BEPS Guidance on Transfer Pricing Aspects of Intangibles

Batanayi Katongera

On 16 September 2014, the Organisation for Economic Co-operation and Development (“OECD”) released a document titled “Guidance on Transfer Pricing Aspects of Intangibles” as a deliverable for Action 8 of the base erosion and profit shifting (“BEPS”) project. Within the document there are the final revisions to Chapters I, II and VI of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (“TPG”).

Chapter I Amendments:
There hasn’t been a complete re-write of this chapter, rather additional guidance and examples are being inserted at the end of the current Chapter I. The new text focuses predominantly on location savings and other local market features.

Location savings were discussed in the 2010 version of the TPG in Chapter IX but this was with particular reference to business restructuring whereas the new guidance is applicable to all cases where location savings exist.

The new guidance goes on to consider additional factors that can create market advantages or disadvantages, such as the proximity of the company to profitable markets, the availability of skilled workers and local country infrastructure. Should adjustments that improve comparability be possible then they should be utilised. Adjustments should not be needed if comparables are identified that perform similar functions, utilise similar assets and bear similar risks and that operate in the same local market.

The additional wording also points to the fact that in addition to features of the local market there may be intangibles, such as contractual rights and government licences that should be considered. The reader is directed to Chapter VI of the TPG for further guidance and examples are provided to distinguish between licences and rights that can “affect the manner in which the economic consequences of local market features are shared between parties to a particular transaction” and those that are available to many, if not all, of those in the market.

The new guidance provides an additional focus on the assembled workforce and multinational enterprise (“MNE”) group synergies as factors that should be considered from a transfer pricing perspective. For example, if a workforce is transferred from one entity to another as part of a restructuring, which will reduce the time, effort and expense that would have been incurred hiring a new workforce then it is possible that a comparability adjustment might be required in respect of the arm’s length price.

Factors that provide MNE group synergies, such as economies of scale, are considered in the new guidance. There are synergies that an entity can receive as a result of deliberate actions or coincidence. The guidance refers to the example of centralising purchasing power as a deliberate action whereas an entity receiving more favourable terms simply because the supplier hopes to attract business from others in its group is deemed coincidental.

Five examples are provided in order to provide clear guidance on how to treat possible scenarios from a transfer pricing perspective when adjustments may or may not be needed.

The above clearly points to the need for a robust and thorough functional analysis to be performed in order for all of the facts to be gathered and any necessary adjustments identified and performed.

Chapter II Amendments:
There are only two minor changes to Chapter II of the TPG and one of these, the rewording of paragraph 2.9 pertaining to transfer pricing methods, has not yet been decided upon. The second change is that a new paragraph is inserted after 2.9, which explains that a rule of thumb is not an appropriate substitute for a complete functional analysis and comparability analysis. This echoes the changes made to Chapter I, which cement the importance of such analyses.

Chapter VI Amendments:
Chapter VI of the TPG 2010 is to be deleted and this new version inserted in its place. The new version is more substantial than the previous version, in terms of both length and depth, and has an annex containing 33 examples. The 2010 version comprises 27 pages of guidance whereas the updated version is 66 pages long excluding the annex.

When the OECD invited comments on the Discussion Draft on Transfer Pricing Aspects of Intangibles published on 6 June 2012 it was inundated with comments. There was a general view that the previous Chapter VI was unclear in parts and that there was a lack of examples illustrating how intangibles should be treated as well as a definition of what actually constituted an intangible.

The OECD have sought to address this and have drafted an annex containing examples of intangibles that is helpfully referred to and referenced throughout the chapter meaning that should the wording of the chapter be unclear you can refer to a concise example.
Paragraph 6.6 of the revision states that “the word “intangible” is intended to address something which is not a physical asset or financial asset, which is capable of being owned or controlled for use in commercial activities, and whose use or transfer would be compensated had it occurred in a transaction between independent parties in comparable circumstances.”

Although a more clear definition has been provided, paragraph 6.2 of the revised chapter is clear to point out that “to the extent that an item or activity conveys economic value, it should be taken into account in the determination of arm’s length prices or whether or not it constitutes an intangible within the meaning of paragraph 6.6.”

The updated guidelines provide a list of steps that should be considered when undertaking the functional and comparability analyses. These are:
• The identification of specific intangibles;
• The legal ownership of intangibles;
• The contributions of MNE group members to their development, enhancement, maintenance, protection and exploitation; and
• The nature of the controlled transactions involving intangibles including the manner in which such transactions contribute to the creation of value.

The previous guidance made a clear distinction between trade and marketing intangibles providing clear examples of each; however the update states that it will not be making such a clear distinction. The definition of ‘marketing intangible’ in the TPG glossary has been updated to include the additional wording “depending on the context , marketing intangibles may include, for example, trademarks, trade names, customer lists, customer relationships, and proprietary market and customer data that is used or aids in marketing and selling goods or services to customers.”

In order to provide further clarification regarding what exactly an intangible is, the new guidance provides detailed listings of items that can be classed as intangible, such as patents, know-how, trademarks, licences, goodwill and group synergies.

The updated Chapter VI also looks at different scenarios surrounding intangibles in depth, for example payments to use a company name and the development and enhancement of marketing intangibles. This extra detail will be of great help to taxpayers in understanding how to treat intangibles and ascertain whether compensation is required for their use.

It goes further to provide guidance to supplement that in Chapter I-III in relation to pricing intangibles. Due to their nature it can be notoriously difficult to price intangibles and therefore any additional guidance is gratefully received. This detailed guidance is split into four sections:
• General principles applicable in transactions involving intangibles;
• Supplemental guidance regarding transfers of intangibles or rights in intangibles;
• Arm’s length pricing when valuation is highly uncertain at the time of the transaction; and
• Supplemental guidance for transactions involving the use of intangibles in connection with the sale of goods or the provision of services.

Chapter VI Amendments:
The guidance appears to be thorough and covers a wide range of useful scenarios, such as situations in which there are no reliable comparables and the use and application of valuation techniques. Perhaps the most useful information, however, is the illustrative examples contained in the annex.

Disappointingly, in the final analysis the new Chapter VI remains a draft until all the BEPS measures are finalised and adopted. Consequently, it contains shaded areas that are still in draft form but the depth of its content is so far promising and certainly a significant improvement on the current Chapter VI.

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