Creating intangibles in emerging markets - TP treatment from IP life cycle perspective - Part I

July 12,2017
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Amitava Sen (Partner, Price Waterhouse & Co., LLP)

  1. Introduction:

The transfer pricing treatment of intangibles, in terms of issues like ‘DEMPE’[1] functions, legal ownership and economic value, has been a long standing area of dispute and debate amongst tax authorities and multinational taxpayers. BEPS Action Plan 8 was initiated to evaluate transfer pricing (TP) TP issues related to intangibles which may lead to base erosion and profit shifting. While developed countries have their own set of tax challenges around intangibles, the evolving business environment in developing countries often creates a set of unique and complex TP issues around development and exploitation of group intangibles which are adopted for emerging markets. When one looks at the global trend of major tax disputes around intangibles, developing countries tend to have issues around outward migration of intangibles developed within a country to low tax jurisdictions or to those offering beneficial tax regimes for intangible ownership. These disputes have led to exit charge claims or other form of compensation claims or in many cases, CFC regulations have been introduced to specifically encompass royalty income (as a category of passive income) earned in offshore locations. On the other hand, the issues around intangibles in developed countries, like India, which are still in early stages of internal IPR development and are mostly technology importing nations, tend to evolve around local development and ownership related aspects rather than outbound migration.

  1. The expanding ambit of intangibles from TP perspective

The OECD’s perspective on the definition and ambit of intangibles makes it clear that the TP evaluation of intangibles may start from the legal ownership and accounting aspects but expands much beyond that. This means that intangibles which are legally identifiable and protected under intellectual property rights (IPR) laws or those which are recognised under accounting norms, may form a subset of intangibles recognised for TP purposes but the TP ambit further expands to any other intangible which can create economic value for the owner or user of the intangible.

This focus on economic value creation has placed significance on functions, assets and risks (FAR) analysis related to DEMPE of intangibles due to which, on one hand, legally registered intangibles may not have economic significance from TP perspective, while on the other hand, unique or non-routine intangibles (business value drivers) may be created in course of business dealings which may not necessary gain legal protection under local IPR laws. The important principle is the ability to disintegrate the value creating ability of a recognised intangible (economic ownership) from its formal legal owner in the group. There may be entities, not being the legal owners, who perform critical / strategic functions or assume key risks related to DEMPE of the intangibles which may lead to economic ownership of the relevant intangibles. Even if the legal owner is funding the DEMP activities, in the absence of critical / strategic functions or key management functions, the sharing of economic returns between the true economic owner and legal owner may become a topic of TP dispute.


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