THE OECD BEPS ACTION PLAN Intangibles and Services Seminar 28-03-2017
INTRODUCTION TO COPENHAGEN ECONOMICS
IP Valuation & Transfer Pricing We help our clients by quantifying the economic value of various kinds of intellectual property and intangible assets, employing state-of-the art economic models. This can be for transfer pricing, dispute, or strategic and monetization purposes. TRANSFER PRICING Transfer pricing valuations and documentation related to TP systems upon business re-structuring efforts I/co license rates for brand, technologies, knowhow Determination of economic benefits from centrally provided services and functions Implementation of global transfer pricing documentation (master file, local file, CbC) Local tax audit support DISPUTES & LICENSING Calculation of damages in e.g. infringement cases and loss of patenting Support settlements and settlement negotiations with economic analysis Determine license rates for commercialization purposes STRATEGY Economic evaluation of early-stage technology Market assessments to determine the market potential for a (to-be-developed) technology and patents Policy-related questions on e.g. the design of licensing, IP and related frameworks CONTACT INFORMATION Hendrik Fügemann hef@copenhageneconomics.com +46 76 1872 665 www.copenhageneconomics.com HENDRIK FÜGEMANN Partner VINCENZO ZURZOLO Senior Economist KATHARINA HUHN Economist MORITZ LUBCZYK Analyst HENRIK KARLSSON Analyst KATRINE VESTERGAARD Assistant 3
Hard Facts about Copenhagen Economics Established year 2000 Offices in Copenhagen, Stockholm and Brussels Single expertise: Economics 70 employees, Ph.D. or M.Sc. in Economics Multiple nationalities: Danish, Swedish, Finnish, German, Italian, Lithuanian, Romanian, American Partner-owned, six partners 4
1 2 Evolvement of TP Regulations Intangibles 3 4 Services Questions & Answers
1 EVOLVEMENT OF TRANSFER PRICING REGULATIONS FROM CUP TO VALUATION TECHNIQUES
From CUP to Valuation Techniques 1 st OECD TP Guidelines DD Business Restruct. 2010 TP Guidelines Scoping doc. on Intangibles DD on Intangibles BEPS Actions 8-10 Attribution of profits to PE Attribution of profits to PE DD on Safe Harbours 2015=19 1995 2008 2010 2011 2012 2015 1999=1 The CUP method as the best method in hierarchy Cross-border transfers of valuable intangibles Significant People Functions Cross-border services Most appropriate TP method CCA Differentiation between intangible transfers and services Marketing intangibles Important functions (DEMPE) Unique & Valuable contributions Opening to Safe Harbours Value creation Control over functions & risks Use of valuation techniques Year = # Number of OECD publications on TP Topics. DD: Discussion Draft. CCA: Cost Contribution Arrangement. 7
2 INTANGIBLES DISENTANGLING DIFFERENT CATEGORIES OF INTANGIBLES DIFFERENT WAYS TO EXPLOIT INTANGIBLES ESTABLISHING THE ARM S LENGTH PRICE FOR INTANGIBLES VALUE OF CONTRIBUTIONS TO INTANGIBLES TRANSFER PRICING METHODS APPROPRIATE FOR INTANGIBLES
Something which is not a physical asset or a financial asset, which is capable of being owned or controlled for use in commercial activities, and whose use or transfer would be compensated had it occurred in a transaction between independent parties in comparable circumstances BEPS ACTION 8-10: 2015 Final Report, par. 6.6.
Disentangling different categories of intangibles Hard Soft Routine Unique Marketing Trade 10
Hard vs. Soft Intangibles Hard intangibles An intangible characterized by legal, contractual, or other forms of protection (local or worldwide) Soft intangibles An intangible not protected/ registered under international or local law. Taken into account, but not considered intangibles for TP purposes 1 Trademarks Patents Know-how Group Synergies Location Savings Government Licenses & Concessions Software / Copyrights Customer List Access to market Skilled Workforce 1 BEPS ACTION 8-10: 2015 Final Report, par. 6.30-6.31. 11
Routine vs. Unique Intangibles Routine intangibles An intangible commonly available on the marketplace. Does not justify the allocation of premium return, over and above normal returns earned by comparable enterprises 1 Unique intangibles An intangible with unique characteristics having the potential for generating returns and creating future benefits that could differ widely 2 Non unique Know-how Retail customer list (e.g. tobacconists) Trademarks Patents Open-source software Commercial Licenses Government Licenses & Concessions Proprietary market and customer data 1 BEPS Action 8-10: par. 6.10. 2 Ibidem, par. 6.116. 12
Marketing vs. Trade Intangibles Marketing intangibles An intangible that relates to marketing activities, aids in the commercial exploitation of a product or service, and/or has an important promotional value 1 Trade intangibles A commercial intangible other than a marketing intangible 2. Trade intangibles relate to the production of goods and the provision of services. Typically developed through R&D 3 Trademarks Customer List/ Relationship Tradenames Proprietary market and customer data Licenses and Big data Patents Government Licenses & Concessions Know How & Trade Secrets Software 1 BEPS Action 8-10: Section A. 3 Amendment to Glossary. 2 OECD TP GL 2010: Glossary. 3 UN Practical Manual on Transfer Pricing, par. 1.6.5. 13
Different ways to exploit intangibles On a stand-alone basis Intangibles & Services Combination of intangibles Trademark Patent Tangibles GW Goodwill 14
Combination of intangibles Some intangibles are more valuable in combination with other intangibles. In isolation, they may have much less value 1 Patent on active ingredient Trademark Regulatory Approval 1 BEPS Action 8-10: par. 6.94. 15
Intangibles & Services Intangibles may also be transferred in combination with services 1 Where comparable arrangements are not available, it may be possible and appropriate to separate services from the transfer of intangibles (e.g. franchising agreements) In other situations, the provision of services and the transfer of intangible may be so intertwined that is difficult to separate the transactions (e.g. brand, software) Service Intangible Service Intangible Testing TP 2 for the provision of service Testing TP for the transfer of rights in the intangible Testing TP on an aggregate basis for the provision of services and the transfer of rights in the intangible 1 BEPS Action 8-10: para. 6.99-6.101. 2 TP: Transfer Price. 16
Establishing the arm s length price for intangibles Three main aspects should be taken into account: The unique features of the intangibles The value of contributions made by the parties to the value of the intangibles The specific industry where the transaction takes place 17
Unique features of intangibles Intangibles often have unique characteristics and have the potential for generating returns and creating future benefits that could differ widely 1 1 Exclusivity 2 Extent and duration of legal protection 3 Geographic scope 4 Useful life 5 Stage of development 6 Rights to enhancements, revisions and updates 1 BEPS ACTION 8-10: 2015 Final Report, par. 6.116. 18
1/2 Value of contributions to intangibles Under the arm s length principle, members of a MNE Group must be compensated for their contribution to the value of the intangible, in terms of functions, risks, and assets related to the Development, Enhancement, Maintenance, Protection, and Exploitation of the intangible 1 Legal ownership of intangibles, by itself, does not confer any returns derived by the MNE Group from exploiting the intangible 2 1 BEPS ACTION 8-10: 2015 Final Report, par. 6.48. 2 BEPS ACTION 8-10: 2015 Final Report, par. 6.42. 19
2/2 Value of contributions to intangibles The MNE Group members making the more significant contributions should receive the greater compensation 1 Functions 2 Design and control of research and marketing programmes Direction and establishing of priorities (e.g. determining blue-sky research) Control over strategic decisions and budgets Defense and protection of the intangible Quality control over functions performed by other enterprises Risks 3 Assets 4 Development of intangibles risk (i.e. risk of failure) Product obsolescence risk Infringement risk Product liability risk Exploitation risk Other intangible assets used in research, development or marketing Physical assets Funding 1 BEPS ACTION 8-10: 2015 Final Report, par. 6.55. 2 Ibidem, par. 6.56. 3 Ibidem, par. 6.65. 4 Ibidem, par. 6.59. 20
The increasing role of industry specific intangibles Depending on the industry sector and other facts specific to a particular case, exploitation of intangibles can account for either a large or small part of the MNE s value creation 1 Telco Apps, Network, IRUs, Customer-related intangibles Pharma Formulae, Patents, Reg. approvals, Trademarks Fashion Trademarks, Models, Supplier agreements Banking Customer list, Asset management systems 1 BEPS ACTION 8-10: 2015 Final Report, par. 6.10. 21
New Techniques Historical TP Methods Transfer pricing methods in brief Comparable Uncontrolled Price One sided methods 1 Transactional Profit Split Direct regard to the price applied in transactions between independent parties (i.e. at arm s length) 1) Selection of the simplest party to the transaction (Tested Party); 2) Application of the margins earned by independent parties Split the combined profit realized by the parties, based on contributions in terms of functions, risks, and assets Replacement costs Reference to costs incurred (or that would have been incurred) in developing the intangible Valuation Techniques Reference to the present value of future flows of income (or cash) attributable to the intangible 1 One sided methods: Resale Price Method (RPM); Cost Plus Method (CPLM); Transactional Net Margin Method (TNMM). 22
TP Methods appropriate for intangibles 1 Comparable Uncontrolled Price One sided methods Where comparable uncontrolled transactions are available (difficult or impossible) Generally not reliable methods for directly valuing intangibles Transactional Profit Split May have application in the sale of full rights in intangibles or partially developed intangibles Replacement costs Valuation Techniques Lack of correlation between cost of developing intangibles and their value once developed Valuation Techniques, in particular discounted cash flows derived from the exploitation of the intangible may be particularly useful 1 BEPS ACTION 8-10: 2015 Final Report, para. 6.131 6.157. 23
3 SERVICES CENTRALIZATION OF SERVICES DUPLICATION OF SERVICES EXEMPLARY UNIVERSE OF SERVICES EVOLUTION OF TP METHODS FOR SERVICES
Whether an activity provides a respective Group member with economic and commercial value to enhance or maintain its business position and [ ] an independent enterprise would have been willing to pay for the activity or would have performed the activity in-house BEPS ACTION 8-10: 2015 Final Report, par. 7.6.
Centralization of services HQ Decentralized Centralized HQ Monitoring Marketing R&D Regional Office 1 Regional Office 2 Op. Co 1 Op. Co 2 Op. Co N Sales Marketing R&D Finance/HR IT Sales Marketing R&D Finance/HR IT Sales Marketing R&D Finance/HR IT Op. Co 1 Op. Co 2 Op. Co N Sales IT Local Finance/ HR Sales IT Local IT Global Sales IT Local 26
Duplication of services No service should be found for activities undertaken by one Group member that merely duplicate a service that another Group member is performing for itself 1 Similarly or equally labeled functions, at different group levels, may differ in intensity, scope, and value creation Services [can be] different, additional or complementary to activities performed in-house 2 1 BEPS ACTION 8-10: 2015 Final Report, par. 7.11. 2 Ibidem. 27
1/2 The definition of a service is not simple One of the main challenges in many countries refers to the deductibility of charges for management services Shareholder activities Activities performed by one Group member solely because of its ownership interest in one or more group members Independent enterprises would not be willing to pay Not considered intra-group services Low Value Added Services Are supportive in nature and not part of the corebusiness of the Group Do not require the use of unique and valuable intangibles and do not involve significant risks The arm s length price is closely related to costs 28
2/2 The definition of a service is not simple One of the main challenges in many countries refers to the deductibility of charges for management services Business Services Are related to the core-business of the Group May involve the use of intangibles (know how) Involve significant people functions (SPF) High Value Added Services Are strictly related to the core-business of the Group Likely to involve the use (or lead to the creation) of valuable intangibles Involve significant people functions (SPF) 29
Exemplary universe of services Accounting & Auditing Consolidated Financial Statements Reporting Extraction & Exploration Financial & Insurance General Services Human Resources Information Technology Internal & External Communication Legal Service Manufacturing & Purchasing Parent company Investor Relations Research & Development Sales & Marketing Senior Management Tax 30
Evolution of TP Methods for services TP Methods At cost / Cost Cost + + Cost + LVAS: E.g. HR, Legal C + [Safe Harbour] Business Services: E.g. Production C + [Benchmark] HVAS: Val. Techniques E.g. R&D, Mktg General functional comparability Comparability requirements Value creation 2008 2010 2015 OECD Developments 2008 Attribution of profit to PE: Significant People Functions 2010 TP GL: Economic Substance, Cross-border services BEPS 8-10: Value creation, Unique & valuable contributions Supplementary Developments US Regs. 1.482: Service Cost Method EUJTP Forum: Low Value Added Services LVAS: Low value added services. HVAS: Low value added services. GL: Guidelines. EUJTP: European Joint Transfer Pricing. 31
How to clear the dust Soft Unique Intangibles Value Creation HVAS Intragroup Services Hard BS Routine LVAS 32
33
Hard facts. Clear Stories. ABOUT COPENHAGEN ECONOMICS Copenhagen Economics is the leading economic consultancy in the Nordic region. Founded in 2000, the firm counts more than 70 people and operates across the world. Global Competition Review (CGR) lists Copenhagen Economics as one of the top 20 economic consultancies in the world. We provide independent advice based on recognised research methods, and our experts have in-depth sector knowledge. www.copenhageneconomics.com