Risk & Economy » Tax » Transfer pricing: Shifting profits from hard-to-value intangibles

Transfer pricing: Shifting profits from hard-to-value intangibles

The need for robust, well-informed intangible asset valuations for the purpose of transfer pricing is becoming ever more invaluable for MNEs

TRANSFER pricing has been the buzz-word of the moment with extensive media coverage in recent years of multinational enterprises (MNEs) repositioning profits to more favourable tax jurisdictions. This movement to prevent international corporations from transferring profits in order to pay little, or no, corporate tax includes the profits gained from intangible assets.

Particularly for MNEs, brand provides a huge proportion of revenue each year. The transfer of profit from intangible assets is now being assessed to ensure that businesses are not transferring taxable profits to low tax jurisdictions to avoid paying the full tax requirement.

Comparable transactions

Many finance, and tax, directors use comparable transactions to assign a fair value to their intangible assets, using data bought on licence agreements to determine an arm’s length price. However, the accuracy and reliability of this method can be questioned. Weak analyses of comparable transactions are immediately noticeable to tax authorities. The data collected for comparable transactions must be accurate and relevant.

A number of companies supply databases on license arrangements, which MNEs use to seek benchmarks for comparable industries and deals, however this is not likely to meet IFRS. The evaluation and analysis of comparables requires detailed knowledge of intangible assets, but data purchases often lack context and detail in order to maintain confidentiality.

It can also be rare for intangible assets to be licensed in their core business application. Therefore it is unlikely that a full analysis of those comparable transactions can be completed to the correct standard, which puts not only the business, but also the individual, at risk of liability if a thorough valuation is not achieved.

Relevance of intangibles to transfer pricing

Transfer pricing does not cover intangible assets alone, but it is the area of transfer pricing arrangements that causes the most contention, as the valuation of intangibles is subjective. It is now a focal point for tax authorities and needs to be completed meticulously with support from a rigorous functional analysis.

The Organisation of Economic Co-operation Development (OECD) is currently investigating base erosion and profit shifting (BEPS) which is being endorsed by the G20 group. These investigations are in place to counteract tax planning strategies that shift profits to low tax jurisdictions to avoid or pay very little corporate tax. Action 8 of the BEPS plan highlights intellectual property and intangible assets as a particular area of concern.

The likes of Google, Amazon and Starbucks have already felt the backlash of their profit shifting schemes and the ramification of the reputational damage, with some consumers opting to boycott the companies.

Tax authorities are extending investigations within the field of transfer pricing to recover more corporate taxes. Therefore performing a full valuation of both tangible and intangible assets will help to reduce;

• Risk of extensive tax liabilities, penalties and interest
• Risk of resource allocated to dispute resolution with regards to money and time
• Reputational risk for the company, brands deployed and individuals involved

Intangible asset valuation methodology

For many businesses, it is more beneficial to gain an independent re-evaluation of their transfer pricing strategy, founded upon a thorough functional analysis and intangible asset valuation and a robust commercial-driven approach. This will allow companies to avoid the risks associated with inaccurate and ill-informed valuations whilst also providing a number of commercial strategies available to them in order to drive higher value.

The intangible asset valuation process applies a combination of three approaches that are widely adopted in the industry;

• The income approach takes estimates of cash flows and discounts them to a present value, taking into account associated time and risk involved.
• The market approach uses comparable transactions. The data is taken from a wealth of reliable and relevant sources to effectively provide well-informed analyses.
• The cost approach looks at either the historic cost of creating the intangible asset or the estimated cost and time that would be required to create an equivalent or replacement intangible asset.

An exhaustive valuation will also provide the finance or tax director with a detailed functional and risk analysis containing commercially benchmarked intangible asset strategies and an application of arm’s length principles.
The future for transfer pricing strategies

With such an incentive to guarantee that the business, and individuals, are not at risk of liability, most MNEs should be (and many currently are) valuing their intangible assets or receiving a second opinion from an independent consultancy.

As businesses are continually gathering an understanding of just how lucrative their IP and brands are, the transfer of profits from these valuable assets is also becoming more apparent to the tax authorities. Therefore the need for robust, well-informed intangible asset valuations for the purpose of transfer pricing is becoming ever more invaluable for MNEs.

John Illsley, valuation director at Intangible Business

Was this article helpful?

Leave a Reply

Subscribe to get your daily business insights