8.3 Transactions Involving The Use Or Transfer Of Intangibles


In addition to identifying with specificity the intangibles involved in a controlled transactions and identifying the owner of such intangibles, it is necessary to identify the specific controlled transactions including understanding the nature of that transactions and how the intangibles are exploited.

  1. Transfers of intangibles or rights in intangibles.
    1. Controlled transactions involving transfer of intangibles or rights in intangibles can occur via an outright sale or grant of license to an associated person. The intangible's owner can grant a license or right to someone else to exploit the intangibles or rights in the intangibles in return for a fee / royalty.

    2. Transfer of rights of intangibles may involve:-
      • transfer of all rights in the intangibles (e.g. sales of intangibles or a perpetual, exclusive license of the intangible); or
      • transfer of limited rights (e.g. via a license or similar transfer of limited rights to use an intangible which may be subject to geographical restrictions, limited duration, or restrictions with respect to the right to use, exploit, reproduce, further transfer, or further develop).

    3. In transactions involving the transfer of intangibles or rights in intangibles, it is essential for tax payers in a transfer pricing analysis to identify:

      • with specificity the nature of the intangibles and rights in intangibles that are transferred between associated persons; and
      • limitation/restrictions on the rights transferred including the nature of such limitations and the full extent of the rights transferred as the nature of limitation can affect the value of the intangibles transferred.

  2. Transfers of combination of intangibles.
    1. Intangibles (including limited rights in intangibles) may be transferred individually or in combination with other intangibles. In considering transactions involving transfers of combination of intangibles, two related issues often arise.

    2. Firstly, the nature and economic consequences of interactions between different intangibles. Some intangibles are more valuable when considered in combination with other intangibles than if they are considered separately.

    3. Secondly, to ensure that all the intangibles transferred in a particular transaction have been identified. Sometimes the intangibles are so intertwined that it is not possible, as a substantive matter, to transfer one without transferring the other.

  3. Transfer of intangibles or rights in intangibles in combination with other business transactions.

    1. In some situations, intangibles or rights in intangibles may be transferred in combination with tangible business assets, or in combination with services. Under such situation the taxpayer needs to provide evidence that:

      • all intangibles have been transferred; and
      • all of the intangibles transferred in connection with that particular transaction can be identified and taken into account in the transfer pricing analysis.

    2. Where it is possible and appropriate to separate transactions of tangible goods or services from transfers of intangibles / rights in intangibles for purposes of conducting a transfer pricing analysis, then the price of a package contract should be disaggregated in order to confirm that each element of the transaction is consistent with the arm's length principle. It should be kept in mind, however, that the interactions between various intangibles and services may enhance the value of both.

    3. In some situations it may be difficult to segregate tangible goods or service transactions from transfers of intangibles / rights in intangibles because transactions may be so closely related.

    4. However, if the arrangement of services and intangibles transferred in combination is so unique, that sufficiently reliable comparables are not available, then it may be necessary to segregate the various parts of the package for transfer pricing purpose, keeping in mind that the interactions between them may enhance the value of both.

  4. Transactions involving the use of intangibles in connection with the sale of goods or the performance of services.

    1. Intangibles may be used in connection with controlled transactions in situations where there is no transfer of the intangible / rights in the intangible. For example, intangibles may be used by one or both parties to a controlled transaction in connection with;
      • the manufacture of goods sold to an associated person;
      • the marketing of goods purchased from an associated person; or
      • the performance of services on behalf of an associated person.

        The need to consider the use of intangibles by a party to a controlled transaction involving a sale of goods can be illustrated as follows

        A car manufacturer uses valuable proprietary patents to manufacture the cars that it then sells to associated distributors. Assume that the patents significantly contribute to the value of the cars. The patents and the value they contribute should be identified and taken into account in the comparability analysis of the transaction consisting of the sales of cars by the car manufacturer to its associated distributors, selection of the tested party and the most appropriate transfer pricing method for the transactions. The associated distributors purchasing the cars do not, however, acquire any right in the manufacturer's patents. In such a case, the patents are used in the manufacturing and may affect the value of the cars, but the patents themselves are not transferred.

    2. Under such situation the following would need to be addressed in the transfer pricing documentation:
      • the nature of such a transaction should be clearly specified;
      • any relevant intangibles used by either of the parties in connection with such a controlled transaction should be identified; and
      • these relevant intangibles should be taken into account when performing the comparability analysis (including the functional analysis), and in the selection and application of the most appropriate transfer pricing method for that transaction.
  1. Many MNE Group outsource the 'manufacturing activities' necessary for the exploitation of the intangibles by way of a contract to Malaysian manufacturers. The intangibles may be in the form of technical know-how, secret formula etc. Generally during the initial stage of setting up of a manufacturing business operation in Malaysia, these are provided to the contract manufacturers for a fee. However, it was noticed that many of these local companies continue paying royalties (indefinitely) even though they have gained the necessary experience, are now well established and has contributed to the improvement and efficiency of the manufacturing process.

  2. The Malaysian companies using the technical know-how of their parent may have incurred significant expenditure to customize such know-how and to enhance its value by their research and development effort. Cost of such research and development activities which contributed to enhancing the value of the original know-how owned by the parent company should be considered when determining the arm's length price for payment of royalties for technical know-how or patents.

  3. Under such circumstances, the taxpayer needs to consider whether it should continue to pay a royalty to the parent company for the 'improved' manufacturing process. If 'yes', the taxpayer must give justification that the original intangibles continue to provide value over time. The taxpayer should also consider its entitlement to a return on the intangibles of the improved manufacturing process especially when the locally created or enhanced intangibles are used by other related companies.

  4. IRBM may disallow royalty paid if it is not shown that the royalties currently paid are for newly developed or enhanced intangibles as the original intangibles may have become obsolete over the years.