Transfer Pricing and IntangibleAssetsAntonio Russo, Baker & McKenzie Amsterdam19 June 20151 2015 IBFD

Why relevant?Arguably one of the most complex areas of transfer pricing, atopic in evolution and an area of controversyOne of most important commercial developments in recent decadeshas been growth in significance to enterprises & MNE groups ofintangible property: less reliance on physical capital.Emerging markets attaching importance to local “specificities” andgrowth potential.Conflicting views?2 2015 IBFD

An overview of the guidance Chapter VI (intangibles) and VIII (CCAs) of the OECD TPGuidelines (1995 – 2006) Chapter IX of the OECD TP Guidelines (2010) BEPS (2013 – 2015 ): Actions 8, 9 and 10 3September 2014, December 2014, June 2015 Revised Chapter I and Chapter VI and VIII of theOECD Guidelines Revised Chapter IX(?) Action 4 (on capital) Action 13 (on disclosure) UN Manual on Transfer Pricing (2013) Relevant international case law 2015 IBFD

A definitional issue?4 2015 IBFD

Well or poorly defined IP?Market powerHuman capitalNetwork effectscopyrightsknow-howBarriers to Trade secretscontractsWell defined andunderstood, generallyaccepted analyticalframework for valuation5First moveradvantagesBusinessOpportunityGoodwillPoorly defined andunderstood, little agreementon valuation approach 2015 IBFD

Separate intangible assets?MMarket powerARHuman capitalcopyrightscontractsKNetwork strademarksTrade secretsFinancial /tangible assetsFirst moveradvantagesBusinessopportunityBarriers to entryGoodwillTCAP6 2015 IBFD

Or value enhancers?MMarket powerARHuman capitalcontractsKNetwork effectsEtrademarkscopyrightsFinancial /tangible assetsBarriers to entryNon-contractualrelationshipsFirst GoodwillCATrade secretsP7 2015 IBFD

Final guidance Chapter I of OECD TP Guidelines 8intangibles vs comparability factors location savings and other local market features assembled workforce group synergiesNew Chapter VI Identifying intangibles and on determining arm's lengthconditions Comparability in intangibles transactions Transfer pricing methods and use of valuation techniques forintangibles transactions 33 examples 2015 IBFD

What is an intangible? something, which is not a physical asset or a financial asset,which is capable of being owned or controlled for use incommercial activities, and whose use or transfer would becompensated [ ] between independent parties in comparablecircumstances.not an accounting definition, not a legal definition, not an economiconly definition 9 2015 IBFD

Ownership: Who Owns the Key Intangibles?TimeResidual profitBenchmarked returnLegal ownerOwnerLegal ownerFoundationEconomic butorUserUserUser 10If intangibles are centrally (i) developed, (ii) managed, (iii) funded and (iv) maintained ownership is clearIf one or more of the elements is performed by different group companies ownership is 2015 IBFDunclear

And it was only the beginning!!!Which parties are entitledto intangibles return?Identifying and characterizing transactionsinvolving intangibles 11Interim guidance onownership6 steps analysisLegal ownership asstarting point onlyDEMPE onExploitationAllocation of returnsshould be in line withvalue creationOutright saleLicensingIntangibles used in the manufacture of goodsor provision of servicesArm's Length Conditions? Use of valuation techniquesArm's length principleConsider two-sided perspective / optionsrealistically availableValue of intangibles can be highly volatile 2015 IBFD

Valuing vs pricing: comparability analysis 12Industry and functional analysis Identify industry root causes of profitability Identify what competitors or investors would be willing to pay for Consider quality and availability of competitor pricing informationwithin industry Identify group specific root causes of profitability Understand processes around root causes of profitability Understand strategic and tactical functions within processes Map and align key players performing significant economic functionsThis is a key factor especially for African countries, where theavailability of large data set on local comparables may be limited;more reliance on economic theory and empirical studies? 2015 IBFD

Comparability analysis (cont’d) Comparability and method selection The rules of Chapters I-III Realistic alternatives for each of the parties need to beconsidered in transactions involving both transfer and use of intangibles Two sided analysis - the perspective of both parties to the transaction need to betaken into account Any of the OECD approved methods can be used in appropriate circumstances Valuation techniques are useful tools Cautions regarding the use of some methods: Cost based methods discouraged One sided methods (TNMM, CP, RPM) not typical useful to directly valueintangibles, but may be used in some residual valuation approaches 13Price does not necessarily equal value: Why do price and value deviate? What does that mean for pricing? 2015 IBFD

Valuation and TP for intangibles Best practices today are centered around the followingapproaches: Transfer pricing methods CUP / CUT RPM TNMM / RPMTraditional valuation methods Cost Approach Market Approach (including Multiples, Acquisition PriceMethod / Market Cap) Income Approach (cash flow / income- based), e.g.: MultiPeriod Excess Earnings (MEEM) Relieffrom Royalty Incremental14cash flow 2015 IBFD

Discussion Draft on Risk, Recharacterization and SpecialMeasures15 Consider whether the party to which risk is allocated can actuallycontrol/manage the risk at issue AND consider whether thetransaction possesses the fundamental economic attributes ofarrangements between unrelated parties, otherwiserecharacterization may occur Special Measures include Contingent payment terms for certain transfers of hard to valueintangibles (lack of reliable comparables, “speculative”assumptions, “acute” “information asymmetries”): see DD June2015 Reallocate returns from an entity that is capital-rich, asset-owningcompany or has minimal functions, to the entity that actuallyperforms the activities makes possible a return from the asset 2015 IBFD

An ever evolving area of TP! QuotingMr B. Gates:(TP guidance for)IP has the shelf life of a banana!16 2015 IBFD

Some relevant cases17 Maruti Suzuki v. ACIT India (2013) Cadbury Ltd. v. ITAT Mumbai Veritas (2009) Cytec (2008), Norway 2015 IBFD

Thank you!18 2014 IBFD