Intangibles: New BEPS Guidelines
One of the main concerns of the OECD regarding the mechanisms of base erosion employed by taxpayers has to do with the use of intangibles, in particular regarding the distortion of their value in controlled transactions, or even their strategic allocation in preferential regimes, without considerations of transfer pricing rules that could be applicable. For these reasons, Chapter VI of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD Guidelines) was modified considerably in order to accommodate new rules that limit the possibilities for the use of these types of assets in aggressive tax planning schemes. The most relevant changes are the following:
Concept of an intangible. BEPS plan Action 8, and now the OECD Guidelines, establish a new concept of an intangible and of exclusive use in the context of controlled transactions: “ ‘intangible’ is intended to address 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.”
Distinctions between legal and economic ownership of the intangible. A change of exceptional importance is the OECD’s proposal relating to the distinction of legal and economic ownership of the intangible. From a transfer pricing perspective, legal ownership is that of the person that, for all legal purposes, has registered the intangible in his name. However, the OECD mentions “for transfer pricing purposes, legal ownership of intangibles, by itself, does not confer any right ultimately to retain returns derived by the MNE group from exploiting the intangible, even though such returns may initially accrue to the legal owner as a result of its legal or contractual right to exploit the intangible.” If the legal owner does not carry out functions, contributes to assets, or incurs any risks associated with the development, enhancement, maintenance, protection and exploitation of the intangible of which he is an owner of (DEMPE functions), whoever carries out these activities could acquire the economic ownership of said intangible, or at least be compensated by them, with the effect reflected in the return for the exploitation or use of the intangible and taxable base of the participants. As an example, and to illustrate how those carrying out the functions should be compensated, it is emphasized that in cases that any entity in the group does not develop the functions associated with obtaining the intangible, and rather only finances its use, it will only be entitled to a risk-free return for its investment, and not to the income derived from the exploitation of the intangible.
Economic analysis of operations involving intangibles. The OECD Guidelines propose minimum norms for the arm’s length analysis of operations involving intangible assets, that require detailed knowledge of at least: i) the intangible involved in the transaction, ii) the related parties which the legal ownership of the intangible in the operation is attributed to, iii) the DEMPE functions carried out by the parties involved in the transaction (even when these are outsourced), iv) the consistency between the legal and economic conduct of the parties involved including the capacity to assume the risks associated with carrying out said DEMPE functions by any of the contracting parties, v) confirmation of the correct organization of the transactions or corrections to the same, and iv) confirmation of the arm’s length nature of the transaction:
Comparability analysis for operations involving intangibles. The comparability analysis for licensing or sale of intangibles is in itself complicated, and therefore, the OECD Guidelines propose certain factors that must be considered, at a minimum, in the analysis of this type of operations, which are: i) whether there is exclusivity in the licensing of the intangible, ii) the period in which legal protection is offered, iii) the geographical market where the license of the intangible is granted, iv) useful life of the intangible, v) development status, vi) rights granted for enhancement, modifications, and updates, and vii) expectations of future income that could be associated with the intangible.
Compensation for intangibles that provide no value. The OECD Guidelines emphasize that not all cases of the exploitation of an intangible are necessarily entitled to a return. As an example, consider the use of a commercial trademark that in principle should not be entitled a return in cases in which its use is limited to signaling the mere belonging to a multinational group.
Use of valuation techniques. For the cases in which intangible assets are transferred and in order to estimate the value of the same, it is necessary to use valuation techniques. The OECD Guidelines consider the use of such techniques and suggest standards regarding the accuracy of financial projections, use of discount rates, calculation of the useful life of intangibles, and the terminal value of the same, etc.
Hard to value intangibles. Finally, the new Chapter VI establishes some considerations in relation to those intangibles that are difficult to evaluate (those intangibles or rights over intangibles for which at the moment of their transfer among related parties: i) no reliable comparables exist, and (ii) at the time the transactions was entered into, the projections of future cash flows or income expected to be derived from the transferred intangible, or the assumptions used in valuing the intangible are highly uncertain, making difficult to predict the level of ultimate success of the intangible at the time of the transfer ). For these purposes, the OECD Guidelines suggest the establishment of contingent clauses that allow the reevaluation of the intangible at a date after its transfer, unless a series of premises are met demonstrating that the participating taxpayers in the transaction carried out all necessary efforts to establish an adequate return for the transfer of the intangible asset(s) in question and provide evidence that the valuation methods do not deviate over 20% with respect to the market value of the intangible five years after its transfer.
The reforms to the transfer pricing regime relating to intangibles are broad and taxpayers should evaluate the same according to their particular circumstances. Additionally, it is important to consider that the holistic approach proposed by the OECD links Action 8 with at least Action 1 (Tax Challenges of the Digital Economy), Action 5 (Harmful Tax Practices), and Action 13 (Transfer Pricing Documentation and Country by Country Reporting). One must consider that this last action requires that the transfer pricing master file at least include, disclosure of policies relating to the generation and use of intangibles in the multinational group, and that the local file clarifies the participation of all Mexican taxpayers in this regard.
