KPMG ................................................................................................................................. 167 - Determining arm’s length royalty rates for licensing transactions and comparability standards for intangibles Ednaldo SILVA, RoyaltyStat LLC ............................................................................................................. 173 - Use of information from databases David JARCZYK, ktMINE ........................................................................................................................ 177 - Intangibles: comparability standards and use of information from databases

12:45-13:00

CONCLUDING REMARKS Speakers: Michelle LEVAC, Chair of Working Party No. 6 William MORRIS, BIAC

13:00

ADJOURN

Page 4 of 180

SESSION I DISCUSSION DRAFT ON TRANSFER PRICING SAFE HARBOURS

Speakers: Patricia LEWIS, Caplin & Drysdale Michael HECKEL, True Partners Consulting An THEEUWES, Tax Executives Institute

Page 5 of 180

-- Safe Harbours -Comments on OECD Discussion Draft Patricia Gimbel Lewis

Caplin & Drysdale One Thomas Circle, N.W. Washington, DC 20005 O: 202.862.5000 F: 202.429.3301 [email protected] www.caplindrysdale.com

November 12, 2012

Page 6 of 180

1

-- Safe Harbours -General Approach of Discussion Draft Treaty-Based Desires to Respect Arm’s Length Standard, Minimize Double Taxation, and Increase Certainty Acute Taxpayer and Government Resource Considerations

Concern with Potential Adverse Selection

#1

#2 UNILATERAL SAFE HARBOURS,

BILATERAL TRANSFER PRICING SAFE HARBOURS

WITH MAP

MOUs

Page 7 of 180

2

Particular Usefulness of Bilateral Safe Harbours  Test-drive solutions  Emulate arm’s length result via government negotiation; reduce adverse selection  Efficiently multiply benefit  Minimize double taxation risk  Enhance compliance  Increase government revenues  Enable customized MOUs for specific-country situations  Reduce impediments to cross-border enterprise  Eliminate inadvertent Permanent Establishment exposure MOU = Many Ought to Use

Overall: A+ Page 8 of 180

3

Suggested Enhancements 1. Make MOUs simpler and broader o o

Rough justice Anti-abuse rule

2. Provide model MOU for Headquarters/centralized services; tackle “benefit” aspect 3. Reduce adverse selection potential via advance election or multi-year requirement 4. Include dynamic safe-harbor updating mechanisms 5. Permit post-year-end adjustments 6. Preclude or limit safe harbors for transactions with tax havens 7. Combine with short-cut APA process for unclear cases ******** Page 9 of 180

4

OECD Public Consultation

Safe Harbours for Transfer Pricing

Paris, 12-14 November 2012

Represented by Anna Theeuwes and Alexander Koelbl 1

Page 10 of 180

Safe Harbours – General considerations  TEI welcomes the Draft’s focus on using safe harbours for nonentrepreneurial, routine tasks; such an approach will make taxpayer transfer pricing compliance less burdensome

 TEI agrees that the use of safe harbours should be optional (i.e., taxpayer may use the arm’s length principle or a safe harbour)  tax authorities should not treat a safe harbour as a rebuttable presumption of the “correct” arm’s length price

 TEI recommends working with ranges for safe harbours  Coordination with the Timing Issues Draft, TEI recommends:  that IP valuation should be done ex ante  that any ex post approach approved in the Guidelines be used only in conjunction with safe harbour rules, and that taxpayers be permitted to select either the safe harbour or the standard arm’s length approach 2

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Safe Harbours – Type of Safe Harbour  OECD should promote the use of safe harbour rules for interest rates, low value-added services, and shared services

 Unilateral safe harbour:  Set in local legislation - easy for member states  Helpful for businesses - for centralised activities out of a country

 Bilateral safe harbour:  Set in tax treaty – not so easy for member states  Complex to manage given the multinational character of MNE transactions  OECD should not encourage the use of bilateral memorandum of understanding (MOUs)  too complex to manage given the multinational character of MNEs transactions.

 Multilateral safe harbour:  Basis to be range in OECD commentaries – member states to translate in DTT or local legislation

 Supportive of development of international standards - This would promote uniformity across MOUs, further decreasing transfer pricing compliance costs and disputes 3

Page 12 of 180

SESSION II SECRETARIAT REQUEST FOR COMMENTS ON TIMING ISSUES

Speakers: Duncan NOTT, BDO Brigitte BAUMGARTNER, Plansee Group Services GmbH Matthew WALL, MDW Consulting Inc. Jutta MENNINGER, BSH / PwC

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TIMING ISSUES RELATING TO TRANSFER PRICING Overview OECD Consultation

DUNCAN NOTT - BDO 8 November 2012

Copyright © November 12 BDO LLP. All rights reserved.

Page 14 of 180

TIMING ISSUES RELATING TO TRANSFER PRICING Overview Transaction date / start date

Financial period end

Tax return filing date

Ex ante pricing

Post hoc pricing

• In advance of / contemporaneous with transaction date

• Set either at the period end of on preparation of the tax return

• Based on historic data, forecasts and expectations • Reflecting functions, assets and risk at the transaction date

• Based on more recent historic data and market and project data since start date reflects actual events not forecasts

• Pricing policy implemented in management accounts

• Implemented through true ups / transfer pricing adjustments

Timing issues relating to transfer pricing Page 2

Page 15 of 180

TIMING ISSUES RELATING TO TRANSFER PRICING Practical problems Key areas for consideration The existence of two approaches to price setting – ex ante and post hoc – can give rise to practical problems, including: • Nature of information regarding potentially comparable transactions that may be relied upon • Taxpayer initiated adjustment and whether/how these will be respected by different taxing authorities • Use and impact of post-transaction date developments • Application of these circumstances to transfers of intangibles of highly uncertain valuation and the ability to assume the existence of a post-transaction risk sharing mechanism Ex post Greater flexibility

Ex ante Third party approach Timing issues relating to transfer pricing Page 3

Page 16 of 180

TIMING ISSUES RELATING TO TRANSFER PRICING Comments and areas for discussion Clear theory

Effective practice

• Clarifying terms

• Clarity on what is appropriate available information for ex ante pricing

- Using ex ante pricing over a period of years – can a forward looking standpoint be maintained?

• Does a ‘hybrid’ approach exist in practice?

• Usefulness of ex ante approach for profit based methods • Extent (or limit) of incidence of price adjustment clauses in third party situations • Expressing a preference for ex ante or post hoc pricing in the Guidelines

• Identifying a reasonable level for contemporaneous documentation of ex ante pricing • When and how to interpose retrospective pricing adjustment

- A place for bad business decisions in transfer pricing policy?

• Enabling the ‘right kind’ of true up • Creating transparency for tax authorities without increasing administrative burden on business

Reflecting the outcome of these areas in the Guidelines Timing issues relating to transfer pricing Page 4

Page 17 of 180

DUNCAN NOTT Director - Transfer Pricing BDO LLP +44(0)20 7893 3389 (DDI)

+44(0)780 580 8969 (Mobile) +44(0)20 7893 2418 (Fax) [email protected]

Page 18 of 180

Timing issues: The relative merits of arm’s length price-setting and the arm’s length outcome-testing approaches LL.M. Brigitte Baumgartner International Tax Manager Plansee Group October 2012 Page 19 of 180

1

Plansee Group Example Sales companies and sales partners in 50 countries

Esashi

Hitzacker

Empfingen

Bruntál Mamer Lechbruck Franklin Niederkorn Livange

Warren

Liezen

Reutte

Sakura Gabrovo

St. Pierre en Faucigny Towanda Biel Alserio

Seon

Tianjin

Seoul

Shanghai

Vista

Tamsui

Zhangzhou Xiamen High Performance

Wugu

Kolkata

Materials

Mysore

Tungsten & Powders Hardmetals & Tools

Page 20 of 180

Plansee Group 2

What are we looking for?

Page 21 of 180

Plansee Group 3

 Certainty: We want to know if we are doing things right!

 Clarity on: when should be the ex post approach acceptable and appropriate and adjustments (timing & consequences on VAT and Customs)  Simplicity: regarding the applicability of TPG  Minimization: of possible disputes with the tax authorities and double taxation issues  Examples

Page 22 of 180

Plansee Group 4

THANK YOU

Page 23 of 180

Plansee Group 5

Working Party No. 6 Public Consultation on the Transfer Pricing Discussion Drafts 12 - 14 November 2012 OECD Conference Centre, Paris The determination of transfer prices when valuation is uncertain Presentation by: Matthew Wall CA CBV MDW CONSULTING INC. Page 24 of 180

Draft Paragraphs 171 - 178 (currently Paragraphs 6.28 - 6.35)

1

Draft Examples 20 - 22 give

More Guidance needed

clearer meaning and purpose

to restrict the use of hindsight for

to Paragraphs 171 - 178

"exceptional circumstances"

3

2 Draft Examples 20 - 22

Draft Paragraphs 3.67 - 3.71

(currently Annex to Chapte VI)

(currently Paragraphs 3.67 - 3.71)

Certain changes (e.g., Examples) and more Guidance (e.g., Paragraphs 3.67 - 3.71) needed to mitigate the risk of misunderstanding, misuse and dispute.

MDW CONSULTING INC.

Page 1 Page 25 of 180

Paragraph 171 – 178 of the Intangibles Draft • Information should be both relevant and reliable for arm’s length pricing. This might be information at the time of the transaction, in the year of the transaction, or at the year-end or tax filing. Example Transfer price at the time of the transaction Transfer pricing adjustment in the year of the transaction Transfer price at the year-end or tax filing

Product A Product B $13.50 $10.00 1.50 5.00 $15.00 $15.00

• More Guidance is needed to restrict the use of information after the year-end or tax filing for “exceptional circumstances only” to avoid the potential for misuse, dispute and double taxation.

MDW CONSULTING INC.

Page 2 Page 26 of 180

SUMMARY CHART of EXAMPLES 20 - 22 from the Intangibles Draft Key Facts and Assumptions

Ex. 20

Ex. 21

Ex. 22

a) Fundamental change in the facts?

Yes

Yes

Yes

b) Foreseeable at the time of the agreement?

No

No

No

c) Following third party terms and conditions?

Yes

No

No

d) Example adjusts the royalty payment?

No

Yes

Yes

e) Example uses a price adjustment clause?

No

Yes

Yes

f) Example uses hindsight?

No

Yes

Yes

OECD Guidance per Discussion Draft

(This chart is for discussion purposes only and does not reflect MDW's views or comments.)

MDW CONSULTING INC.

Page 3 Page 27 of 180

Hindsight The Tax Court of Canada has many cases that consistently state each case must be decided based on the facts and circumstances at the time without the benefit of hindsight. ... the Court must not second-guess the business judgment of the taxpayer ... should not use the benefit of 20-20 hindsight to substitute its judgment for the taxpayer’s judgment ... ... the determination ... was made not with the benefit of hindsight. When expenditures are being incurred by a person, that person does not know what the future will hold. Expenses should not be denied simply because a person, with the benefit of hindsight, made a poor business decision. ... This is easy to say in hindsight but not reasonable ...

MDW CONSULTING INC.

Page 4 Page 28 of 180

Recommendation Please consider the following guidance to be included: a)

A tax administration’s examination of a controlled transaction ordinarily should be based on the transaction actually undertaken by the associated enterprises as it has been structured by them, using the methods applied by the taxpayer insofar as these are consistent with the methods described in Chapter III.

b)

If the contractual arrangements between the related parties include a price adjustment clause or other terms that require the use of information after the fiscal year or tax filing of the transaction, the tax authority should then be allowed to consider and use this information as it relates to the contractual arrangements.

c)

If the economic substance of a transaction differs from its form, the tax authorities should then be allowed to consider the actual facts and circumstances (i.e., not assumptions) involving independent enterprises in the same or similar circumstances, and compare this to a transaction between related parties.

d)

In other than the exceptional circumstances described above, information after the fiscal year or tax filing of the transaction should not be used to determine or adjust the arm’s length price of a controlled transaction.

MDW CONSULTING INC.

Page 5 Page 29 of 180

References For further details, please consider: a)

MDW’s comments on the OECD’s Discussion Draft on Intangibles.

b)

MDW’s comments on the OECD’s Discussion Draft on Timing Issues.

c)

Contacting the presenter at: Matthew Wall CA CBV MDW Consulting Inc. 416.737.2276 [email protected]

MDW CONSULTING INC.

Page 6 Page 30 of 180

www.pwc.de

OECD - WP 6 - Special Session on the Transfer Pricing Aspects of Intangibles

Paris, November 12, 2012

Dr. Jutta Menninger

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Determination of Transfer Prices when valuation is uncertain: What is “highly uncertain”? • Current Discussion Draft on Intangibles (DDI): paragraphs 171 - 178

• Par. 171 DDI: When valuation of intangible property at the time of the transaction is highly uncertain. See par. 9.87 TPG • Par. 9.87 TPG: Transaction of an intangible when it does not have an established value (e.g. pre-exploitation).

• Several disciplines (economics, physics, natural science) provide support, how to deal with risk and uncertainty via statistical tools. • Valuation practice uses methods like the Monte Carlo Simulation: - Sensitivity analysis to understand the effect of uncertainty,

- Numerical estimation of probability distribution, - Random number generators with certain statistical properties. PwC

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November 2012 2

Determination of Transfer Prices when valuation is uncertain: Steps to deal with high uncertainty

• Par. 172 DDI: In determining the anticipated benefits, financial valuation techniques, particularly those based on the discounted value of projected cash flows, may be helpful tools. • Par. 173 DDI: Shorter-Term agreements or price adjustment clauses • Par. 174 DDI: Renegotiation of pricing agreements by mutual agreement of the parties • Par. 175 DDI: The arrangements that would have been made in comparable circumstances by independent enterprises should be followed without using hindsight.

PwC

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November 2012 3

Determination of Transfer Prices when valuation is uncertain: Suggested changes to DDI

• Define, what is meant by “highly uncertain”. • Introduce statistical tools as a means to deal with risk and uncertainty, e.g. in par. 172 and maybe also in example 21. • In most cases performing a sensitivity analysis based on statistical tools should be sufficient to determine a reliable transfer price at the time of the transaction. • Alternatively the taxpayer might be allowed to agree a price adjustment clause at the time of the transaction; although it should be noted, that in third party transactions this is not very often the case.

PwC

Page 34 of 180

November 2012 4

Contact

WP/StB Dr. Jutta Menninger Partner Transfer Pricing and Valuation Services PwC Munich, Bernhard-Wicki-Str. 8 Phone: +49 89 5790-6400 E-Mail: [email protected]

PwC

Page 35 of 180

November 2012 5

Thank you…

© 2011 PricewaterhouseCoopers AG Wirtschaftsprüfungsgesellschaft. Alle Rechte vorbehalten. In diesem Dokument bezieht sich "PwC" auf die PricewaterhouseCoopers Aktiengesellschaft Wirtschaftsprüfungsgesellschaft, Frankfurt am Main, die eine Mitgliedsgesellschaft der PricewaterhouseCoopers International Limited (PwCIL) ist. Jede der Mitgliedsgesellschaften der PwCIL ist eine rechtlich und wirtschaftlich selbständige Gesellschaft.

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SESSION III GENERAL DEFINITIONAL APPROACH FOR INTANGIBLES

Speakers: Jennifer RHEE, Richter Consulting Vanessa. DE SAINT BLANQUAT, MEDEF Anne QUENEDEY, SALANS

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Public Consultation with the OECD Definitional Aspects of Intangibles Paris November 12 - 14, 2012

WWW.RICHTERCONSULTING.COM

Page 38 of 180

OECD Invites Comments on the Scoping of its Project on Intangibles - 2010 •

Need for a clear definition and criteria of “intangibles” for transfer pricing purposes: –





Accounting, legal, economic, or transfer pricing definition.

Categorization of intangibles: –

“Soft” vs. “hard” intangibles;



Routine vs. non-routine intangibles;



Legally vs. non-legally owned intangibles.

Further guidance on specific types of intangibles: –

Marketing intangibles;



Know-how and trade secrets.

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1

The Scoping Document on Intangibles is Released by the OECD - 2011 •

Specific areas identified for further work in terms of definitional aspects related to intangibles: –

Usefulness of language related to payment for transfers of “something of value” from Chapter IX;



Relevance and usefulness of accounting, financial valuation, and legal definitions;



Factors to consider in determining whether or not an intangible is used or transferred:





Future economic benefits;



Legal protection;



Separate transferability.

Relevance and usefulness of the categorization of intangibles:



Routine and non-routine intangibles;



Marketing and trade intangibles.

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2

OECD Releases a Discussion Draft on the Transfer Pricing Aspects of Intangibles - June 2012 •

Definition in the Discussion Draft: –

“The word “intangible” is intended to address something which is not a physical asset or a financial asset, and which is capable of being owned or controlled for use in commercial activities.”



No reliance on accounting or legal definition of an intangible;



Legal protection and separate transferability being not necessary conditions for an intangible;



Distinguish intangibles from market conditions;



No attempt is made towards the categorization of intangibles;



A general list of illustrations is provided to give further guidance on identifying intangibles.

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3

Comments Provided by the Public on the Discussion Draft - September 2012 •

Majority of the respondents, who provided comments on the definition, see it as too broad and not precise enough.

The definition of intangibles is No comment, 44%

Too broad, 42%

Good as is, 9%

Too narrow, 5%

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4

Comments Provided by the Public on the Discussion Draft - September 2012 •



Major areas of concern of the public with respect to the definition of intangibles: –

An intangible is defined as “something”, and not as an “asset” or as a “property”;



Transferability of an intangible;



Legal and/or contractual protection of an intangible.

Other concerns: –

Categorization of intangibles;



Goodwill and going concern as intangibles;



Assembled workforce viewed primarily as non-intangible;



Group synergies.

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5

Questions



Does the Discussion Draft achieve the objectives established in the scoping document?



Does the definition of intangibles assist in the following:



Identify when an intangible asset has been transferred between related companies; or



Identify the existence of an intangible asset in determining intercompany pricing?

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6

OECD – 12th November 2012

General definitional approach for intangibles Vanessa de Saint-Blanquat

Page 45 of 180

Why is a clear definition of intangibles necessary in the area of transfer pricing? Key concerns: 1. Intangible assets resulting from a subjective view (ex-post analysis, vague definition, valuation, related return, residual profit split …) a) b)

c)

2. 3.

will create intangibles that might not be internationally recognised as such contradicts the aim of the OECD TP Guidelines that transaction and its price can only be determined if its nature is previously and clearly identified creates insecurity for both taxpayers and tax administrations + increases double taxation risks

Solution should be based on simple definition and formal process Objective : to protect administration and MNE’s interests (proper allocation of profits & facilitating business economic activities)

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2

What is an asset? What is an intangible? What is an intangible asset? ASSET

Not an asset if not transferrable (excluded : “something”)

Recognised by legal, contractual or accounting principles and subject to ownership, control and transferability

Not an intangible if only “right of income”, added-value or expense

INTANGIBLE ASSET

INTANGIBLE

Meets both criteria of an intangible and an asset

3 cumulative factors : protection (ex ante or ex post), functions (creation, maintenance and management), costs

(all assets are not intangibles and all intangibles are not assets)

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3

What about in practice? Process : 2 step analysis 1. Does an intangible exist? (according to the aforementioned definition) 2. How is it included in the TP policy ? (according to economic & functional analysis)

An intangible that is not an asset

An asset that is not an intangible

A company owns an intangible and licenses it to its subsidiary, which sells and commercialises the goods or services developed by its parent company. The subsidiary indeed contributes to local market development and needs to earn sufficient margin to reflect this, but does not “co-own” its parent’s intangible because it solely plays a normal role in the value chain

If a company restructures its business and ceases to carry out an activity that is transferred to another company in the group (eg: a local company is closed as another company handles its activity with more synergies at a regional level from another country), some assets may be transferred from one company to the other, but such transfer of assets does not imply the transfer of an intangible Page 48 of 180

4

Intangibles : the relevance of property law definitions, accounting definitions and separate transferability Anne Quenedey Partner Email : [email protected] 12 November 2012

Page 49 of 180

Relevance of property law definitions  Most detailed comments not in Part A “Identifying Intangibles” (paragraph 7) of the Discussion Draft but in Part B “Identification of Parties Entitled to Intangible Related Returns” (paragraphs 30 to 36)

 What is already acknowledged in the Discussion Draft:  



Intangibles protectable under intellectual property registration systems Intangibles legally protected via unfair competition legislation or other unforceable laws or by means of employment contracts “There may also be intangibles whose use is not protected under any applicable law” (paragraph 32) However : “Because legal registrations and relevant contracts form the starting point for an analysis of which members of an MNE group are entitled to intangible related returns, it is good practice for associated enterprises to document in writing their decisions to allocate significant rights in intangibles […].” (paragraph 36)

Page 50 of 180

Relevance of accounting definitions  “Intangibles that are important to consider for transfer pricing purposes are not always recognised as intangible assets for accounting purposes.” (paragraph 6)

 Comments on the example of research and development costs: 



Research and development costs are not always booked as an asset for accounting purposes (paragraph 6) Not all research and development expenditures produce or enhance an intangible (paragraph 10) accounted : YES = INTANGIBLE

R&D

accountable : YES = INTANGIBLE ? accounted : NO

accountable : NO

Page 51 of 180

Relevance of separate transferability  Discussion Draft: 





“while some intangibles may be identified separately and transferred on a segregated basis, other intangibles may be transferred only in combination with other business assets. Therefore, separate transferability is not a necessary condition for an item to be characterised as an intangible for transfer pricing purposes.” (paragraph 7) “It may sometimes be difficult or impossible to segregate or separately transfer the various intangibles contributing to brand value.” (paragraph 19) “It is generally recognized that goodwill and ongoing concern value cannot be segregated or transferred separately from other business assets.” (paragraph 21)

 Transferability separate or not is a necessary condition

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SESSION IV CATEGORIES OF INTANGIBLES

Speakers: Ronald VAN DEN BREKEL, Ernst & Young Wendy NICHOLLS, Grant Thornton UK

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Discussion Draft on Intangibles OECD Public Consultation 12 November 2012 Ronald van den Brekel, Ernst & Young

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Agenda ►

Introduction



Use of concept



Points of attention

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Introduction ► Section ►

D.1.(vi) Intangibles:

An intangible (i) that is not similar to intangibles used by or available to parties to potentially comparable transactions, (ii) whose use in business operations (e.g. in manufacturing, provision of services, marketing, sales, or administration) is expected to yield greater future economic benefits than would be expected in the absence of the intangible, and (iii) whose use or transfer would be remunerated in dealings between independent parties, will be referred to as a Section D.1.(vi) intangible.



Unique and valuable intangibles vs. routine intangibles in context of comparability



Relationship with profit split Page 56 of 180

Use of having a definition of a unique and valuable intangible ►

Welcome attempt to clarify “unique and valuable”



DD par 121: “only where the intangibles in question can be clearly and distinctly identified and where the intangibles are manifestly section D.1.(vi) intangibles.



Relationship with “unique and valuable contributions”



Comparability ►



1) tested party = “routine” function -> avoid (routine) rejection of comparables 2) tested party = intangible owner -> proposed concept might lead to (routinely) rejecting CUT’s

Page 57 of 180

Points of attention ►

Concept ► ►



Avoid “artificially” splitting an intangible into several “micro intangibles” or otherwise “unbundling” or “atomizing” intangibles To distinct between unique/valuable and routine. However: risk that comparability factors by “backdoor” are promoted to intangibles -> to be clarified

Definition in draft ► ►

Replace by more natural term Subjective and circular -> to be further elaborated

Page 58 of 180

Ernst & Young Assurance | Tax | Transactions | Advisory Ernst & Young is a global leader in assurance, tax, transaction and advisory services. Worldwide, our 167,000 people are united by our shared values and an unwavering commitment to quality. We make a difference by helping our people, our clients and our wider communities achieve their potential. Ernst & Young refers to the global organization of member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit www.ey.com. © 2012 EYGM Limited. All Rights Reserved.

This publication contains information in summary form and is therefore intended for general guidance only. It is not intended to be a substitute for detailed research or the exercise of professional judgment. Neither EYG Limited nor any other member firm of the global Ernst & Young organization can accept any responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. On any specific matter, reference should be made to the appropriate advisor. Page 59 of 180

Categorisation of Intangibles: Should the Discussion Draft Distinguish Between Routine vs. Unique and Valuable Intangibles?

Wendy Nicholls Partner, Head of Transfer Pricing Grant Thornton UK LLP

© 2012 Grant Thornton UK LLP. All rights reserved.

Page 60 of 180

Routine vs Non-routine: not helpful; not clear; not useful?

• •

• • •

Are 'routine' intangibles something that protects the business from competition but do not create super profits? If so, 'routine' intangibles are presumably assets or rights used in the ordinary course of business, for example brought into being by  'normal' levels of expenditure on marketing (by distributors) or  know-how that is widely available in the market (by a manufacturer or service provider) Our (and some other contributors') views are that intangibles must be capable of separate transferability for a consideration Hence, we do not consider that most 'routine' intangibles would be intangibles and the distinction would be moot The Draft suggests 'separate transferability is not a necessary condition...' (para 7) but does seem to agree that the routine vs non-routine distinction is not necessary and the approach should 'not turn on these categorisations' (para 13)

© 2012 Grant Thornton UK LLP. All rights reserved.

Page 61 of 180

Routine vs Non-routine: are they terms used by business?

• • • • •





Is a 'routine' intangible actually an intangible at all? Is it an arbitrary distinction? Are these terms used by businesses? Is there a 'bright line' between what is routine and what is not? Does one extra euro of marketing spend require the parties to share the intangible related returns? Is that consistent with third party behaviour? We agree not all intangibles, even unique ones, are valuable (consider all the redundant patents that gather dust on shelves) or consistently maintain that value throughout their lives. We also agree that the distinction between valuable intangibles (which would generate extra profit potential and which one might be able to sell) and other intangibles is vital to get the transfer pricing right The concept of 'unique and valuable' is therefore a helpful distinction (see para 128 regarding profit split and para 2.109). Distinguishing the term 'unique and valuable' reduces the need for inclusion of the term 'routine'.

© 2012 Grant Thornton UK LLP. All rights reserved.

Page 62 of 180

Routine vs Non-routine: suggested way forward







Whilst para 13 suggests that WP6 has not relied on the routine vs non-routine distinction, references are made to it in para 108 (residual profit split), para 148 (financial projections) and again in para 166 (useful life) If, as we and presumably WP6, believe, the routine vs non-routine distinction is arbitrary, tends towards over simplistic assumptions and does not add clarity to the analysis of who should get 'intangible related returns', then these inconsistent references should be removed In conclusion:  We agree with WP6's view that there should not be a distinction between routine and non-routine intangibles  We consider that the distinction between 'unique and valuable' intangibles and other intangibles is vital to get the transfer pricing right  Further guidance on comparability is needed in this area (especially qualitative factors) and work is required to make the wording in the Draft more internally consistent

© 2012 Grant Thornton UK LLP. All rights reserved.

Page 63 of 180

SESSION V TREATMENT OF GOODWILL AND WORKFORCE IN PLACE

Speakers: Caroline SILBERZTEIN, Baker & McKenzie Agata UCEDA, International Tax Centre, Leiden Laurence DELORME, A3F

Page 64 of 180

Goodwill and transfer pricing OECD consultation, 12-14 November 2012

Caroline Silberztein, Partner [email protected]

BAKER & MCKENZIE GLOBAL TRANSFER PRICING AND GLOBAL TAX POLICY GROUPS Page 65 of 180

Need clear definition(s) for an "important and monetarily significant" TP intangible: different words for fundamentally differing concepts (not a mere question of “context”): Name

Proposed definition

Reference

Goodwill

Portion of the purchase price, paid in Accounting the context of an acquisition of an entire business, which is not allocable to any identified asset of said acquired business

Going concern

A business or activity which is not about to be liquidated

Accounting

Common law goodwill

Clientele, activity

Legal

Profit potential

Expected future profits / losses

Not an intangible asset but a concept used for valuation purposes; see Glossary and TPG 9.66

Reputational characteristics

Reputational characteristics of otherwise existing assets

Comparability factors 2

Page 66 of 180

Examples could be improved if it was made clear what notion they are referring to: –

Example 13 : “… over the years of its operation in branch form, Ilcha developed substantial goodwill and ongoing concern value in country B. The transfer of the going business to Company S… implicitly conveys the value of that continuing goodwill to Company S” => Valuation of assets transferred in combination?



Example 14: Whether Company S is or is not ”entitled to intangible related returns associated with goodwill in respect of Product Y created through the advertising costs it has borne.” => Product-related marketing intangible?



Example 15: “Depending on the facts, a substantial portion of the value described in the purchase price allocation as goodwill of Company T may have been transferred to Company S together with the other Company T intangibles… may have been retained by Company T.” => Premium paid above identified asset value? 3

Page 67 of 180

Goodwill (accounting definition, “survaleur”) may arise from a number of factors, for instance: –

Intangible assets which are not identified or are specifically allocated to goodwill for accounting purposes



Control premium paid by the acquirer,



Premium to exclude competitors from the acquisition



Premium paid because of anticipated synergies with the acquirer's other assets or activities (may or may not materialise)



Over-optimistic evaluation by an acquirer who has imperfect information on the assets and liabilities of the acquired entity (as is always the case in arm's length acquisitions)



Etc.

 Goodwill should therefore not be assumed to systematically correspond to the value of assets of the acquired entity;  Goodwill value may or may not disappear, depending on the 4 facts and circumstances ofPageeach case. 68 of 180

Thank you for the opportunity to share our views and contribute to the debate on this important OECD project.

BAKER & MCKENZIE GLOBAL TRANSFER PRICING AND GLOBAL TAX POLICY GROUPS Page 69 of 180

Goodwill definition  Accounting: purchase price minus fair market value of assets  Psychology (buyer): bigger ego of the CEO -> bigger goodwill  Commercial/Legal: good reputation, clientele and established (assembled) well run business  Other languages: fondo de comercio (well established, synergies of the business)  Etymology: hope that "good will" come and several religious meanings  Synergy and established/assembled business common factor in all definitions  In all cases the concept has an objective/intrinsic component and (often more dominant) subjective/external component Date of presentation

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1

Goodwill measurement  Value, like beauty, is in the eye of the beholder  Aggregate value of assets vs. sum of separate tangibles and intangibles (definition in draft par. 20) ~ what is the difference to synergies?  If all intangibles assets are already identified and valued AND synergies, market circumstances, assembled workforce and other factors are considered in the comparability analysis: is there anything left?  Is there really anything left?  Most likely not, but if there is, that must be "goodwill"  Proposition: goodwill for transfer pricing purposes as the synergies resulting from having certain Functions Risks and Assets established Date of presentation

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2

Can you count the black dots?

Date of presentation

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Page 72 of 180

3

Why does it matter?  For transfer pricing purposes goodwill matters primarily when buying/selling assets intercompany: is there any goodwill? where? how do we account for it?  Possible scenarios:  When selling going concern (full business): what happens to goodwill?  When selling only some fixed or intangible assets whereas rest of the business stays: what happens to goodwill?  When selling a combination of Functions Risks and Assets ("FRAs") while some FRAs stay locally: what happens to goodwill?

Date of presentation

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4

The OECD public consultation on the Discussion Drafts on issues related to Transfer Pricing Safe Harbours, Timing Issues and Intangibles The OECD Conference Centre, Paris 12-14 November 2012

Discussion Draft (« DD ») on Intangibles Provisions on Assembled Workforce

Laurence Delorme

Page 74 of 180

Assembled Workforce in DD Section A paragraphs 25 & 26, and section D paragraph 124 Comparability factor

Intangible

impacting arm’s length price for services

capable of being transferred for a price

(25) Existence of a uniquely qualified/experienced employee group may affect arm’s length price for services provided or goods produced

(26) Contractual rights and obligations MAY be intangibles within meaning of section A.1, so that a long term contractual commitment to make available the services of uniquely qualified employees MAY constitute an intangible

(26) Transfer of an existing assembled workforce may provide a benefit to the transferee by saving it expense/difficulty of hiring and training new workforce

(26) Transfer or secondment of isolated employees does not, in and of itself, constitute the transfer of an intangible (124) Comparability adjustments may be required for matters such as assembled workforce. While such factors may not be intangibles (within meaning of section A.1.), they can nevertheless have important effects on arm’s length prices in matters involving the use of intangibles.

12 November 2012

(26) As a factual matter, a transfer or secondment of employees MAY result in the transfer of valuable know-how or trade secrets for which compensation MAY be required in arm’s length dealings.

A3F Association Française des Femmes Fiscalistes Page 75 of 180

2

Business comments (1/2) • Ambiguities in DD (i) what is meant under “transfer of an assembled workforce”, and (ii) whether “assembled workforce” qualifies as an intangible (within the meaning of section A.1 of the DD), or comparability factor (paragraph 124) • Clarifications needed Circumstances when “a long term contractual commitment to make available the services of uniquely qualified employees may constitute an intangible” –



Employer entitled to claim compensation from an employee, based on e.g. unfair competition legislation or labour law, employment contract restricting employee’s freedom (non compete, non disclosure agreement, star athletes’ contracts) Where this is the case based upon legal rights and obligations, transaction to be valued would relate to know-how and trade secrets themselves (or to value provided in the contract), and not to group of employees

• Clarifications and practical guidance needed – How in practice to undertake comparability adjustments for differences in factors such as assembled workforce

12 November 2012

A3F Association Française des Femmes Fiscalistes Page 76 of 180

3

Business comments (2/2) • Employee secondments (international mobility within MNEs) – Globalization, division and specialization of labour within MNEs – Economic necessity for cooperation on an international basis => extensive secondment programs for engineers and management executives – Seconded employees retain employment contract with home office and remain on home payroll – Service transactions, appropriately compensated with a cost or cost plus method – Skills and expertise as comparability factors only, not intangibles • Assembled workforce – Cannot be “owned or controlled” by the employer, hence cannot be sold or licensed independently of the entire business to which the workforce relates, i.e. issue of “transfer of an assembled workforce” arises only as part of a business transfer – As such, to be considered as business attribute that influence the value of an MNE’s assets, but not to be qualified as an intangible asset – Assembled workforce is NOT an intangible within the meaning of section A.1 – Assembled workforce can contribute to the development of intangibles (e.g. know-how and other legally protectable intangibles), and should be taken into consideration in transfer pricing comparability analysis 12 November 2012

A3F Association Française des Femmes Fiscalistes Page 77 of 180

4

SESSION VI DOES THE DISCUSSION DRAFT FOCUS TOO HEAVILY ON RESTRAINING ABUSIVE BEHAVIOUR?

Speakers: Georg GEBERTH, BIAC James PHILLIPS

Page 78 of 180

Public Hearing on the treatment of Intangible Assets 12th November 2012 Paris Does the Discussion Draft focus too heavily on Restraining Abusive Behaviour?

Seite 1/5

November 2012 Page 79 of 180

Georg Geberth (Siemens AG)

Businesses need a clear Definition of „Intangible“ not driven by Anti-Abuse The draft definition (« something ») is too vague and clearly driven by anti-abuse thoughts. Businesses need more clarity.

Foundation of a Definition of Intangibles • Legal principles • Accounting Principles • Contractual arrangements

Possible elements of a definition • An asset • Being capable of being owned and controlled • Separately transferrable Seite 2/5

November 2012 Page 80 of 180

Georg Geberth (Siemens AG)

Business concerns over Anti-Abuse Language

The draft implicitely focuses on abuse by mentioning numerous times that legal consequences apply only « where the parties’ conduct is aligned with contracts » etc.

Examples: • In total this or a similar wording is being used in at least 13 Paragraphs (29, 35, 37, 38, 40, 41, 42, 44, 46, 48, 55, 66, 180) • It would be better to have a clear wording, without mentioning the possibility of an abusive behaviour in all those cases • Instead, a general clause could be added at the end of the text

Seite 3/5

November 2012 Page 81 of 180

Georg Geberth (Siemens AG)

Instead, Businesses need a clear Allocation Process The draft does not define a clear and reliable process for the Allocation of Intangible Assets. Businesses need more certainty.

Allocation of Intangibles: • Who owns legal protection? • Who performs functions in relation to the ownership, the maintenance or the management of the intangible? • Who incurs costs in relation to the intangible? • Right to earn income from exploiting the asset • Right to exclude others from exploiting the asset • Right to transfer ownership or use of the asset to another owner Seite 4/5

November 2012 Page 82 of 180

Georg Geberth (Siemens AG)

Does the Discussion Draft focus too heavily on restraining abusive behaviour? Tuesday 13 November James Phillips Comments are provided in a personal capacity only

Page 83 of 180

Introductory comments •









The purpose of the OECD Guidelines should be to provide a common and objective framework, acceptable to both businesses and tax administrations, multilaterally, to help reduce the risk, and the incidence, of double or less than single taxation. The purpose of the OECD Guidelines is not to provide, or substitute for domestic, anti-avoidance or anti-abuse guidance or legislation. Unfortunately, the general tone of the current draft, no doubt a reflection of governments under domestic political pressure to increase tax yields from MNEs, seems to emphasise a preconception of, certain, tax administrations that the OECD Guidelines are an avoidance tool used by multinationals to avoid taxation which is their due. Whilst it may seem self-evident, it does bear repeating that MNEs are just as worried about double taxation as Tax Administrations and their governments are about less than single taxation, and this dynamic can impact investment decisions. This is most particularly true at the interface between Developed and Emerging Economies and intangibles are a frequent source of concern on such issues.

Page 84 of 180

Introductory comments •









The organisation and structuring of IP by an MNE is often done for wholly legitimate business reasons and it should not be seen as some form of automatic indication of aggressive tax planning. It is best practice for businesses to ensure strong control, which can often mean centralised control, of all of their high-value assets and this is even more true of intangible assets which are at particular risk of being exploited in an unauthorised manner. Businesses are required to respect the arm’s length principle, including for their intangibles - it is not a choice and correct transfer pricing is, in nature, a compliance obligation. Whilst profit splits for intangibles may superficially appear tempting, their current emphasis in Chapter VI is likely to generate serious unwanted consequences, particularly in relation to materially higher compliance burdens and costs for MNEs and significantly greater incidences of double taxation. Chapter VI, once finalized, should strive to continue the OECD’s solid track record in guiding Tax Administrations and MNEs alike in their interpretation of Article 9, particularly in such a difficult topic area as intangibles. Page 85 of 180

Introductory comments •







The OECD Guidelines and Chapter VI must therefore continue to be fundamentally based around what independent parties would do in unrelated transactions – i.e., they must reaffirm the pre-eminence of the arm’s length principle in the context of the transfer pricing of intangibles. More specifically, the Guidelines should focus around their primary and founding purpose – to provide an acceptable structure for taxpayers and tax administrations to work within in order to help avoid double and less than single taxation and, by so doing, allow international trade to grow and do its part to help rebuild the world economy. Using the OECD Guidelines other than for determining the arm’s length principle is to render the consensus weakened for increased international trade which has been so important in helping deliver economic growth, and reducing global poverty, over the last 20 years. The current financial crisis will, eventually, pass - it is far from historically unique. If, however, an additional long-term impact of the Great Recession is to retrench cross-border trade by reducing opportunities for profitable gain via the institutionalisation of double taxation, its legacy will be even more negative than it already is. Page 86 of 180

SESSION VII DOES THE DISCUSSION DRAFT PLACE TOO MUCH EMPHASIS ON PROFIT SPLIT APPROACHES?

Speakers: Gary SPRAGUE, Treaty Policy Working Group Arnaud LE BOULANGER, CMS Bureau Francis Lefebvre

Page 87 of 180

Does the Discussion Draft Place Too Much Emphasis on Profit Split Approaches?

OECD WP6 Consultation, 12-14 November 2012

Gary D. Sprague, Partner ([email protected]) Holly E. Glenn, Principal Economist ([email protected])

TREATY POLICY WORKING GROUP Page 88 of 180

Discussion Draft Does Place Too Much Emphasis on Profit Split Approaches –

Under the most reliable method requirement of the TPG, a method other than the PSM normally is the most appropriate method to apply to many transactions involving rights in or use of intangibles.



All other methods (except CUP) are based directly on comparable entities which themselves own and exploit the important intangibles necessary for their business. 

Comparable distribution entities may own client lists, operate in fast growing markets, employ an experienced sales force, and have experience in branded goods distribution.



Comparable manufacturing entities may own process technology, employ a skilled workforce, and own highly sophisticated production assets.



Comparable R&D entities may employ highly skilled engineers, have deep expertise in the industry, and have a long track record of developing successful products.



“Comparable” does not mean “identical”. It means no material differences, or that material differences can be addressed with “reasonably accurate adjustments”. TPG 1.33.



Assuming reliable comparables (with comparability adjustments when needed), a one-sided method is appropriate in most cases and a CUP method also normally is more reliable than a PSM. Page 89 of 180

2

Existing TPG Guidance on Selection of Methods Normally Can Apply –

One-sided methods normally should apply when local entity is not making unique contributions. TPG 2.59, 3.18, 3.19. 





The use of intangibles that are normal to the function is not a reason to use a two-sided method. TPG 2.60. 

Examples: distribution of branded goods, deployment of experienced development team, manufacturing using process intangibles.



We agree with DD para. 87 on this point.

Comparability adjustments can be made as necessary. TPG 2.68. 



TPG 2.109 refers expressly to contract manufacturing and contract service activities.

Example: adjustments can account for differences in technology in product, barriers to entry, growing market share, etc. TPG 2.72.

The TPG provide additional tools to increase reliability. 

Use of the arm’s length range. TPG 2.73.



Choice among different possible net profit indicators. TPG 2.76.

Page 90 of 180

3

Discussion Draft Should Focus on Reliability –

PSM frequently is an appropriate method when exploitation and further development rights are transferred, as both sides to the transaction typically are making unique and valuable contributions.



PSM is not the most appropriate method when reliable comparables exist to used a one-sided method.





Use of PSM, usually without comparable data, generally requires economically complex and frequently controversial assumptions.



Fact that a group is profitable or that “something of value” may exist in an entity’s business is not a principled reason to employ PSM.



PSM will also require loss sharing, if method is applied consistently.

Recommendations: 

Discussion Draft should acknowledge cases where one-sided methods normally are appropriate.



Further guidance could be provided on comparability factors and on use of comparability adjustments to improve reliability of one-sided methods in transactions involving the use of intangibles.



Further guidance could be provided in TPG 3.38 and 3.39 for cases where availability of local comparables is limited.



Paras. 128, 136 and 141 should be reconsidered. Page 91 of 180

4

Thank you for the opportunity to share our views and contribute to the debate on this important OECD project.

TREATY POLICY WORKING GROUP Page 92 of 180

OECD – Public consultation on transfer pricing discussion drafts - Intangibles Does the Discussion Draft Place Too Much Emphasis on Profit Split Approaches? Arnaud Le Boulanger, CMS Bureau Francis Lefebvre Partner, Chief Economist 13 November 2012 OECD Conference Centre, Paris |

Page 93 of 180

Does the Discussion Draft Place Too Much Emphasis on Profit Split Approaches? – Many commentators (more than 25) discuss in their response the fact that the discussion draft places too much emphasis on Profit Split approaches, or at least present drawbacks of this method that may not be sufficiently addressed in the document • Why do respondents largely appear to express the same general comments?

• Recommendations to better balance the merits and drawbacks of the Profit Split method compared to others

13/11/2012 |

Page 94 of 180

2

Why do so many respondents believe that the discussion draft places too much emphasis on Profit Split approaches? – The proposed guidelines set quite significant restrictions to the use of any methods… – Standards required for comparability purposes have been raised again to a level that may disregard the concept of reasonableness expressed in Chapter I of the OECD Guidelines

– The draft includes a very interesting discussion on valuation techniques. However, the draft is largely focused on the drawbacks of these methods and on the degree of subjectivity required to apply them – Other methods, such as some one-sided ones as the TNMM, are not specifically discussed in the draft

– … except to the use of the Profit Split method

13/11/2012 |

Page 95 of 180

3

Recommendations to better balance the merits and drawbacks of the Profit Split method compared to others – Does the Discussion draft miss some drawbacks of the Profit Split method? • Is this really a method that unrelated parties would use for intangibles? – Unrelated parties only rarely share any information regarding their profits, in transactions involving strategic assets such as intangibles – In what circumstances would unrelated parties use it for intangibles?

– How to minimize possible debates between taxpayers and tax administrations over Profit Split approaches when applied to transactions involving intangibles? • In our experience, Profit Split methods that create less debates between taxpayers and tax administrations are generally those based on allocation keys using obvious, quantitative data readily available such as costs or workforce. • Is this applicable to transactions involving intangibles?

13/11/2012 |

Page 96 of 180

4

SESSION VIII INTANGIBLES:

ENTITLEMENT TO INTANGIBLE RELATED RETURNS

Speakers: Alison LOBB and John HENSHALL, Deloitte Linda FERNANDEZ, Transfer Pricing Discussion Group

Page 97 of 180

The treatment of risk and control of risk, including the consistency of the draft with Chapter IX TPG Revision of Chapter VI Special Considerations for Intangibles

WP6 Public Consultation 13 November 2012 John Henshall, Partner, Deloitte Page 98 of 180

© 2012 Deloitte LLP. Private and confidential.

Recognition of the arm’s length principle •

Intangible property rights are commercial assets; a form of monopoly granted by law.



The arm’s length principle requires that MNEs follow what happens between unrelated parties according to IP laws and commercial practice.



The Guidelines need to help MNEs and tax authorities to understand what happens between unrelated parties and how to gather evidence to show compliance with the arm’s length principle. The level of functional control required is therefore that which an independent party would be expected to have in comparable circumstances.



Where comparable data exists to show the allocation of risk associated with intangible-related activity, this is the best material that MNEs and tax authorities can provide to evidence compliance with the arm’s length principle. If such evidence is available, and comparability adequately assessed, then compliance with the arm’s length principle has been satisfied.



Where such third party evidence is not available, then, as for functions, the guidance should take into account the allocation of risk when allocating intangible related returns. In that case, is there consistency with Chapter IX?

2

OECD WP6 Public Consultation Nov. 2012

Page 99 of 180

© 2012 Deloitte LLP. Private and confidential.

Consistency with Chapter IX (Business Restructuring) •

Inconsistency can arise between Chapter VI and Chapter IX only if the guidance in either one would lead to a non-arm’s length result.



Per Chapter IX the examination of risks should start with the contractual arrangements between the parties. The three additional questions that should be asked also apply to intangibles: ‒ Is the allocation of risks in the controlled transaction arm’s length? ‒ Does the conduct conform to the contractual allocation? ‒ What are the consequences of the risk allocation?



The impact of the allocation of risk, and conduct of the parties, is decided for independent parties by IP law. Chapter VI must respect that position under the arm’s length principle.



Commercial court cases around the world provide one source of evidence of how third parties should agree the impact of risk and activity allocation on the right to enjoy a return from intangibles. This material should be used when available to provide factual evidence of arm’s length behaviour, and in particular takes into account the relative bargaining power of the parties.



See for example • • • •

3

Jay-Lor International Inc et Al v Penta Farm Systems Ltd et Al 2007 FC358, Allied Signal Inc v Dupont Canada Inc (1998) 78 CPR (3d) 129, Uniloc USA Inc v Microsoft Corp., 632 F.3d 1292 (Fed. Cir. Jan 4, 2011) and Meridian International Services Limited v Richardson &ors (08) EWCA Civ 09

OECD WP6 Public Consultation Nov. 2012

Page 100 of 180

© 2012 Deloitte LLP. Private and confidential.

Treatment of risk if no arm’s length evidence available •

Relevant (but not conclusive) factors to consider in determining whether arrangements are arm’s length are • functional control of and capability to undertake risks; and • financial capacity to bear the associated risks; and • commercial “reality” of the transaction, including evidence of arm’s length behaviour in a commercial setting or dispute.

This is consistent with Paragraph 9.22 of Chapter IX: •

It is only in the absence of comparable transactions evidencing the consistency with the arm’s length principle of the risk allocation in a controlled transaction that the examination of which party has greater control over that risk is relevant;



In such circumstances, the examination of which party would have greater control over the risk “...can be a relevant factor”, meaning both that it need not be a relevant factor and that even if it is, it is not the only (or determinative) factor; and



The financial wherewithal to bear risk is also a relevant but not determinative factor.

4

OECD WP6 Public Consultation Nov. 2012

Page 101 of 180

© 2012 Deloitte LLP. Private and confidential.

Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited (“DTTL”), a UK private company limited by guarantee, and its network of member firms, each of which is a legally separate and independent entity. Please see www.deloitte.co.uk/about for a detailed description of the legal structure of DTTL and its member firms. Deloitte LLP is the United Kingdom member firm of DTTL. This publication has been written in general terms and therefore cannot be relied on to cover specific situations; application of the principles set out will depend upon the particular circumstances involved and we recommend that you obtain professional advice before acting or refraining from acting on any of the contents of this publication. Deloitte LLP would be pleased to advise readers on how to apply the principles set out in this publication to their specific circumstances. Deloitte LLP accepts no duty of care or liability for any loss occasioned to any person acting or refraining from action as a result of any material in this publication. © 2012 Deloitte LLP. All rights reserved. Deloitte LLP is a limited liability partnership registered in England and Wales with registered number OC303675 and its registered office at 2 New Street Square, London EC4A 3BZ, United Kingdom. Tel: +44 (0) 20 7936 3000 Fax: +44 (0) 20 7583 1198. Member of Deloitte Touche Tohmatsu Limited

Page 102 of 180

© 2012 Deloitte LLP. Private and confidential.

OECD Business Consultation on 2012 Discussion Draft on Transfer Pricing For Intangibles (“DDI”) November 12-14, 2012

Topic: Entitlement to IntangibleRelated Returns Under DDI Transfer Pricing Discussion Group (“TPDG”) Founded and Chaired by Steven Hannes, McDermott Will & Emery

Presentation for TPDG by Linda H. Fernandez, J.D. Eli Lilly Page 103 of 180

Return Entitlement •

TPDG supports DDI’s introductory statement: where relevant registrations and contractual arrangements align with the conduct of the parties, the party entitled to use the intangible (and exclude others from using it) is the party entitled to intangible returns.



TPDG strongly disagrees with (a) the DDI’s extreme “expectation” that entity claiming entitlement to returns from intangibles will perform, through its own employees, the important functions for development, enhancement, maintenance and protection of intangibles and (b) the DDI’s proposed requirement that the entity “control” important functions.



TPDG’s objections to the “expectation” and control requirement. – – – –



Inconsistent with third party conduct in the marketplace; an inappropriate, theoretical substitute for the arm’s length standard’s traditional reliance on facts. Third parties are often hired to provide services related to intangibles (R&D, marketing, and so forth); the hiring party does not control the services provider. Inconsistent with principles of OECD’s Transfer Pricing Guidelines (“TPG”) allowing outsourcing, whereby hiring party has capacity to decide to put its capital at risk. Conflicts with the fact-based and commercially-realistic standard in the DDI (e.g., Example 11) and OECD TPG for return entitlement for intangibles that are licensed.

TPDG’s other objections to DDI’s “control” proposal. – –

“Control” is not defined nor easily definable; it is not an administrable standard. A hiring party does not “control” a third party service provider, but it does have the capacity and expertise to enter into the contract and to bear its own risks. 2 Page 104 of 180

Return Entitlement •

Issue of Risk – –



The hiring party bears risks on discovery, development, enhancement, etc., but the service provider has its own risks & opportunities. The OECD TPG need to clarify and recognize the different types of risk borne by the hiring party and the service provider.

TPDG Proposals – – –

The legal or contractual owner of the intangible asset that bears risks and owns opportunities should be entitled to claim intangible returns for tax purposes. Outsourcing of functions related to intangible discovery, development, enhancement, etc. by an “informed hiring party” with financial capacity and expertise should not jeopardize its ownership of intangibles or its entitlement to intangible-related returns. To the extent the intangible owner outsources many or most functions related to discovery, development, enhancement, etc., its status as intangible owner entitled to returns can be questioned by the tax authority, but the taxpayer will have the opportunity to establish as a fact that it is an “informed hiring party.” In other words, that it has the financial capacity and expertise to agree to a budget or other contractual terms with the service provider as well as to determine that the contract’s terms are followed.

Page 105 of 180

3

Return Entitlement •

Concluding TPDG Observations –



– –

Chapter VI should use fact-based approaches anchored in the marketplace for determining entitlement to intangible related returns for both licensed intangibles and intangibles that are discovered, developed, enhanced, etc. by way of services performed by others, whether related or unrelated. In general, OECD TPG for intangibles (and other) pricing should avoid the DDI’s proposed reliance on speculation and theories about how either the related parties or unrelated parties “should” or “would” structure transactions or otherwise behave. Chapter VI should consistently rely on the related parties’ facts and the facts of the chosen comparables. Courts make decisions based on facts, not theories of behavior. Tax authorities should do the same to determine entitlement to intangible-related returns. The OECD TPG should consistently emphasize that before rejecting transactions or companies as “insufficiently reliable” to be used (perhaps with adjustments) as “comparables” in connection with intangibles (and other pricing matters), one must consider the relative (un)reliability of the theoretical alternatives (e.g., almost all profit splits of the residual). *

*

Page 106 of 180

*

4

SESSION IX INTANGIBLES: ENTITLEMENT TO INTANGIBLE RELATED RETURNS (CONTINUED)

Speakers: Catherine SCHULTZ, National Foreign Trade Council Kate NOAKES, Fidal International Direction Ian BRIMICOMBE, AstraZeneca

Page 107 of 180

Goals of Guidance • Conceptually sound and principled: conforms to the arm’s length principle • Clear: can be administered by tax authorities and complied with by MNEs • Objective: leads to predictable results and thereby avoids uncertainty and disputes

Page 108 of 180

Role of Registrations & Contractual Arrangements • Rights to intangible property typically arise from registrations and contractual arrangements • At arm’s length, persons with the legal right to use (and exclude others from using) intangible property can derive significant expected returns from such rights. Actual returns from intangible property may be disproportionate to the costs of obtaining or developing the rights. • In an associated enterprises setting, the arm’s length principal therefore requires that legal rights under contractual or other legal arrangements serve as a starting point for the functional analysis. Further, such rights typically attract the residual returns from the use of the intangible property given that the returns from other related assets or functions (such as R&D, marketing, or other intangible development functions) likely are easier to benchmark.

Page 109 of 180

Disregard of Transactions, Registrations and Contracts • The arm’s length principle requires that legal and contractual arrangements, which govern the allocation of risk and the ownership of assets, be respected except in rare and unusual circumstances • Rare and unusual circumstances include only where the conduct of associated enterprises is not consistent with the transaction or contractual arrangements • The functions performed by associated enterprises may be consistent with a broad range of potential legal or contractual arrangements and therefore will usually not be reliable as the primary basis for determining the return for an individual intangible • A standard that permits tax authorities to disregard legal or contractual arrangements when it believes that parties at arm’s length “would have” structured their arrangements in a different manner would not be consistent with the arm’s length principle, would be impossible to administer on a uniform basis, would substitute the administrative judgment of the tax authorities for the business judgment of the taxpayer, and would lead to increased uncertainty and disputes Page 110 of 180

Compensation for Marketing activities Paragraphs 49-51 of the OECD Draft on Intangibles and Examples 3-8 Kate Noakes, Partner – FIDAL International Direction, Paris.

Page 111 of 180

The existing paradigm



Is it still fit for purpose? What needs to change?



Reward follows functions, assets (including IP) and risks – so far so good - what is wrong with this picture?

 Reward

Full Risk Distributor Limited Risk Distributor Marketeer Functions, Assets, Risks



Often used with broad comparables data to set operating profit margin targets (resale price) or cost plus service fees for broad categories of entities with no IP related reward to the Marketeer, little if any to the Limited Risk Distributor (lower part of the range), and some for the Full Risk Distributor (higher part of the range). Page 112 of 180

Issues to consider 

Is the existing paradigm is too simplistic?



Easy to understand, apply and defend on one level, but it is potentially unsophisticated – where in the range to target? – how to make proper comparison with third party IP use/risk given lack of transparent information?



Potentially ignores marketing/brand related IP development functions and risks; changes to IP and its use over time; exclusivity of contractual arrangements; length of contract; stage of market development; global versus local marketing and brand development AND the very difficult questions of how to factor these into price setting, cost reimbursement by brand owner and so on



In practice, will we end up changing anything?



When are royalties appropriate and when is profit split appropriate? Page 113 of 180

OECD WP 6 Entitlement to Intangible Related Returns: The Importance of Performance of Important Functions and Control Ian Brimicombe Group Head of Tax and Treasury 13 November 2012

Page 114 of 180

Performance of Important Functions and Control • Identify important functions • Assess whether a function creates valuable intangibles

• Performance of functions • Risk and cost • Control

• Where are the fault lines for transfer pricing related to intangibles? •Draft discussion document on intangibles

2

Page 115 of 180

Identify Important Functions • Understanding the taxpayer business – at a group level • Activities • Build and Run spend (balance sheet and P/L) • Products/Services and component parts

• Markets • Risks within the group’s control • Dynamics and trends – growth and decline of products, markets, technologies, brands • Global functions and organisational structure • People, capabilities and culture

• M&A activity • Value drivers (intangibles; barriers to entry etc)

• Taxpayer contracts • A division of responsibilities, activities, risks, costs of each party • Relate this division between related parties to the group picture

• Assess the taxpayer entity in the group context for relative assessment

3

Page 116 of 180

Assess whether a function creates valuable intangibles • Commercial expenditure / activity does not necessarily create an intangible or valuable intangibles • Manufacturing tablets – comparable know-how • Sales force – commoditised know-how (not uniquely qualified) • AZ logo – value?

• Not all intangibles deserve separate compensation or premium returns • Normal returns may well apply e.g. Patent administration

• Look for economically significant intangibles in the context of the global business under review • R&D • Brands • Licenses

4

Page 117 of 180

Performance of functions • An understanding of the division between entities of the functions that generate economically significant intangibles is critical to the transfer pricing analysis • What do we mean by performance of function? • Conduct and contractual alignment is very important (walking the talk)

• No need to physically perform the function • Arrange under its control via independent or associated parties (outsourcing) • Retained capability and expertise needed to exert control and risk/cost bearing are key indicators of performance of a function that may entitle returns on intangibles

5

Page 118 of 180

Risk and cost • Bearing risk • Incurring cost and the financial capacity to meet downside risks • Being subject to volatility of possible outcomes of an investment decision

• Risk and cost are relatively simple to align to a legal entity structure i.e. a potential fault line in transfer pricing • Financial capacity to invest and bear risk is necessary but not sufficient and does not on its own equate to performance of a function • Alignment of costs, risks, competent risk management and control / decision making = functional performance and entitlement to returns on valuable intangibles • Service providers also have risk – failure to deliver service, negligence, stock mismanagement, foreign exchange, specific performance metrics etc but would

not be entitled to an intangible return

6

Page 119 of 180

Control • Control means capacity/capability to make decisions on investment and associated risk management • How far does a principal have to control the risks associated with the development, enhancement, maintenance and protection of the intangibles? • A rigid interpretation i.e. 100% of control must reside in the party claiming an intangible return would be inconsistent with third-party commercial

behaviour in outsourcing arrangements • Day to day control of local operational risks PE’s • Concept of an “informed hiring party” is an appropriate threshold for control • Hiring of experts should not necessarily give rise to a shift in control / intangibles

7

Page 120 of 180

Control • MNC control framework not necessarily aligned to legal entity structure • Governance framework – committees / other bodies • Group delegation of authority and accountability • Cascade of authority may be made by global function (R&D, Commercial, Manufacturing) ..... • .....results in geographical spread of individual accountability and committees made up of personnel from many countries (who move around)

• Control not singly determinative of intangible ownership • See appendix

8

Page 121 of 180

Where are the fault lines for transfer pricing related to intangibles? • What functions generate economically significant intangibles?

• Lack of alignment between the operation of global business functions and legal entity boundaries • Non-discrete legal entity functional performance

• Legal entity separation of function and risk/cost bearing • Complexity of control framework in MNC’s • Does the discussion draft resolve these issues?

9

Page 122 of 180

Draft discussion document on intangibles • Makes some excellent points: • Market conditions are not intangibles • Requires identification of relevant / economically significant intangibles • Performance and or control must be aligned with contractual assignment • Ensuring services rendered are appropriately rewarded • Entitlement to returns on intangibles needs to be informed by market practice

• Points to be clear on • Physical performance of a function is not necessary (para 40 “It is expected....”) • More guidance to identify MNC associates that are retained to perform functions and are not entitled to a return on intangibles e.g. Marketer / distributor • Are there marketing intangibles or not? • Reflect acknowledgement that degrees of control and risk exist in service providers

• Leads to a question of comparability • Does the taxpayer’s contractual arrangement reflect the bargain that would have been struck between unrelated parties under the same economic conditions?

10

Page 123 of 180

Appendix Extract from presentation made on 9 June 2009: “Consultation on the OECD Discussion Draft on the Transfer Pricing Aspects of Business Restructuring”

11

Page 124 of 180

The nature of decision making in MNE’s (1)

In this illustrative example each group decision making body:

Parent Board Executive team

•Has a Global remit; •Is populated by personnel from many countries provided by global functions;

Portfolio management

•Dynamic remit and constitution; •Draws on group data to make decisions; •Is not primarily driven by the allocation resources to legal entities.

Page 125 of 180

Product family Product

The nature of decision making in MNE’s (2) Strategic Vision and Objectives Global Functions

R&D, BD

Manufacture

Marketing/ Selling

Products

Product A

Research / Development Project Life Cycle Management Post-Launch

Product B

Underpinned by global support functions e.g. Finance, HR, Legal, CF, Legal entity framework Page 126 of 180

The nature of decision making in MNE’s (3)

Global R&D

Global Marketing & Selling

Legal entity

Marketing & Selling

R&D

Global Manufacturing

Manufacture

Global supporting functions e.g. Finance, HR, legal Local Board and corporate organisation

Page 127 of 180

Reconciling group behaviour with requirements of the arm’s length principle (1) • Given that the nature of “control” and decision making is at least in part by decisions made by global bodies and functions focused on global objectives……….. • ……and is a subjective concept……….. • ……its use in formulating a view on arm’s length behaviour is, in my view, limited. • Essentially “control” is not necessarily a determining factor for the allocation of risk in MNE’s.

Page 128 of 180

SESSION X OPTIONS REALISTICALLY AVAILABLE AND PERSPECTIVES OF THE PARTIES

Speakers: Isabel VERLINDEN, PriceWaterhouseCoopers Carol Doran KLEIN, USCIB Patrick BRESLIN, Bates White, LLC

Page 129 of 180

www.pwc.de

Draft Chapter VI - Transfer Pricing Aspects of Intangibles OECD Public Consultation Paris, 12 - 14 November 2012 “Options Realistically Available”

Isabel Verlinden: [email protected] Andrew Casley: [email protected] David Swenson: [email protected] Irving Plotkin: [email protected] Marios Karayannis: [email protected] Vivienne Ong: [email protected]

Page 130 of 180

Options Realistically Available (“ORA”): Current IP draft Current Discussion Draft on Intangibles (Draft Chapter VI): •

Paras. 80 – 84: General remarks –

Mandatory evaluation of ORA to each party for transactions involving the use or transfer of intangibles



2-sided approach required



Lowest price seller accepts vs. highest price buyer willing to pay (i.e. minimum price concept?)



Assumption: MNE groups seek to optimise resource allocation, at least on an after-tax basis



If prices is consistent with ORA of each parties (i.e. mismatch in prices), to consider: o

Recharacterisation / Non-recognition of transaction? (Para 1.65 TPG)

o

Comparability adjustment? (Para 9.34 – 9.38 TPG)

o

Indemnification? (Para 9.122 TPG)

o

Adjustment of conditions of transaction?



Paras. 126 and 139: Determining the arm’s length price when comparables cannot be identified



Example 19



Reference to Paras. 9.59 – 9.64 TPG, Paras. 1.34 and 2.122 TPG.

PwC

Page 131 of 180

November 2012 2

Options Realistically Available (“ORA”): Current TPG OECD Transfer Pricing Guidelines: Chapter IX •

Para. 9.59: Parties will only enter into the transaction if no alternative is clearly more attractive.



Para 9.60: Non- recognition vs. adjustment of conditions of transaction



Para. 9.62: Examples for ORA (termination of contract) -

Stop using the function, or internalise it,

-

Engage a more efficient provider, Or

-

Seek more lucrative opportunities.

• Para. 9.63: Sound commercial reasons only at the level of the MNE group are not enough, i.e. the remuneration needs to be at arm’s length from the perspective of each of the restructured entities. • Para. 9.64: ORA is not intended to create a requirement for taxpayers to document all possible hypothetical ORA. OECD Transfer Pricing Guidelines: Chapters I, II and III •

Para. 1.34: Link between ORA (Para. 9.59) with Chapter III (comparability assessment) -



Para 2.122: Use of the profit split method (residual analysis) -

PwC

Are there any economically relevant differences (e.g. level of risks involved)?

Lowest price seller accepts vs. highest price buyer willing to pay  Replication of bargaining power between 3rd parties? Page 132 of 180

November 2012 3

Points for discussion •

Non-recognition of transactions or structure –



OECD TPG § 1.64 – 1.69: Recharacterisation / Non-recognition only in the case of 

Economic substance of a transaction differs from its form



Structure practically impedes the tax administration from determining an appropriate transfer price



Generally accepted that associated enterprises are able to make a greater variety of contracts and arrangements than independent enterprises



Viewpoint: 

Clarify that ORA should not become a test for recharacterisation / non-recognition, but should rather, seek to achieve a balance with business reality



Limit the application of ORA only to transactions involving transfer of intangibles (and not extended to simple transactions involving the “use of” / licensing of intangibles)



Limit the application of ORA to identify “sensible” options and not impose unnecessary burden of proof for taxpayers to consider all possible options

Analysing / Reconciling each various ORA –

Best method rule (US) / Most approach method (OECD): Different TP methods apply to each ORA - How to reconcile?



How to ensure consistency in determining which ORA is the best option? Perspectives (transferor vs. transferee vs. group) often do not match.



How to account for differences at both perspectives (e.g. application of discount rates, risk factors)?



Viewpoint: 

PwC

Guidance requested on practical application of ORA (currently unclear) Page 133 of 180

November 2012 4

Example 19 – Points of attention • Insufficient information on functional and risk profile of parties involved  Leads to lack of clarity in: –

Selection of TP methodology: How to determine that the Discounted Cash Flow as the best method / most appropriate method?



Use of critical assumptions (e.g. useful life of IP, discount rates, tax rates): How to select them?

• Use of after-tax income i.e. How to reconcile the use of after-tax income to determine pre-tax transfer prices •



PwC

Reality check –

Group vs. individual perspectives: In practice, group considerations / taking into account group benefits or synergies also feature prominently in decision making processes. ORA should take such considerations into account.



Complexity of real-life situations: The example shows straight forward options, which may not adequately take into account unforeseeable situations in practice (e.g. Changing market business conditions or business drivers) that groups cannot control

Viewpoint: –

Clarify facts of the example



Provide step-by-step guide to readers through the various decision points envisaged in the example (e.g. Choice of TP methodology, critical assumptions used, ORA)

Page 134 of 180

March 2011 5

Thank you!

PwC

Page 135 of 180

November 2012 6

Options Realistically Available, Perspectives of the Parties and Example 19 November 13, 2012, United States Council for International Business

Page 136 of 180

Realistically Available Alternatives • Principles of paragraphs 9.59 through 9.64 should be applied • Best available alternative • Respecting the transaction vs. determining the price taking into account alternatives • Risk profiles of the parties • Options that may be hypothetically available vs. those that are realistically available • Cost approach, downplayed by the Discussion Draft, is often the “reasonable alternative” for many intangibles

Page 137 of 180

Perspectives of the Parties • How would unrelated parties account for relative tax advantages or disadvantages faced by the transferee following the transfer in determining the arm’s length price? • Unrelated parties would not know their tax positions and generally would assume a uniform statutory rate as a way of recognizing that cash flows are subject to tax. • Use of post-tax framework is inconsistent with the rest of the OECD Guidelines Page 138 of 180

Example 19 – Residual Value • Example adopts the simplifying assumption that all nonroutine profit is attributable to IP. Residual valuation approaches are not helpful in determining ALP for licensed IP. • CM structure or other cost savings are not relevant to IRR. • Licensees earn non-routine returns for risk involved in licensing and developing • Licensees may use local IP to enhance value of licensed IP • Example 19 relies on many key, but potentially unrealistic, assumptions – Country X has “reasonable alternative” to continue as manufacturer at $600 – Pervichnyi has “reasonable alternative” to continue as IP developer Page 139 of 180

Business consultation on the OECD Discussion Draft Chapter VI of the OECD Guidelines on Transfer Pricing

Options Realistically Available, Perspectives of the Parties and Example 19

Patrick Breslin, Bates White LLC

November 13, 2012 Page 140 of 180

2

Options realistically available (e.g. para. 80 – 83) • Independent parties compare alternatives in making decisions to invest, approve projects or conclude transactions   

Necessary in order to maximize value or benefits and/or minimize related costs Rational commercial behavior: seek best value at best price (e.g. para. 1.34) Opportunity costs (benefits) have real effects on prices   

Hypothetical examples provided in various comments: e.g. Strategic benefits, Risks of outsourcing, “Freed up” resources for other projects e.g. Capital budgeting decisions, rent/lease vs. buy decisions, comparison shopping

• No action is taken if the only available alternatives make one worse off  

e.g. Outsourcing risks loss of control of valuable intangibles (e.g. trade secrets) e.g. NPV of a project is negative (or IRR < Opportunity cost of capital)

November 13, 2012 Page 141 of 180

Patrick Breslin, Bates White LLC

3

Illustrating options realistically available • Typical arm’s length transactions involve 2 parties, each with at least 2 options  

Both parties will compare their available options (e.g. Example 19) Deals conclude at a point between   

 

a) the minimum acceptable value to the seller and b) the maximum price acceptable to buyer, when b exceeds a Values a and b result at least in part from each party’s other available options

NPV puts the parties’ expected income on a comparable basis Market prices (e.g. acquisitions) also result from the NPV analyses of two parties 

Market price and NPV are conceptually connected (e.g. share price of a stock)

• Topics on options realistically available    

Is the issue already fully covered in Chapter IX (e.g. 9.59 – 9.64)? Administrative burden: e.g. exhaustive searches for alternatives (3.81 and 9.64), available data Realistic options in presence of risks?...hypothetical analyses?...uncertain outcomes? Other topics?

November 13, 2012 Page 142 of 180

Patrick Breslin, Bates White LLC

4

Topics and issues: Example 19 •

Commentary regarding Example 19:  

Useful depiction of arm’s length behavior based on the separate views of each party Some concerned that the financial analysis:      



Some propose variations in assumptions about the two party analysis with respect to: 





Reduces attention to facts and circumstances, functional analysis, and non-financial drivers (see p. 126) Implies use of NPV as a “primary method” rather than high level check on comparability Discounted cash flow (DCF) disregards the transaction as structured Is too detailed or too simplified as an example, data availability issues highlighted Applies an after tax analysis to a tax question Residual value fully attributes to intangibles (in contrast with para.108)

Risk profiles and discount rates, other marketplace comparables, other options available

Allocation of location savings (lower costs and tax benefits) to seller questioned

Other financial analysis topics regarding realistic options:     

Risk (e.g. “risk free” and risk-adjusted discount rates; probabilities of outcomes) Control (e.g. over risks, resources, strategy) Financial capacity and required returns of investors Rights to returns and benefits under realistic scenarios Other topics?

November 13, 2012 Page 143 of 180

Patrick Breslin, Bates White LLC

SESSION XI INTANGIBLES: USE OF FINANCIAL VALUATION TECHNIQUES

Speakers: Jochem QUAAK and Dick DE BOER, Duff & Phelps Richard GINSBERG, Canadian Institute of Chartered Business Valuators Emmanuel LLINARES, NERA Economic Consulting

Page 144 of 180

The Relevance of Financial Reporting related Valuations for Transfer Pricing Purposes Prepared for the public consultation on the discussion draft of chapter VI of the OECD Transfer Pricing Guidelines 12-14 November 2012 OECD Conference Centre, Paris Jochem Quaak Tel +31 20 851 5159 [email protected] Dick de Boer Tel +31 20 851 5195 [email protected]

Page 145 of 180

November 14, 2012

Arm’s length Principle versus Fair Value measurement Arm’s Length Principle

Fair Value

Authoritative statement stems from Article 9 of the OECD MTC: In essence the ALP states that transfers of goods or services should be made at market prices set by reference to what independent parties would have paid under similar circumstances

Definition: “The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at measurement date”



Separate entity approach

 Willing buyer and willing seller



All options realistically available and two sided approach

 Highest and best use



Comparability analysis on the basis of the 9-step approach

 Economic analysis to understand value drivers, risks, market and industry circumstances, etc.



Sufficient reliability of comparable data

 Fair Value hierarchy regarding quality of input



Most appropriate transfer pricing method

 Valuation techniques

Conclusion: Large similarities between the Arm’s Length Principle and Fair Value definition

Duff & Phelps

November 14, 2012

Page 146 of 180

2

Valuation techniques The OECD Guidelines describe five methods for determining arm’s length prices. The five methods are:

As included in IFRS 13, the three widely used and commonly accepted valuation techniques are:

 Comparable Uncontrolled Price

 Market approach

 Resale Price Method  Cost approach

 Cost Plus Method

 Income approach Income approach comes in many forms, e.g.: » Discounted cash flow method » Relief from royalty method » Excess earnings method

 (Residual) Profit Split Method  Transactional Net Margin Method

Conclusion: Various valuation techniques show large similarities with the approved OECD methods Duff & Phelps

November 14, 2012

Page 147 of 180

3

Overall conclusions • In our comment letter we advocate that:



Fair Value Measurement as defined in IFRS 13, envisages achieving the same objective as the arm’s length principle as applied in transfer pricing;



Valuation techniques applied under IFRS 13 could be a sound starting point in establishing an arm’s length price for intangible assets; and



The OECD would give more relevance to the role of (valuation) accounting standards and valuation techniques.

• A similar and transparent approach would result in lower costs, enhance consistency and mitigate risks on double taxation.

The opinions found within this presentation are those of the presenters and do not necessarily reflect the opinions of Duff & Phelps

Duff & Phelps

November 14, 2012

Page 148 of 180

4

Appendix

9-step approach for transfer pricing

What would we do for Fair Value Measurement (based on IFRS 13) in accounting?

Step 1: Determination of years to be covered.

Determination of transaction date.

Step 2: Broad-based analysis of taxpayer’s circumstances (factors relevant to the taxpayer or the environment in which the controlled transactions take place).

Analysis of the relevant factors and circumstances with respect to the financial reporting related valuation (e.g. PPA), to understand the context and drivers of the transaction.

Step 3: Understanding the controlled transaction(s) under examination, based in particular on a functional analysis, in order to choose the tested party (where needed), the most appropriate transfer pricing method to the circumstances of the case, the financial indicator that will be tested (in the case of a transactional profit method), and to identify the significant comparability factors that should be taken into account.

An entity takes into account the characteristics of the asset or liability being measured that a market participant would take into account when pricing the asset or liability at measurement date (e.g. the condition and location of the asset and any restrictions on the sale and use of the asset) [IFRS 13.11] to understand functions, risks, value drivers, market circumstances, etc., taking into account highest and best use of the asset.

Step 4: Review of existing internal comparables, if any.

IFRS 13 seeks to increase consistency and comparability in fair value measurements and related disclosures through a “fair value hierarchy”. The hierarchy categorizes the inputs used in valuation techniques into three levels. The hierarchy gives the highest priority to (unadjusted) quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. [IFRS 13.72]

Step 5: Determination of available sources of information on external comparables where such external comparables are needed taking into account their relative reliability. Step 6: Selection of the most appropriate transfer pricing method and, depending on the method, determination of the relevant financial indicator (e.g. determination of the relevant net profit indicator in case of a transactional net margin method).

The valuation technique(s) appropriate for the measurement, considering the availability of data with which to develop inputs that represent the assumptions that market participants would use when pricing the asset or liability and the level of the fair value hierarchy within which the inputs are categorized. Three widely used valuation techniques are: [IFRS 13.62] • Market approach • Cost approach • Income approach

Step 7: Identification of potential comparables: determining the key characteristics to be met by any uncontrolled transaction in order to be regarded as potentially comparable, based on the relevant factors identified in Step 3 and in accordance with the comparability factors set forth at paragraphs 1.38-1.63.

An entity shall use valuation techniques that are appropriate in the circumstances and for which sufficient data are available to measure fair value, maximising the use of relevant observable inputs and minimising the use of unobservable inputs. [IFRS 13.61] This relevant data used is dependent on the inputs used in the fair value hierarchy and valuation technique applied.

Step 8: Determination of and making comparability adjustments where appropriate. Step 9: Interpretation and use of data collected, determination of the arm’s length remuneration.

Interpretation and use of data collected, calculation of a Fair Value.

Duff & Phelps

November 14, 2012

Page 149 of 180

5

Selected Comments on OECD Guidelines Presented by: Richard Ginsberg CA, CBV November 14, 2011

Working Party No. 6’s Special Session on the Transfer Pricing Aspects of Intangibles Page 150 of 180

Foreward

This presentation contains general information only and none of Deloitte Touche Tohmatsu, its member firms, or affiliates (“Deloitte”), by means of this presentation or its publication, rendering accounting, business, financial, tax, legal, investment or other professional advice or service. Some of the opinions expressed within this presentation are my own and do not necessarily represent positions, strategies or opinions of Deloitte, nor The Canadian Institute of Chartered Business Valuators. This is not an official presentation from Deloitte. The presentation is for general information purposes only and should not be considered as a substitute for professional advice and counsel.

2

OECD TP WP6: Comments on OECD proposed guidelines

Page 151 of 180

Introduction

Valuation Standard

Financial Reporting

Approach

Conclusion

Key Comment Areas 1.

Developing a valuation standard

2.

Use of financial reporting valuations for Financial Reporting purposes

3.

General approach to valuing intangibles

3

OECD TP WP6: Comments on OECD proposed guidelines

Page 152 of 180

Introduction

Valuation Standard

Financial Reporting

Conclusion

Approach

Developing a Valuation Standard There is a significant professional body of knowledge from which to draw valuation expertise: CICBV

Members

Valuation Standards

Valuation Accreditation Training Definition of Value

1,500 CBVs

ASA 2,200 BV members

   

   

IVSC

AICPA

IASB

FASB

67 organizations

3,100 ABVs (CPAs accredited in business valuation)

NA

NA

   

   

   

   

Leverage the expertise of these bodies to either Adopt

1

2

Defer to a pre-existing Valuation Standard and/or Definition • •

Create Commission valuation profession to develop an OECD-specific standard

• •

Fair Value Measurement standard under IAS13 Recoverable Amount under IAS36

CICBV, ASA, IVSC Fair market value standard

OECD guidelines should refer to a distinct valuation standard, whether created or adopted 4

OECD TP WP6: Comments on OECD proposed guidelines

Page 153 of 180

Introduction

Valuation Standard

Financial Reporting

Approach

Conclusion

Usefulness of Purchase Price Allocations as a Reference Valuation of intangibles for Financial Reporting can be a useful reference for transfer pricing, but requires some careful considerations: Identification basis

1 Legal/Contractual or Separable

2 Finite versus Indefinite Lived

3 Marketplace Participant

4

Materiality

Financial Reporting

Considerations for OECD

• Legally or contractually identifiable • Can be separated • Goodwill incorporates any residual premium paid above tangible and identifiable intangible assets

• A tax reorganization may involve the transfer of assets that are not yet identifiable for financial reporting purposes (i.e. future technology development rights, an intercompany contract for routine or other services), but have value. • These valuable assets are inherently imbedded in goodwill for accounting purposes but can be unlocked via an inter-company reorganization

• Focus on matching principle • Amortization of „existing‟ assets over their useful lives • Indefinite lived assets not amortized but tested for impairment annually

• A tax reorganization may involves the transfer of assets that have an indeterminable useful life, that for financial reporting purposes may be subsumed into goodwill • An identifiable intangible for financial reporting may only reflect the amortizable portion of value transferred in a reorganization

• Valuation inputs reflect marketplace participant assumptions • Represents an „exit value‟ • Entity-specific synergies included in goodwill, if at all

• Does not consider value-in-use or value-to-owner, if different than a marketplace participant • Entity-specific synergies included in goodwill if paid for • Entity-specific synergies may not have been paid for, and therefore, unreported value may exist

• Financial statements reflect only the material intangibles on a consolidated basis • Aggregations can occur at an operating segment level • Does not consider inter-company intangibles (I.e. inter-company contracts, licensing arrangements, etc.)

• Tax reorganizations often involve multiple business units with disaggregated ownership of intangibles • Stratifications that may not be relevant or applicable for financial reporting, may be relevant for transfer pricing • Inter-company contracts, arrangements, or other intangibles may be highly relevant

OECD guidelines should neither endorse nor disavow valuation of intangibles for financial reporting purposes – their usefulness will depend on specific facts and circumstances 5

OECD TP WP6: Comments on OECD proposed guidelines

Page 154 of 180

Introduction

Valuation Standard

Financial Reporting

Approach

Conclusion

Approach to Intangible Value Measurement • OECD draft guidelines appear to prioritize a ‘Definitional’ or Bottom-up approach to determining intangible value – 1) identify and define the intangible; 2) measure the value of that intangible • Instead, we recommend the prioritization of an ‘Enterprise’ or Top-down approach – 1) measure the value transferred; 2) allocate that value to separate intangibles • To illustrate the difference and potential issues to consider, we would like to re-visit the illustrative example previously presented in November 2011:

Illustrative Example – Situational Overview • Assume that an MNE group acquires an independent Company A for a price of 100, out of which 70 is allocated to the value of identified intangible assets and 30 is allocated to goodwill. • It is assumed in this example that the value of tangible assets is negligible. • Assume that following the acquisition, the identified intangible assets are transferred from Company A to an associated Company H and that Company A is converted into a contract research entity. • In this new capacity, Company A will continue its research and development activities on behalf of Company H, with the latter bearing the risk of failure of those activities and being the owner of the future intangibles that may eventually result from them. • The question may arise whether the determination of an arm‟s length price for the transfer of intangibles from company A to H should take into account part or all of the goodwill that has been recognized for an amount of 30 upon the acquisition of A by the MNE group.

6

OECD TP WP6: Comments on OECD proposed guidelines

Page 155 of 180

Introduction

Valuation Standard

Financial Reporting

Approach

Conclusion

Definitional or Bottom-Up Approach Company A

Company A

Goodwill $30

Goodwill 30%

Company A (Limited Risk Developer) $30

Intangibles 70%

Company H (IP Owner) $70 Intangibles $70 Transfer of Intangibles Company H

Definitional approach is susceptible to overlooking the transfer of undefined intangibles (i.e.: goodwill) 7

OECD TP WP6: Comments on OECD proposed guidelines

Page 156 of 180

Introduction

Valuation Standard

Financial Reporting

Approach

Conclusion

Top-Down Approach: Valuation Process A Top-down approach to the determination of the value allocation between Company A and Company H as a six step process:

Pre-Reorganization

1

Determine the value of Company A prior to any reorganization

Post-Reorganization

2

Determine the value of Company A on a proforma basis, post-reorganization

Value Transferred

3

Deduct the post-reorganization value of Company A from the pre-reorganization value

Value of Intangibles

4

Determine the value of any intangibles owned by Company H on a pro-forma basis

5

Deduct the value of Company H intangibles from the value transferred

6

Deducted the value of Company H goodwill from the pre-reorganization goodwill value of Company A

Company A

Company H

Value of Goodwill Transferred Value of Goodwill Pre-Reorganization

Company A Value of Goodwill Retained

8

OECD TP WP6: Comments on OECD proposed guidelines

Page 157 of 180

Introduction

Valuation Standard

Financial Reporting

Conclusion

Approach

Value Summary Company A

R&D Contract $10 million

Company A

Workforce

$7 million

Goodwill $30

Intangibles $70

Company A $17 million

Company H (IP Owner) $83 million

Future Development Rights $5 million

Goodwill $13 million Technology $70 million

Not captured in Definitional Approach

Company H

Top-down approach results in $13 million of additional intangible value allocated to Company H 9

OECD TP WP6: Comments on OECD proposed guidelines

Page 158 of 180

Workforce $8 million

Introduction

Valuation Standard

Financial Reporting

Approach

Conclusion

Key Considerations 1.

Create or Adopt a distinct valuation standard of reference

2.

Neither endorse nor disavow the valuation of intangibles for financial reporting purposes

3.

Adopt a Top-down approach to value determination for the transfer of intangibles rather than a definitional approach

10

OECD TP WP6: Comments on OECD proposed guidelines

Page 159 of 180

QUESTIONS? Richard Ginsberg CA, CBV

Deloitte [email protected]

11

OECD TP WP6: Comments on OECD proposed guidelines

Page 160 of 180

Use of Financial Valuation Techniques for Transfer Pricing Purposes Pim Fris & Emmanuel Llinares Special Consultant & Senior Vice President

Working Party No.6 of the OECD Committee on Fiscal Affairs - Paris 14 November 2012 Page 161 of 180

A few preliminary remarks

1.

Intangibles definition and valuation (Section A) –

Market valuation (e.g., stock market prices) can reflect intangible identification and valuation that one may not necessarily be in a position to apprehend (value chain analysis should enable to avoid this)

 Risks that Section A of the draft Chapter VI is interpreted too narrowly when following a deterministic approach only and misses important intangibles. Intangibles should be defined as something “reflecting entitlement to or an expectation of future profits”

2.

3.

The transactions involving intangibles (section C) –

Transfer of intangibles as part of a transfer of a business are not really dealt with by Chapter IX



The bridge to be made between value an activity / business and value of individual intangibles is to be made more explicitly in Chapter VI: a transaction C.2.(iv) needs to be added

Bridging the gap between individual asset and collective business value creation (section D) –

A satisfactory identification of intangibles should be achieved by looking at these two levels of valuation



Valuation of individual intangibles and assessment of the relative entitlement thereto of the parties concerned can be done with help of a Value Chain Analysis (VCA). To this end Chapter I, section D.1 needs to be extended. VCA is too implicit in the guidance of Chapters I, II and III of the Guidelines



The recommendation of NERA Economic Consulting in its comments has been to complement the valuation of individual intangibles by an analysis of the collective value creation of the business concerned



An assessment of relative entitlement of the different parties involved to the value of the intangibles in the specific case can be done by means of a bargaining analysis, based on bargaining positions informed by the outcome of a Value Chain Analysis

Page 162 of 180

1

Commonly used financial valuation techniques for intangibles Market comparables (e.g., multiples) approach  

Method relies on the use of comparable “one shot” transactions (sale of an asset) or inference from intangibles sensitive stock prices Main challenge: Comparability of the third party transactions or market data being relied upon – opportunistic and case- or deal-specific issues need to be identified

Income Based approach    

Commonly applied

Discounted cash flow method and real options method (when factoring in information access over time) Starting point (and an important challenge): Modeling of cash flows associated with the intangible Profit split methods and Comparable Uncontrolled Price / Transaction method are often applied in order to determine these cash flows Valuation obtained from Income Based Approach can be “reverse engineered” to infer intangible-related cash flows and intangible-related transfer prices

Replacement costs    

Can be applied

Can be applied

Paragraphs 112 and 113 discourage the use of simple return on costs approach However, return on historical costs does not correspond to replacement costs When properly applied, the replacement costs approach can provide useful insight on the value of an intangible (for example when valuing know-how associated with a workforce or in the context of deriving a bargaining range) Application of this method notably involves determining the opportunity costs required for a party to redevelop an intangible of equal value

In (complex?) intangible related valuations, the use of a bargaining range will be helpful Page 163 of 180

2

The Bargaining Range and realistically available options What are the options realistically available to the transacting parties? Bargaining Range (e.g., royalty rate in % of sales or “one shot” value)

0% or €0 ?% or €?

?% or €?

Minimum Intangible Owner Would Accept:

Maximum Intangible User Would Pay:

Based on profits from realistically available alternatives

Based on: Added profits from using the intangible and the economic costs of the next-best alternative



CUPs and or comparable asset transactions can be point of references (not systematically in the range depending on comparability)



In the absence of reliable comparables, (residual) profit split method and income approaches should enable the estimation of both ends of the range



Replacement costs (including opportunity costs) approach can be looked at to estimate maximum willingness to pay in some circumstances



Bargaining theory can be used to narrow the range or determine a transaction price - realistically available options should be documented whilst the decisions reg arding the transaction are being made Page 164 of 180

3

Contact Us Beijing Sébastien Gonnet +86 10 6533 4395

London Pim Fris +44 20 7659 8500

Chicago Harlow Higinbotham +1 312 573 2803

Los Angeles Nihan Mert-Beydilli +1 213 346 3000

Frankfurt Alexander Voegele +49 69 133 8532 Geneva Emmanuel Llinares Jean-Sébastien Lénik +41 22 819 94 94

Paris Emmanuel Llinares Jean-Sébastien Lénik +33 1 70 75 01 95 Toronto Jennifer Shulman +1 416 783 3355

Madrid Victoria Alonso Cantero +34 91 212 64 00 New York City Stuart Harshbarger +1 212 345 3000

© Copyright 2011 NERA Inc. All rights reserved.

Page 165 of 180

SESSION XII DETERMINING ARM’S LENGTH ROYALTY RATES FOR LICENSING TRANSACTIONS

Speakers: Brian CODY, KPMG Ednaldo SILVA, RoyaltyStat LLC David JARCZYK, ktMINE

Page 166 of 180

Determining Arm’s Length Royalty Rates for Licensing Transactions and Comparability Standards for Intangibles

Public Consultation on Transfer Pricing Discussion Drafts OECD Conference Centre, Paris 12 – 14 November 2012

Page 167 of 180

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY KPMG TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN. You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials.

© 2012 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

Page 168 of 180

OECD - Public Consultation on Transfer Pricing Discussion Drafts

1

Determination of royalties for license arrangements – Licensor’s share not equal to the entire excess or residual profit earned by the licensee 

One of the key reasons that uncontrolled parties enter into licenses is to shift the risk associated with the exploitation of the intangible from the licensor to the licensee. In return for accepting this risk, the licensee generally receives a share of any intangible profit arising from the successful exploitation of the intangible, and may incur losses if it is unsuccessful in exploiting the intangible.



Discussion Draft defines the intangible related return attributable to a particular intangible as “the economic return from business operations involving use of that intangible after deducting (i) the costs and expenses related to the relevant business operations; and (ii) returns to business functions, assets other than the particular intangible in question, and risks, taking into account appropriate comparability adjustments.” (Paragraph 28)



Consistent with this definition, there are many potential sources of a licensee’s excess or residual profits/losses besides intangibles and “routine” business functions, including:





Location savings and other comparability factors identified in the Discussion Draft ;



Economies of scale or scope;



Varying levels of capacity utilization across the business cycle; and



More generally, the realization of risk not associated with intangibles.

The payment made between the licensee and the licensor – royalty – is not equal to total profits less a routine return, but rather must account for the licensee’s economic contributions and allow for the opportunity of the licensee earning above (or below) routine returns.

© 2012 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

Page 169 of 180

OECD - Public Consultation on Transfer Pricing Discussion Drafts

2

Variety of viable intangible valuation methods exist and may be applied depending on the particular facts and circumstances of the transaction 



Discussion Draft provides some mixed signals on the role of valuation techniques in evaluating the transfer pricing of intangibles, detailing the application of discounted cash flow methods to transfer pricing while at the same time indicating that certain valuations (such as those done for purchase price accounting) have “no” relevance for transfer pricing. –

Techniques used in financial statement analyses, however, are no different in substance from valuation approaches used in economics and business generally.



Similarly, the guidance on choosing between the income method and cost method should emphasize the need to use the method that is most appropriate, given the specific facts.



Other approaches may be more appropriate than these traditional method depending on data availability and other considerations. 

Residual profit split – Potentially useful, traditional method accepted in the OECD Guidelines, which deserves additional consideration (i.e., detailed example) in the Discussion Draft.



So-called “rule of thumb” – An anecdotally-appealing approach that, nonetheless, lacks empirical rigor.

Whatever valuation methods is employed, it must nonetheless must address issues of asset life, discount and amortization rates, allocation of excess or residual income to nonintangibles, data reliability (particularly of financial projections), other similar considerations.

© 2012 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

Page 170 of 180

OECD - Public Consultation on Transfer Pricing Discussion Drafts

3

Third-party licensing arrangements can provide invaluable insights into the evaluation of the arm’s length nature of intercompany transactions 

Third-party license arrangements identified on commercial or internally maintained databases are often disregarded in their entirety due to perceived differences or lack of information regarding comparability factors, including the exact nature of the intangibles, useful life, stage of development, and expectation of future benefits.



Such differences notwithstanding, third-party license arrangements should be viewed as:





A key source of potential information on terms that are common in transactions among uncontrolled entities – helping to inform whether or not specific types of business arrangements are arm’s length – and specific information on pricing.



Particularly helpful when dealing with transactions involving intangibles that are not key drivers of profits – e.g., licenses of accounting software, the license of relatively routine technology and knowhow, the license of trademarks that are used to differentiate the goods bearing such marks from purely generic products, but which do not support unusually high profits.

License arrangements can also provide insights into which of the legal entities (licensor vs. licensee) is entitled to returns from the use of the intangible property and other salient considerations, including: –

Payment method and terms (e.g., fixed royalty rate vs. royalties that vary with profit);



Allocation upon termination of the arrangement of any potential incremental intangible value created over the course of the license; and,



Oversight carried out by the licensor over the course of the arrangement.

© 2012 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

Page 171 of 180

OECD - Public Consultation on Transfer Pricing Discussion Drafts

4

Thank You Brian Cody Principal KPMG LLP +1 312 665 1912 [email protected]

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.

© 2012 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International.

Page 172 of 180

Use of Information from Databases OECD Presentation

Ednaldo Silva, Ph.D. [email protected] November 14, 2012 Page 173 of 180

The content of these slides is not for public distribution and may not be copied or distributed without the Author’s permission. All Copyrights Reserved.

Databases are integral to transfer pricing administration and taxpayer compliance because they are the only source of external comparables. U.S. Treas. Regs. § 1.482-4(c)(4), Example 3, contains a hypothetical case in which the IRS “uses a database of company documents filed with the Securities & Exchange Commission (SEC) to identify potentially comparable license agreements between uncontrolled taxpayers.”

Inspired by this example, we started the RoyaltyStat database in 1996 from license agreements filed with the SEC and launched an interactive website on January 2, 2000. Today, we have over 13,750 unredacted license agreements, and we add about 2,000 new agreements per year. RoyaltyStat today includes over 2,500 pharmaceutical agreements, over 1,000 medical device agreements, over 1,000 software agreements, and over 500 computer hardware and semiconductor agreements. This large number of agreements, which can be used to support the transfer of intangibles, is substantial compared to the number of publicly-traded companies used as comparables for the transfer of tangible goods and the provision of services.

Page 174 of 180

The content of these slides is not for public distribution and may not be copied or distributed without the Author’s permission. All Copyrights Reserved.

1

Some claim the arm’s length principle is impractical because comparables cannot be found. However, the development and growth of RoyaltyStat and other databases provide evidence against this claim. The license agreements in RoyaltyStat can be searched online by industry, agreement type, description of the intangible (which in RoyaltyStat is a structured and standardized field, not a product of copy and paste), exclusivity, territory, and other important filters. These agreements reflect the licensing of intangibles in many countries, including OECD members and developing countries. License agreement databases can be used to determine the arm’s length royalty rates for the majority of intangibles in the marketplace. They can be used also to determine safe harbors as part of the OECD effort to simplify transfer pricing in routine cases. When comparables cannot be found to use the CUP method, such as for blockbuster intangibles (e.g., drugs, software), taxpayers can use the residual profit split method.

Page 175 of 180

The content of these slides is not for public distribution and may not be copied or distributed without the Author’s permission. All Copyrights Reserved.

2

A useful database that can be used to support the transfer of intangibles must contain a fullcopy of each disclosed license agreement, because the intangible property, including all rights conferred and contractual obligations, must be compared and adjustments can be made where appropriate, such that an arm’s length royalty rate can be computed in a manner that can sustain audit scrutiny or controversy. RoyaltyStat is a dynamic source of information because it’s constantly updated. This database offer publicly disclosed, verifiable information and can be used to: 1) Find comparable royalty rates and determine safe harbors. Comparables make the argument for using formulary apportionment less compelling; 2) Provide an alternative to the use of secret comparables; 3) Protect corporate taxpayers against transfer pricing adjustments; and 4) Safeguard tax administrators from making adjustments that can be denied in appeals or tax court for being “arbitrary, capricious or unreasonable.” Under the existing arm’s length paradigm, transfer pricing cannot be supported without comparables, and comparables cannot be found without a reliable database that is constantly updated by experienced professionals.

Page 176 of 180

The content of these slides is not for public distribution and may not be copied or distributed without the Author’s permission. All Copyrights Reserved.

3

David R. Jarczyk

President & CEO, ktMINE [email protected] Working Party No. 6 Public Consultation

© Copyright 2012 ktMINE. All rights reserved. W: ktMINE.com

Page 177 of 180

The CUP Method…In A Practical Way

© Copyright 2012 ktMINE. All rights reserved. W: ktMINE.com

Page 178 of 180

Databases…Global Benchmarks ▲ Royalty

Rate Intelligence

− Over 13,000 unredacted license agreements − Identifies comparable royalty rates − Example question: what is a reasonable royalty rate for this situation? ▲ License Agreement

Intelligence

− Over 70,000 unredacted and redacted license agreements − Provides transparency to third-party deal structures, functions performed,

risks assumed, and payment terms − Example questions: • Do third parties share significant fluctuation in the foreign exchange rates? • Would a licensee ever pay to register the licensor's trademark in the licensed territory? • How do third parties share rebates?

• Would a licensee bear warranty risk and product liability risk for its territory? • Would third parties set a royalty rate to increase as the sales of the licensee increase? © Copyright 2012 ktMINE. All rights reserved. W: ktMINE.com

Page 179 of 180

Factors of Comparability Determine Existence of Market Royalty Rates

External Market Royalty Rates

Internal Market Royalty Rates

Assess Comparability

Interdependent Comparability Factors Business Relationship Between Licensor & Licensee

Exclusivity & Restrictions

Uniqueness of IP

Profit Potential

Functions & Risks Born by Licensor vs. Licensee

Territory & Field of Use

Duration

Rights to Receive Updates & Modifications

Establish Defensible Market Royalty Rates © Copyright 2012 ktMINE. All rights reserved. W: ktMINE.com

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