The Role and Value of Intellectual Property and the Transfer Pricing Ghost

In recent years, Intellectual Property has been recognized as a valuable business asset by Companies all over the world. Intellectual Property is an intangible asset  which cannot be defined by physical parameters , they  are a  product of one’s mind or intellect  and  includes know – how ,industrial  designs and copyrights related rights , trademarks and geographical indications ,patents , layouts of designs of integrated circuits and trade secrets.

Regardless of what product a Company sells or what service it provides, it is regularly using and creating a great deal of intellectual property.

Intellectual Properties assist Companies in every aspect of business development and strategy from product development and designing or service delivery to marketing and promotion of a Company’s Products or services to exporting or expanding through licensing or franchising.

All the Companies or business organizations have a trade name or brand name, logos or taglines (to market their products or services) which are protected by the Trademark laws .

Some Companies  develop or create original designs for their products  and processes  or innovations of a  which are secured by Patents. Most companies  have valuable confidential business information  , customer lists , sales tactic ,  copyright instruction books manuals and forms. Many would have produced, or assisted in the publication, dissemination or retailing of a copyrighted work

The OECD1 classified intangibles into two categories

  1. “Trade Intangibles” and
  2. “Marketing Intangibles”

[1] OECD refers to Organization for Economic Co-operation and Development

Trade Intangibles are generally createdas a result of research and development activities and include technology, patents, designs, inventions, formulae, know-

how, methods, drawings, technical data, etc used in the production of goods or services

Marketing Intangibles- include trade names, trademarks, customer lists, distribution networks, logos, symbols, pictures, etc, which give a product promotional value.

Intellectual Property is seen as being responsible for increasing the Company’s market value, improving future profitability expanding and protecting competitive positions by creating a barrier to the entry of competitors, enhancing customer value propositions, and increasing the attractiveness of businesses in an increasingly interconnected world

Intellectual Property may generate an income for a Company through the licensing, sale, or

Commercialization of the IP-protected products or services that may significantly

improve Company’s market share or raise its profit margins. There are numerous examples of Companies‘s value increasing overnight by acquiring important patents in key technologies. Similarly, a good trademark which has become well known among consumers may also enhance a company’s current value and may contribute to making your company’s products and services more attractive to consumers.

The Transfer Pricing Ghost

 

Although the role and value of Intellectual Property has been recognized by many mulch-national corporations who have invested billions of rupees in registration maintenance and protection of IP, they have been haunted by the evil of Transfer Pricing as a tax issue.

Transfer prices are the prices at which services, tangible property and intangible property are traded across international borders between related (associated) parties.

The tax authorities’ worry that multinational corporations will set transfer prices which will minimize their tax obligations. Intangibles  rank first in enquiry of transfer pricing audits.

Transfer pricing and Intellectual Property is the focus area of not only business establishments but also tax authorities worldwide. This is one area which has witnessed highest level of litigation or rather and highest value of tax adjustments globally.

The intangible nature of IP rights renders them easily movable capable of being transferred/assigned or licensed, the supply chain for any multinational company involves transfers of goods, services, finance or rights to use intangible from one group company in country to another group company in different country to use intangible assets of activities which create the non-routine profit of the company.

In some cases, that IP is passed from foreign parent to local subsidiary. In others, some IP may be created locally as the operations of the local manufacturers. Some transfer pricing traps in which unwary multinationals may fall into are establishing a subsidiary, research and development sites, cost sharing arrangement etc.

For example take a U.S. company that has a licensing agreement with a U.K. affiliate to market and sell its products in Europe. The products are manufactured in the Far East and shipped to a distribution center in the India, where they are packaged using materials supplied by an Eastern European company. In addition, American executives provide technical know-how to the Europeans. All of these transactions are taxable in some way and each country wants its share of the tax income

The OECD sets out the arm’s length principle which has been adopted by almost all tax authorities all over the world. Under the guidelines the charge should be that which would have arisen had the licensor and licensee not been members of the same group. However, although the theory of how to set an arm’s-length licence rate is well versed, the practical application of that theory is often very difficult. The difficulty is in assigning a value to intellectual for purpose of taxation. The difficulty gets compounded when they are traded with associated companies.

The guidelines of the arms-length concept are based on the notion that inter-company transactions should be treated as if they were transactions carried out between independent commercial entities. Companies should be aware that they are usually required to have specific documentation on how they set their prices for inter-company transactions in order to comply with the arms-length standards.

Meeting the complex transfer pricing guidelines is extremely difficult in today’s global environment. More regulations and increased audits have created greater compliance demands and as a result multinational Companies are faced with penalties and double taxation.

The Companies could overcome this problem if IP and tax experts work in collaboration and apply their expertise internationally, and come up with an effective transfer pricing program designed to satisfy documentation requirements around the world and perhaps minimize tax overpayment in this process.

One way to prevent the problem of double taxation and complying with transfer pricing contracts is creating strong contracts between the group companies for their licensing/R&D or cost sharing contracts arrangement of intellectual property. The License agreement could have provisions that the associated company can use the intellectual property only for the purpose of performing the contract or provisions have work done by the subsidiary company belongs to the parent company , the contract should have clear control lines will and hence no additional payment is required. The above is to avoid double taxation in two countries.

Another alternative for dealing with this issue is to enter into an Advance Pricing Agreement (APA). An APA is an agreement between a multinational corporation and one or more tax authorities that binds the parties to a transfer pricing method for transactions over a fixed period. The parties negotiate the agreement prior to the transactions in issue.

Therefore the trick to overcome the evil of Transfer pricing is tax efficient intellectual property structuring by identification of which group  Company owns the Intellectual Property  and which group company uses them and then creating licensing structures at arm’s length principle and  migration of Intellectual Property in favorable jurisdictions ,  thus by reconciling  global strategies for intellectual property with differing tax regulations early in the planning process, multi-national companies can save millions of dollars while avoiding endless battles with disgruntled tax authorities.

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