Aiming at the revision of the special considerations for intangibles, the OECD published a discussion draft for Chapter VI of the OECD Transfer Pricing Guidelines in June 2012. In November 2012, more than 120 delegates from business and politics convened with the Working Party 6 (WP 6) delegates and the OECD Secretariat in Paris in order to discuss the comments that have been handed in before. Although the report of the convention does still not reflect a consensus, some key contents of a further revised draft and their potential effects can already be highlighted.

Key elements and goals of the discussion draft

In the past years, my daily work with clients and KPMG’s Global Transfer Pricing Services team has demonstrated that from our clients’ point of view, there is neither clear guidance nor a business consensus with regard to transfer pricing aspects of intangibles. Saying this, it would clearly be helpful to have a useful and widely accepted definition or at least a description of what should and could be recognized as an intangible asset, who should be entitled to the returns from intangibles and how to value intangibles for tax and transfer pricing purposes. However, this wish might be hard to fulfill – in particular if such attempts are made with focus on misconduct and abuse rather than support and the goal of common understanding. But let’s see…

Definition of intangibles

The transfer pricing practice finds itself caught between the locally applicable laws and regulations, the OECD definitions in the model convention as well as in the transfer pricing guidelines, third party contracts and last but not least the respective accounting standards. Hence, it is a common goal of tax authorities and taxpayers to establish a framework that allows for an easy implementation. As it is the case with most standards, the discussion draft of Chapter VI provided by the OECD therefore starts with the definition of intangibles. According to the draft, an intangible asset is “something that is not a physical asset or a financial asset, and that is capable of being owned or controlled for use in commercial activities” (OECD Discussion Draft on Intangibles, p.7 : www.oecd.org/ctp/transferpricing/50526258.pdf).

The comments made by many parties during the public consultation period but also during the convention, clearly criticize the rather vague expression “something”, but also the inclusion of goodwill as an intangible, what seems more harmful than healing the issue of uncertainty and debates over intangibles. Similar comments are made regarding the inconsistency of how the definitions of intangibles are used throughout the draft.

From my point of view – and many practitioners’ and scholars agree – there is generally no need to broaden the definition of intangibles to capture the wider transfers that would get captured by Chapter IX of the guidelines anyway. And hence the definition should be more consistent with the existing legal as well as accounting definitions of intangibles and should not be driven by an attempt to avoid misconduct and abuse at first hand.

All those critics will likely motivate the WP 6 to revise its attempt to establish an overall definition of what an intangible is and what not with the next draft. However, the Party will likely have to remain vague as there is little chance for consensus by all stakeholders.

Entitlement to intangibles returns

Once an intangible is defined as such, it is important to determine the parties which are entitled to the returns related to these assets. Subsequent to the definition of intangibles returns, the OECD lists the factors which should be taken into consideration when allocating intangible returns among a multinational enterprise.

While the draft on one hand often refers to some kind of profit split considerations and on the other hand rarely speaks about comparable uncontrolled prices (CUP). Several comments criticize in particular the absence of any reference to the role of transactions between uncontrolled parties in the discussion of entitlement to returns from intangibles.

Also often heard critics address the missing discussion of risk as a driver for the attribution of returns related to intangibles. The determination of which party is entitled to a return should be reformulated towards identification of the party bearing the risk of intangible development or enhancement.

From my perspective, it is particularly important to consider both the characterization of the transaction by the taxpayer – i.e. the controlled parties involved – and the arm’s length nature of the reviewed transaction in the light of transactions between uncontrolled parties. It is therefore not astonishing that it was mentioned many times during the convention in Paris that re-characterization of a transaction should only happen in exceptional cases if at all and not become a common approach.

With regard to the entitlement to returns from intangibles, it becomes obvious that the WP 6 will very likely again discuss this in detail. Hence, many people expect the consideration of uncontrolled transactions, i.e. CUP / CUT as well as TNMM (Transactional Net Margin Method) to gain more attention in a next draft.

Value of intangibles and valuation

As mentioned earlier, the draft addresses the value and the valuation of intangibles in various chapters and refers somewhat indirectly to profit split or eventually profit split equivalent considerations. CUP or TNMM considerations are seldom or never addressed.

Further critics refer to the missing distinction between the value of an intangible to the multi-national group and the value to specific legal entities. An issue quite apparent in the case of acquisitions, where the price paid reflects the synergy value of the group, which is likely to be greater than the value to individual legal entities. Many comments also criticize the statement that certain valuations (such as those done for purchase price accounting) have “no” relevance for transfer pricing. However, the valuation techniques used in financial statement analyses are no different in substance from valuation approaches used in economics and business generally. They are simply applied using specific assumptions that are dictated by accounting standards and which may or may not be consistent with the assumptions that should be used for transfer pricing. While it may be appropriate to state that the assumptions used in financial statement valuations are not expected to carry over to the valuations for transfer pricing purposes, the discussion draft should provide explicit direction that the “most appropriate” method should be used. Moreover, the approaches used in valuation/purchase price accounting should be applied based on the specific facts and circumstances of the intangible transfer at issue.

Massive critics finally refer to the notion of “options realistically available” in characterizing a particular transaction as a whole or when it comes to valuation. As mentioned above, the Discussion Draft applies the concept of realistic alternatives in a way that effectively ignores data from comparable transactions among unrelated parties.

The discussion of realistic alternatives or options realistically available will likely continue also with the next draft to be issued by the WP 6 during the first half of 2013.

What is likely to happen next?

As the comments of the delegates, the public consultation in Paris as well as an event hosted by KPMG with acknowledged academic and economic experts showed, the subject of intangible assets will be of big interest to Switzerland and all countries engaged in international transactions. I expect the WP 6 of the OECD with its next discussion draft to mainly address and alter its statements regarding:
- The considerations of who is entitled to the returns from intangibles including the consideration of CUPs as well as effectively existing arrangements between third parties.
- How to define intangibles in a way that allows enough flexibility on one hand but provides also good guidance in disputes on the other.

There are certainly more areas that will see alternations and the hope of many stakeholders is that the WP 6 and the OECD will successfully address those areas guided by the attempt to provide strong support to multinational enterprises and tax administrations rather than first of all fight misconduct and abuse.

By Markus Wyss
Partner, Global Transfer Pricing Services
kpmg.com