For transfer pricing purpose, in analyzing transactions involving the use or transfer of intangibles between associated persons, the following factors should be taken into consideration :-

1. Identifying the intangibles
   
   1. Specifically identify the intangibles used or transferred in the controlled transaction together with the economically significant risks associated with the DEMPE of the intangibles.
      
      
   2. When a taxpayer pays royalty for the use or transfer of intangibles, the taxpayer needs to provide evidence for:
       
      • the intangibles that are involved;
        
        
      • the processes where the intangibles are utilized
        
        
      • the benefit obtained from the intangibles;
        
        
      • the specific, economically significant risks associated with the transactions involving the intangibles; and
        
        
      • withholding tax payments that are made with regards to the royalty payment.
        
        
2. Analyzing the contractual terms
   
   1. Identify the full contractual arrangements with special emphasis on determining legal ownership of intangibles based on the terms and conditions of legal arrangements, including relevant registration, license agreements, other relevant contracts, the contractual rights and obligations and the contractual assumption of risks in the relations between the associated persons.
      
      
   2. In identifying the contractual arrangements, the following information is necessary and may be obtained from legal documents including public registration such as patent or trademark registration and written contracts such as licensing agreements:
      
      • legal ownership;
        
        
      • role, responsibilities, obligations and rights of the relevant parties including those who undertake the functions and controls the risks with respect to the DEMPE functions;
        
        
      • identity the funder and level of risks assumed by the funder;
        
        
      • quantum of payment and mode of payment; and
        
        
      • how expenses and receipts related to intangibles are allocated.
        
        
   3. Correspondence and communications between the parties involved are also important in identifying and analyzing the controlled transactions involving intangibles and evaluating the terms of the transactions (including risks assumption involving the transfer or use of the intangibles).
      
      
   4. The determination of legal ownership is distinct from the question of remuneration. 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, this would depend upon the functions the legal owner performs, the assets it uses, and the risks it assumes, and upon the contributions made by other MNE group members through their functions performed, assets used, and risks assumed (refer to paragraph 8.2.3).
      
      
3. Functional Analysis
   
   1. Functional analysis needs to be done to identify the parties performing economically significant functions, using assets, and managing risks related to DEMPE of the intangibles.
      
      
   2. Taxpayer needs to identify:
      
      • the economically significant functions that contribute to the value of the intangibles and instrumental to the success of the DEMPE of the intangibles
        
        
      • ascertain the relative importance of each DEMPE functions; and
        
        
      • group members who:-
        
        • perform and exercise control over the functions associated with the DEMPE of the intangibles;
          
          
        • provide the assets and funding, and have financial capacity necessary to bear the cost in relation to the funding; and
          
          
        • assume and exercise control over the various specific, economically significant risks associated with the intangible and have the financial capacity to bear the risks associated with DEMPE of the intangibles.
          
          
   3. Carefully evaluate the relative value of contributions by various entities to the DEMPE to ensure all affected entities in the group are appropriately compensated on an arm's length basis.
      
      
   4. The performance of activities by a Malaysian taxpayer which are economically significant and important include:
       
      • research and development activities which leads to customization / enhancement of existing products or new products;
        
        
      • activities which leads to improvement in manufacturing processes;
        
        
      • the performance of advertising, marketing and promotional activities by the Malaysian taxpayer which leads to creation / enhancement of marketing intangibles such as customer lists, marketing / distribution channel, or favorable contracts; and
        
        
      • managing customers' relationship, localization of products / advertisements or marketing survey including collection of local data.
        
        
   5. All these local functions performed by the Malaysian entities which improved the value of intangibles should be appropriately compensated and the costs incurred for such expenses should not be merely reimbursed to the local entity without any profit element, especially when they are performed in conjunction with the manufacturing or distribution functions.
      
      
   6. A local entity who is not the legal owner of the intangible may nevertheless be entitled to a share of returns from its exploitation if the local entity has contributed to the enhancement of the intangibles. Thus, the local entity is considered as having 'economic ownership' of the associated intangibles created.
      
      
4. Control of the performance of significant functions.
   
   1. In carrying out the functional analysis, a taxpayer needs to assess the capacity of a particular entity to exert control and the actual performance of such control functions. It is not essential that the legal owner physically performs and controls all the functions related to DEMPE of an intangible. Where associated persons other than the legal owner perform and control relevant functions that are anticipated to contribute to the value of the intangibles, they should be compensated on an arm's length basis.
      
      
   2. Similarly, where the performance of the DEMPE functions by a local entity is said to be controlled by another entity, documentary evidence has to be provided, to show that the said entity has the capability to control and perform its control functions.
      
      
   3. A local entity carrying out core functions as mentioned in paragraph 8.2.2 (iii)(e) above would control the strategic operations decisions regarding its activities and should be entitled to more than a routine low cost plus remuneration for its performance and control of the core functions. It is highly unlikely to separate the performance and control of a function.
      
      
5. Funding 
   
   1. Group members involved in the creation of intangibles may contribute physical assets, intangibles or funding for the project. The nature and amount of compensation attributable to any of the group members should be appropriately determined based on the arm's length principle.
      
      
   2. Funding and risks taking are closely integrated as funding is often linked with certain risks such as bad debts risks or the risks of losing all the funds. Compensation to the funder will depend on the level and extent of the risks it bears.
      
      
   3. To show control over a specific financial risk, a taxpayer must provide evidence that the funder is capable of making relevant decisions related to the risk bearing opportunities together with the actual performance of these decisions (including risk mitigation activities).
      
      
   4. Generally, a funder who only exercise control over financial risks associated with the provision of funding, without the assumption of further risks in relation to the investments, and without any control over the use of the contributed funds or the conduct of the funded activity, would only entitle the funder to a risk-adjusted rate of anticipated return on its capital.
      
      
6. Risks associated with DEMPE of the intangibles
    
   1. Many local entities are treated as contract risk free service providers, by contending that higher return to foreign entity is justified because the foreign entity:
      
      
      • provides funding for the project, hence bearing the risks of failure of the R&D functions; and
        
        
      • establishes and controls strategy / direction and priorities of research program or creative undertakings while the local entity is merely implementing such strategy / direction.
        
        
   2. Although the strategic decisions and overall directions from parent / foreign entities are cascaded down to the local entity, this does not imply that the foreign entity has control over the R&D functions of the local entity or would bear the related risks.
      
      
   3. If the local entity performs important R&D functions and even customizes the know-how provided which leads to enhancement of intangibles or creation of new intangibles, and the management and personnel of the local entity are responsible for operational decisions and monitoring of its R&D activities, the local entity is in a better position to control over the operation and its related risks than an entity who is controlling the functions / risks from afar.
      
      
   4. As mentioned in paragraph 8.2.2 (v) above, provisions of funding will not entitle the funder to a premium return, if it did not perform control functions and bear risks with regards to the R&D activities. Besides that, other important assets possess by the local entity such as skilled workforce must be considered when determining the return to the local entities. The parent / foreign entity will be entitled to a return for the provision of funding and overall direction and strategy, while the local entity should also be entitled to a return on their core R&D functions and control of risks related to the operation of R&D activities. Hence, the local entity should not merely be reimbursed on a cost plus margin as a risk free service provider since the performance, control functions and its associated risks are closely linked and should not be separated and assigned to different parties.
      
      
   5. When analyzing the economic substance of a transaction in relation to risks, it is necessary to examine whether the conduct of the associated persons over a period of time has been consistent with the allocation of risks and not merely at the time when risks are realized and whether changes in the pattern of behavior of the parties have been matched by changes in the contractual arrangements.
      
      
   6. Hence, a routine service provider who earns a very low margin should not suffer the loss when certain risks are realized, as it had consistently earned a minimal margin when the risks did not materialized. In a genuine case, a local entity who bears the risks would earn a reasonable margin and have taken mitigating actions to protect itself against any risks should it materialized.