March 15, Clark J. Chandler

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1 Presentation to Working Party No. 6 on the taxation of multinational enterprises, meeting with business representatives on the valuation of intangibles for transfer pricing purposes, understanding the valuation landscape March 15, 2011 Clark J. Chandler

2 ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY KPMG TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN. You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials. 2

3 Issues to be covered: Conceptual background on the level of value (i.e., marketable minority, control, special purchases, etc.) Determinants of value Competitive & proprietary economic advantages Functional, commercial, legal & other value drivers Discounts and premiums Developing an appropriate cost of capital and its impact upon value 3

4 Putting this into a transfer pricing structure Many of the concepts outlined above deal with the pricing of equities E.g., marketable minority and control premium Adapting them to the pricing/valuation of intangibles Definition of Intangibles (What are we talking about?) Why do companies pay for intangibles? What attributes of a transaction can lead to a discount or premium? Discount rates what is different about transfer pricing? 4

5 Definition of intangibles Intangible property Can be transferred separately from the overall business Commands a positive price in the market More limited in scope than business restructuring Not all economic attributes that lead to high profits are intangible property Economies of scale 5

6 Why do companies pay for intangibles? Necessary input Commercial advantage/contribute to higher profits 6

7 Necessary input Examples: accounting software, IT systems, trademarks and patents that are needed to be in business Relationship to profit: Are necessary to be in business Even if there is a loss Are necessary to compete, but do not lead to an expectation of higher than normal profits Valuation considerations Market comparables may exist May be hard to use cost, as marginal cost is often very low 7

8 Intangibles that are an important source of competitive and proprietary advantage Examples: pharmaceutical patent, unique trademarks, monopoly due to legal rights Functional, commercial, legal & other value drivers There is generally some type of barrier to entry (e.g., legal, switching costs) Must be sustainable over time Must be attached to a specific asset/collection of assets Strong relationship between profits and price But this does not imply that price equals profits 8

9 What attributes of a transaction can lead to a discount or premium? Marketable minority, control, special purchases : impact of restrictions (or lack of restrictions) on price Examples of restrictions that can impact price: All legal rights (sale) vs. some limitations on legal rights (license) Nestle Appeals decision Limitations on use (geography, field of use) Limitations on preventing others from using the intangible (exclusivity/nonexclusive) Other party has the ability to either restrict use or reclaim rights 9

10 What attributes of a transaction can lead to a discount or premium? Trapped assets (special purchases) Value in a specific use is much greater than in other uses May be trapped in a use that lowers value (software to run dedicated word processing machines) Aggregation/bundling can lead to synergies or dis-synergies 10

11 Developing an appropriate cost of capital Extensive valuation literature on discount rates What s different about transfer pricing? Legal entity v. group considerations GE Capital case in Canada Impact of contractual terms that shift risk on discount rates/cost of capital WARA weighted average return on capital 11

12 Impact of the Cost of Capital on Value Discount Rate Rate Weight Used to Compute the Average Weighted Average Routine Profits 10% 50%.05 Residual Profits 20% 50%.10 Total/Average 15% 12

13 Thank You Presenter s contact details Clark J. Chandler KPMG LLP (202)

14 2011 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved WDC The KPMG name, logo and cutting through complexity are registered trademarks or trademarks of KPMG International.