By 13 September Dear Mr. Andrus,

Transcription

1 Transfer Pricing Associates B.V. H.J.E. Wenckebachweg AS Amsterdam The Netherlands T +31 (0) F +31 (0) Attn. Mr. Joseph Andrus Organisation for Economic Co-Operation and Development (OECD) Head of Transfer Pricing Unit Centre for Tax Policy and Administration By joe.andrus@oecd.org 13 September 2012 Dear Mr. Andrus, Transfer Pricing Associates ( TPA ) is pleased to accept OECD s invitation to share our views on the Proposed Revisions of the Special Considerations for Intangibles in Chapter VI of the OECD Transfer Pricing Guidelines and Related Provisions issued on 6 June 2012 ( Discussion Draft ). TPA supports the OECD s decision to release the Discussion Draft as an interim draft for public comments. TPA is of the view that the result of previous public consultations at the OECD regarding the topic of intangibles, the published Discussion Draft and subsequent commentary from the business community are all important contributions for Working Party No. 6 in the process of updating Chapter VI. TPA is especially pleased that the OECD has provided a total of 22 practical examples in the Annex to the Discussion Draft, to replace the current Annex to Chapter VI of the OECD Guidelines. It is our view that these case study examples and the anticipated revisions to Chapter VI of the OECD Guidelines will provide more practical guidance to multinational enterprises (MNEs) and tax authorities on how to deal with everyday transfer pricing issues involving intangibles. Our submission focuses on providing comments on some of the key concepts introduced, as well as addressing particular areas where we believe further work is needed by the OECD. Additionally, we raise a few questions we believe will provide further insight into topics raised by the Discussion Draft. TPA congratulates the OECD with its initiative, but also encourages the OECD to provide further guidance on the topic of intangibles within a reasonable time frame. Further delays will potentially create unprecedented levels of controversy between MNEs and tax authorities or between tax authorities around the world. 1 Your bridge to worldwide transfer pricing services 721 of 1013

2 As such TPA will be addressing: a. implications of changes and new concepts; b. the approach of evaluating entitlement to intangible related returns ; c. valuation methods of the use and transfer of intangibles; d. areas for further work. a. Implications of changes and new concepts 1. The Discussion Draft establishes a significant shift from Chapter VI of the OECD Guidelines (2010). As a general note, TPA is of the view that the text of the Discussion Draft provides more direct guidance to practitioners on how to deal with transfer pricing aspects of intangibles. On the other hand, certain paragraphs of the Discussion Draft raise additional questions, and generate ambiguity compared to Chapter VI of the OECD Guidelines (2010). 2. It is our belief that the departure from accounting, legal and tax definitions (i.e. Article 12 of the Model Tax Convention) presented in Paragraphs 5 and 12 of the Discussion Draft has the potential to eliminate important standards and definitions that are typically used by practitioners as a starting point to evaluate an intangible for transfer pricing purposes. This stance by the OECD will likely lead to an increase in controversy between MNEs and tax authorities on intangibles. 3. TPA strongly supports the notion of excluding market conditions or other circumstances that are not capable of being owned, controlled or transferred by a single enterprise in Paragraph 8 from the definition of intangibles for transfer pricing purposes. 4. The introduction of the four functions related to intangibles (development, enhancement, maintenance and protection) and the four risks related to intangibles (development risk, product obsolescence risk, infringement risk and product liability risk) are providing more explicit guidance to taxpayers on performing a functional analysis. TPA recommends to the OECD to provide more clarity on the level of involvement needed by each of the group companies of an MNE (threshold test) in Paragraph 40 of the Discussion Draft, for a group entity to claim an entitlement to intangible related returns. 5. Paragraph 53 addresses the extra-ordinary circumstances under which tax authorities can disregard the contractual allocations of entitlement to intangible related returns, notwithstanding the fact that the four functions, four risks and intangible related registrations and contractual entitlements (so called cloud of contractual rights ) are fully aligned. TPA is of the view that Paragraph 53 leaves too much room for interpretations from tax authorities perspective, with the risk that the majority of cases will be attacked by tax authorities rather than the few ones which are described in a narrow fashion under Paragraphs of the OECD Guidelines (2010). 722 of P age

3 6. The wording under Paragraph 109 indicates that the application of income-based valuation techniques, especially valuation techniques premised on the calculation of the discounted value of projected future cash flows, may be particularly useful when properly applied and when based on appropriate assumptions. TPA encourages the use of income based methods since these methods enable practitioners to consider more parameters that may affect value and that have economic relevance than other valuation methods. Furthermore, TPA believes that Paragraph 110 rightfully reflects that MNEs should be careful in using valuations for transfer pricing purposes that were actually conducted for IP law, accounting, managerial, anti-trust law and other purposes. However, TPA recommends taking these valuations into consideration whilst conducting a valuation for transfer pricing purposes in order to get a better understanding of the setting in which the valuation for transfer pricing purposes takes place and to allow MNEs to leverage from the sometimes relevant valuations performed for a different purpose. 7. In summary, TPA believes that the analysis to determine entitlement to intangible related returns does increase the complexity and level of variables to be addressed by a taxpayer, before such entitlement is being confirmed and captured in a written documentation for transfer pricing purposes. Therefore, TPA advocates the OECD to provide guidance on the level of detailed analysis required in relatively straight forward cases where intangibles are being used or transferred by one group entity to another, e.g. a single US licensor licenses the right to produce and distribute (based on a patent owned by the US) to its French manufacturer, which subsequently sells these products to third parties in the market place. When this particular case results in more than one group entity being entitled to the intangible related returns, the concepts start having an overlap with the concept of cost contribution arrangements/cost sharing agreements and create different outcomes than under the original Chapter VI. b. The approach of evaluating entitlement to intangible related returns 8. The approach of evaluating entitlement to intangible related returns is one of the most significant changes introduced in the Discussion Draft. Rather than focusing on balance sheets and ownership of intangibles, the approach centres on profits/losses and cash flows of stakeholders of the intangibles in question. Defining the functions of developing, enhancing, maintaining and protecting an intangible as required to be entitled to a return introduces a change in the paradigm for MNEs in terms of how functions, assets, risks, and costs with respect to intangibles are examined. 9. The introduction of the concept of entitlement to intangible related returns by the OECD in Paragraph 29, is laying the foundation for requiring MNEs to fully align the legal/contractual arrangements, the performance of functions relating to an intangible, the risks associated with those functions, as well as the costs borne, in order to receive the recurring benefits of an intangible. TPA believes that the concept of entitlement to intangible related returns is an important step in aligning the legal, economic and accounting realities of group companies involved in intangibles. TPA has created a diagram 723 of P age

4 that provides clarity in this matter. See Appendix I for the determination of which group entities would be entitled to intangible related returns. 10. The emphasis placed on controlling the risks and functions that are related to an intangible begins to align Chapter VI further with the rest of the OECD Guidelines, specifically Chapter IX. The threshold of entitlement aims to establish a standard that could prove to be a key factor leading to the evaluation of which parties within an MNE are entitled to intangible related returns. The introduction of the threshold of responsibility seems to have similar attributes and requirements of the qualified membership of a Cost Sharing Agreement (investor s model/classification). TPA questions whether the complexities introduced here do require OECD to address at the same time the relevant context not only for use/transfer of intangibles (Chapter VI), but also for cost contribution arrangements/cost sharing agreements (Chapter VIII). The threshold of entitlement seems to be focused on circumstances that exist prior to any sharing of intangible related returns between related parties (i.e. prior to licensing or cost-sharing). If a cost-sharing participant invests in the cost-shared intangibles via an up-front payment, this should entitle him to intangible income going forward in some respects. TPA is of the view that the OECD wording is essentially focused upon situations where rights lie prior to any transaction, so as to better be able to price any proposed transaction. TPA recommends that OECD clarify this position further. 11. In its current form the Discussion Draft does not seem to allow in any way for acknowledgement of a simple financial commitment from the outset as making a party entitled to intangible related returns. For example, if Entity A in Country X and Entity B in Country Y decide to co-fund a brand new research project and the activities are performed by Entity B in their lab; does this allow for Entity A to be recognized as a 50/50 owner if it only funds half of the research from the starting date of the project? In a third party setting Entity A would expect to be entitled to intangible related returns; however, the wording of the Discussion Draft indicates such entitlement would not be present in the above example. 12. The introduction of the `control over risk` theme for intangibles in Paragraph 42 does bring some challenges for MNEs, since it is not always clear whether these risks relate to (1) simply the holding of intangibles by a group entity and/or (2) active management of the four risk categories in Paragraph 43. TPA recommends OECD to clarify its position. c. Valuation methods and intangibles 13. Due to the complex nature of intangibles, the process of assigning value and pricing intercompany transactions involving the use or transfer of intangibles should be conducted on a case-by-case basis and requires an in-depth analysis of the parties involved, business reasons for the transaction and other important factors. In order to properly price an intercompany transaction TPA recommends to avoid strictly applying one method, but rather having a primary source of reference to determine the value as well as use the other sources to place the value and valuation process in the relevant business context. 724 of P age

5 14. Rather than looking at every intangible through the same lens, the practitioner, and tax authority alike, should evaluate each intangible as a unique asset and examine factors that differentiate the intangible and contribute to its value. TPA is of the belief that the Discussion Draft provides support for this perspective, specifically in Paragraph TPA is of the view that in performing a valuation analysis of an intercompany transaction involving the use or transfer of intangibles, the focus should not be on utilizing market based comparables as the initial step. Due to the unique nature of intangibles developed within an MNE, there are typically no 100% comparable intangibles in the marketplace that could be used effectively without some or even considerable adjustments. For example, it would be extremely difficult to find a reliable comparable transaction involving same/similar intangibles in the market when testing an intangible that has been internally generated by an entity within an MNE and is being transferred to a related party. On the contrary, various royalty rates references used in industry between third parties are considered a useful complementary reference point, i.e. cannot be rejected if/insofar providing appropriate information to determine the level of intercompany royalty rates. 16. Because of the need for further guidance, TPA recommends the creation of a Communication Protocol, or typical process to perform a transparent and defensible valuation study, similar to the guidance provided in Paragraphs 3.4 and 3.5 of the OECD Guidelines (2010), which provides a typical process for selecting the most appropriate comparables set. This typical process, as outlined in Paragraphs 3.4 and 3.5 of the OECD Guidelines (2010), is already used when performing a database search of one of the available royalty databases in order to determine the quantitative reference points as described under Section 15 above. However, a Communication Protocol/typical process for the intercompany transfer of intangibles does not exist yet. See Appendix II for a sample proposed outline, prepared by TPA, of ten steps of a typical valuation process in case an intangible (or the right to use and/or commercially exploit an intangible, i.e. through a license arrangement) is being transferred by one group entity to another group entity. 17. While Section D of the Discussion Draft allows the application of a variety of valuation methods to be used when no reliable comparables exist, TPA believes that further clarity and guidance is needed in Section D of the Discussion Draft on how to apply specific valuation methods. Although in some countries the legislation is already specific on ranking of valuation methods in the case of an intercompany transfer of intangibles, TPA recommends to the OECD to provide a listing without ranking instead, since - like the traditional transfer pricing methods (CUP, Cost plus, Resale price, TNMM/CPM and Profit split) - rankings would create a bias towards the income based method, which certainly is not always the most appropriate method for valuing a transferred intangible. d. Areas for further work 18. The Discussion Draft references the importance of economically significant intangibles in Paragraph 11, and also introduces the idea that intangible related returns may be positive, 725 of P age

6 negative or zero in Paragraph 28. TPA suggests further clarification by the Working Party when evaluating the Discussion Draft. 19. TPA believes that the concept of entitlement to intangible related returns is a step in the right direction by the OECD. However, this introduction may provide further ambiguity among MNEs and tax authorities. It appears that there is a large amount of overlap between the four sets of functions; separating individual functions from one another may become increasingly complex within an MNE. As such, TPA believes that further work is needed by the Working Party with respect to this point. 20. An additional area that should be further clarified is the application of valuation techniques and/or methodologies. As such, TPA would urge the OECD to provide more guidance in Section D regarding the practical application of valuation techniques regarding pricing intercompany transactions involving intangibles. A Communication Protocol/typical process template is attached as Appendix The issue of whether an assembled workforce provides a service or represents a transfer of know-how is also a pressing question for the Working Party. Paragraph 26 of the Discussion Draft attempts to provide an answer to this question; however, TPA is of the view that further work is needed on this subject. TPA refers to Commentary on Article 12, Paragraphs in the OECD Model Tax Convention on Income and on Capital (July 2010). Paragraph 11.3 states that The need to distinguish these two types of payments, i.e. payments for the supply of know-how and payments for the provision of services, sometimes gives rise to practical difficulties. TPA and its alliance partners will be pleased to contribute to the further development of updated Chapter VI and other relevant sections of the OECD Guidelines with respect to intangibles. Yours sincerely, On behalf of Transfer Pricing Associates 1, Steef Huibregtse 1 For a complete list of Transfer Pricing Associates and Transfer Pricing Associates alliance partners please see 6 Page 726 of 1013

7 Appendix I: Visual Representation of the Threshold of Entitlement to Intangible Related Returns Note: In case a group entity within an MNE through its FTEs on its payroll is: i. involved in development / enhancement / maintenance / protection of intangibles, ii. managing the four types of intangibles related risks, and iii. has sufficient access to a cloud of contractual rights relating to these intangibles, an entitlement to intangible related returns exists. The major question is what is the threshold definition before entitlement to intangible related returns exists at the level of a group entity. 727 of P age

8 Appendix II: Communication Protocol Ten steps for the valuation of intangible assets in the context of an intercompany transaction Below is a description of the typical process that can be followed when performing a comparability analysis of intangibles that are components of a transaction with a related party when the transaction is an outright transfer of an intangible or involves the license (value in use) of an intangible. This process is considered to be a good practice and is not compulsory, and any other search process leading to the identification of a reliable valuation may be acceptable, as reliability of the outcome is more important than the process. This process, if applied correctly, has the potential to lead towards a more transparent valuation, but completing the steps does not guarantee that the outcome will lead to an arm s length result. Step 1: Determine the type of transaction. Evaluate if and insofar the transaction involves a straightforward transfer of an intangible. Step 2: Functional analysis of the parties involved, including the functions performed, assets used and risks assumed as well as the period or date when the transaction takes place. Step 3: Determine which intangibles are the object to be transferred and the nature of those intangibles and the risks associated with the intangibles. Determine if there is a need to separately identify each intangible or whether intangibles can be grouped together. Step 4: Evaluate the parties which are potentially entitled to the intangible related returns, i.e. which group entity/entities is/are acting as the seller of the intangible(s). Step 5: Identification of internal and external comparables. If comparables exist, apply one of the five methods accepted in Chapter II of the OECD Guidelines (2010). If no reliable comparables exist, apply steps 6 through 9. Step 6: Evaluate the business case for this transaction and the benefits triggered by the intangibles. In order to determine these benefits one should consider the impact the intangibles have on the expected future cash flows of the business (which could be a direct or indirect impact). Allocate the expected future cash flows attributable to the intangible and assess the risk profile of the intangible taking step 3 into consideration. The ability to allocate expected future cash flows to an intangible is paramount assuming a going concern situation and taking into consideration the expected lifetime of the intangible. Some elements to consider: a. Demand b. Substitutes c. Exclusivity d. Extent and duration of legal protection 728 of P age

9 e. Geographic scope f. Economic life of the intangible g. Development stage h. The rights to enhancements and revisions i. Expected future benefits Step 7: Examine both the seller s and buyer s perspectives and the major options realistically available to each of the parties involved in the transaction as well as any unique or unusual aspects of the controlled transaction that result from the parties being related. For example, a discount for not being able to trade/transfer the intangible(s) in a free market place. Step 8: Selection of the most relevant valuation techniques and the most appropriate transfer pricing method to apply. Step 9: Execution of the valuation techniques and transfer pricing methods. Step 10: Full implementation of the above intercompany transfer of intangibles through drafting / signing intercompany legal agreement(s) and other implementation steps. 729 of P age