Intellectual Property in Transfer Pricing Planning
April 28, 2010 in Transfer Pricing International Journal
This article provides a general overview of the issues which are relevant to tax-efficient Intellectual Property (IP) structuring. Because of the complexity of these structures, differing commercial considerations between companies and multiple jurisdictions involved, there is no standard solution. However, we have suggested some checklists and frameworks to help in that process.
First we should define our key terms, as follows:
- we will use the term “IP” as shorthand to refer to the wider set of intangible assets. In principle, all IP rights that are identifiable and have a market value can be included in IP restructuring schemes. These can include trade mark rights (including brands), copyrights, patents, designs, database rights, domain names, know-how rights, semi-conductor topography rights and plant breeders’ rights, for example. Whether the IP rights are registered and/or otherwise formally legally protected is generally not highly relevant from a tax perspective, although for certain classes of IP if they are not, tax authorities may question whether there is economic substance, and therefore value, attached to these rights. On the other hand, it will often be relevant to consider whether IP rights are legally enforceable (that is, use by others can be prevented), since in the absence of legal rights it may be said that a putative independent buyer would not be prepared to pay a price. Tax authorities may also assume that know-how has already been shared across a group, so that the onus will be on the company to explain why this is not the case. Where rights are not registered (e.g. copyright, database rights, rights in know-how) it may not be simple to establish current legal ownership;
- by Transfer Pricing we will refer to the provision of goods, services, funding or rights to use intangible assets between related parties. There is an international requirement to set internal charges in a group at “arm’s length” levels, or face tax penalties. This is related to the fact that transfer pricing is a major tax planning tool, especially where intangible assets are involved. We will refer to the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (TPG);
- we will use the terms Parentco, IP Holdco and Opco to describe, respectively, the parent company in a multinational group, the company in that group in which the group’s IP may be centralised, and an operating subsidiary.
We have kept our discussion at the conceptual level with some real world examples, rather than discussing the relevant legislation of any particular jurisdiction.
Three analytical frameworks can help to understand the techniques and issues involved in transfer pricing planning using IP: the supply chain, the IP decision process and the economic objective. These are discussed in turn below.
The supply chain for any company involves transfers of goods, services, finance or rights to use intangible assets along the “value chain” of activities which create the non-routine profit of the company, and into the value chain from the supporting functions.
The intangible nature of IP rights renders them easily movable and creates the potential for valuable tax planning (tax planning with intangibles is more popular than tax planning with risks, the other major tool of transfer pricing planning, anecdotally because it is easier to understand). This often involves the migration of IP into favourable tax jurisdictions and the creation of licensing structures and resulting royalty streams. Devising and implementing these structures requires detailed thought from and collaboration between tax, IP and transfer pricing economics experts and close collaboration between them. This expertise must be applied internationally. Without it, there is a risk that a scheme can prejudice the underlying IP rights, rendering them worthless in the process.
For IP rights to be capable of being transferred and licensed, the relevant rights need to be identifiable and capable, under domestic law, of being transferred. Some restructuring arrangements involve a transfer of legal title; others will only require the transfer of “economic ownership”, which will not necessarily amount to a transfer at all from an IP legal perspective, but rather a licence, in which the licensee is given the right to exploit the IP in question for its own gain. In certain cases this kind of “transfer” of economic ownership may be sufficient to obtain tax benefits since, typically, the tax structuring focuses on economic value.
While IP restructuring can be tax-driven, it can also be driven by a wish to centralise the management and control of IP rights so as to maximise their (marketing) value for the group, or to find a “home” for acquired brands in the context of a merger or acquisition (M&A) transaction in which substantial IP rights are involved.
The differing terms used in a tax context, as opposed to an IP context, can result in statements being made to tax authorities about the proposed structure that are not desirable from an IP perspective. For example, in IP terminology, “transfers” of IP are transfers of ownership of the intangible asset, whereas in tax terminology the “transfer” may be a licence – a right to do or use something which would otherwise be preventable by the right owner through the enforcement of an IP right.
While an IP transfer might involve an outright transfer of legal and beneficial title, it may also involve a licence from the Parentco to the IP Holdco on terms that enable the IP Holdco to exploit the IP in question by sub-licensing it to Opcos for royalties that IP Holdco will retain, rather than passing them back to Parentco. That licence from the Parentco to the IP Holdco may be characterised as having brought about a transfer of “economic ownership” from a tax perspective, while remaining a “licence” from a legal IP perspective. References to “transfer” in this article should be read in both ways – the comments made apply equally to both methods.
It is important for the IP experts to liaise with the tax experts to ensure that the communications with tax authorities work to achieve the desired aim without prejudicing the subject IP.
Any company that wishes to maximise the after-tax return from IP will consider some variant of the decision process in Figure 2, i.e. a series of questions about where to own the IP and how to transfer it to that location, for example, and in each case the relevant technique for achieving this outcome and how to avoid the potential pitfalls. We will return to this framework at the end of this article.
The after-tax return from any IP will be the outcome of the underlying commercial potential of the IP and the tax rate and risk of the jurisdiction in which it is owned, which we can decompose in the manner of Figure 3.
ll. Implied objectives of transfer pricing planning involving IP
If we accept the overarching economic objective of Figure 3, then the following sub-objectives follow:
- minimise the after-tax development cost;
- maximise the cash flow;
- maximise the number of periods for which the cash flow will be generated;
- minimise the effective tax rate;
- minimise the risk associated with the intangible asset;
- minimise the country risk;
- trading-off these objectives where necessary; and
- using transfer pricing and IP planning techniques.
We will discuss the techniques and constraints/pitfalls for each of these sub-objectives in turn in the next section.
A. Minimise the after-tax development cost
In practice, minimising the after-tax development cost of IP could involve cost plus development in a low cost jurisdiction, or jurisdictions with favourable tax frameworks for IP development.
The key issues in choosing a location which can minimise the after-tax cost of IP development is to identify a low cost location for development taking into account any existing Research and Development (R&D) tax credits which may be foregone if development is located in or transferred to another jurisdiction, and the availability of similar benefits in the prospective new location. Enjoying this article? To continue reading you need to take out a FREE trial to the Transfer Pricing Library.
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