1. In applying the arm's length principle, a taxpayer needs to understand the type and the characteristics of intangible properties. This would help in identifying the factors that contribute to an intangible's value and the types of comparables needed for comparability analysis.

  2. When determining the relative value of contribution by each party or comparability of the transactions, it is necessary to examine the nature and importance of contribution, cost incurred and risks assumed in DEMPE of the intangible property. Other factors to consider include:

    1. expected benefits and usefulness of the intangible property;

    2. prevailing industry rates;

    3. terms of the agreement including geographic limitations, duration of the license, any termination or negotiation rights and exclusivity rights;

    4. legal protection;

    5. benefits to the licensor, arising from sharing of information on the experience of the licensee contributing towards further developments of the property;

    6. possibility of sub-licensing;

    7. the extent of any capital investment, start-up expenses or development work required or stage of development of intangible;

    8. rights to receive update, revisions or modifications of the intangibles; or

    9. technical assistance, trademarks and know-how provided along with access to any patent.

  1. In selecting the most appropriate transfer pricing method in a case involving a transfer of intangibles or rights in intangibles, attention should be given to:

    • the nature of the relevant intangibles;
    • the difficulty of identifying comparable uncontrolled transactions and intangibles in many, if not most, cases; and
    • the difficulty of applying certain transfer pricing methods in cases involving the transfer of intangibles.

  2. When selecting the most appropriate transfer pricing method, consideration should be given to the economic consequences of the transaction and not an arbitrary label of the transactions itself.

  3. It is important not to simply assume that all residual profit, after a limited return to those providing functions, should necessarily be allocated to the owner of intangibles. The selection of the most appropriate transfer pricing method should be based on a functional analysis that provides a clear understanding of the MNE Group's global business processes and how the transferred intangibles interact with other functions, assets and risks that comprise the global business. The functional analysis should identify all factors that contribute to value creation, which may include risks borne, specific market characteristics, location, business strategies, and MNE Group synergies, among others. The transfer pricing method selected, and any adjustments incorporated in that method based on the comparability analysis, should take into account all of the relevant factors materially contributing to the creation of value, not only intangibles and routine functions.

  4. Depending on the facts and circumstances of each case, any of the five OECD transfer pricing methods may constitute the most appropriate transfer pricing method to determine the arm's length price and conditions for the controlled transaction involving intangibles. Other methods may also be used, where appropriate

  5. The determination of arm's length prices for a transfer of intangibles or rights in intangibles can be made when comparables and information related to it can be identified to make reliable comparability adjustments to account for any differences in the controlled and uncontrolled transactions.

  6. Where information regarding reliable comparable uncontrolled transactions cannot be identified, the arm's length principle requires use of another method to determine the price that independent parties would have agreed under comparable circumstances. In making such determination, it is important to consider:

    1. the functions, assets and risks of the respective parties to the transaction;

    2. the business reasons for engaging in the transaction;

    3. the perspectives of and options realistically available to each of the parties to the transaction;

    4. the competitive advantages conferred by the intangibles including especially the relative profitability of products and services or potential products and services related to the intangibles;

    5. the expected future economic benefits from the transaction; and

    6. other comparability factors such as features of local markets, location savings, assembled workforce, and MNE group synergies.

  7. Due to the relationship between them, associated persons might sometimes structure a transaction involving intangibles in a manner that independent parties would not contemplate. However, where associated persons' transactional structures are not typical transactions entered into by independent parties, the effect of those structures on prices and other arm's length conditions should be taken into account in evaluating the profits that would have accrued to each of the parties at arm's length.

  8. One sided methods, including the resale price method and the TNMM, are generally not reliable methods for directly valuing intangibles. A one sided method can be used to indirectly value intangibles, by determining values for some functions and deriving a residual value for intangibles. It is important to bear in mind that not all residual return is attributable to the legal owner. Care should be exercised to ensure that all functions, risks, assets and other factors contributing to the generation of income are properly identified and evaluated.

  9. The use of transfer pricing method based on the cost of intangible development to estimate the value of intangibles should be avoided. There rarely is any correlation between the cost of developing intangibles and their value or transfer price once developed.

  10. The transfer pricing methods most likely to prove useful in matters involving transfers of one or more intangibles are the CUP method and the transactional profit split method. Valuation techniques can also be useful.

Where reliable comparable uncontrolled transactions can be identified, the CUP method can be applied to determine the arm's length conditions for a transfer of intangibles or rights in intangibles. In some situations, intangibles acquired by an MNE Group from independent parties are transferred to a member of the MNE Group in a controlled transaction immediately following the acquisition. In such a case, the price paid for the acquired intangibles will often (after any appropriate adjustments, including adjustments for acquired assets not re-transferred) represent a useful comparable for determining the arm's length price for the controlled transaction under a CUP method.

Where it is not possible to identify reliable comparable uncontrolled transactions for a transfer of intangibles or rights in intangibles, a transactional profit split method can be utilized to determine the arm's length conditions for such transfer. The guidance in applying transactional profit split method is fully applicable to matters involving the transfer of intangibles or rights in intangibles. However, in evaluating the reliability of transactional profit split method, the availability of reliable and adequate data regarding combined profits, appropriately allocable expenses, and the reliability of factors used to divide combined income should be fully considered.

  1. Valuation techniques to estimate the arm's length price may be used where reliable comparable uncontrolled transactions for a transfer of one or more intangibles cannot be identified.

  2. The application of income based valuation techniques, especially valuation techniques premised on the calculation of the discounted value of projected future income streams or cash flows derived from the exploitation of the intangible being valued, may be useful when properly applied. Depending on the facts and circumstances, valuation techniques may be used as a part of one of the five OECD transfer pricing methods, or as a tool that can be usefully applied in identifying an arm's length price.

  3. Where valuation techniques are utilized in a transfer pricing analysis involving the transfer of intangibles or rights in intangibles, it is necessary to apply such techniques in a manner that is consistent with the arm's length principle and these Guidelines. Principles related to realistically available options, economically relevant characteristics, accurately delineating a transaction and risks analysis framework, and aggregation of transactions apply fully to situations where valuation techniques are utilized in a transfer pricing analysis. Depending on the facts and circumstances of the individual case, the calculation of the discounted value of projected cash flows derived from the exploitation of the intangible should be evaluated from the perspectives of both parties to the transaction in arriving at an arm's length price. Furthermore, the guidance laid down in these Guidelines on selection of transfer pricing methods apply in determining when such techniques should be used.

  4. It is essential to consider the validity of the underlying assumptions used for valuation techniques and the consistency of those assumptions with the arm's length principle. A careful examination of such assumptions are essential before accepting the valuations performed for accounting purposes as determinative for transfer pricing purposes.

  5. Taxpayers making use of valuation techniques in determining arm's length prices for transferred intangibles should explicitly set out each of the relevant assumptions made in creating the valuation model, describe the basis for selecting the valuation parameters, and should be prepared to defend the reasonableness of such assumptions and valuation parameters. It is a good practice for taxpayers relying on valuation techniques to present as part of their transfer pricing documentation some sensitivity analysis reflecting the consequential change in estimated intangible value produced by the model when alternative assumptions and parameters are adopted.

  6. IRBM will request further explanation if there are any inconsistencies in the assumptions made in a valuation of an intangible undertaken for transfer pricing purposes and valuations undertaken for other purposes. For example —
    1. if high discount rates are used in a transfer pricing analysis, when the company routinely uses lower discount rates in valuations for other purposes; or
    2. if it is asserted that particular intangibles have short useful lives but the projections used for other business purposes demonstrate that related intangibles produce cash flows for years beyond the "useful life" that has been claimed for transfer pricing purposes.

  7. The following paragraphs identify some of the specific concerns that should be taken into account in evaluating certain important assumptions underlying calculations in a valuation model based on discounted cash flows:-

    1. Accuracy of financial projections.
      • It is essential to examine carefully the assumptions underlying the financial projections of both future revenue and future expense, if the accuracy of such projections is contingent on developments in the market place that are both unknown and unknowable at the time the valuation is undertaken.

      • In evaluating financial projections, the source and purpose of the projections can be particularly important. It is usually the case that projections prepared for non-tax business planning or investment purposes are more reliable than projections prepared exclusively for tax purposes, or exclusively for purposes of a transfer pricing analysis.

      • The length of time covered by the projections should also be considered in evaluating the reliability of the projections. The further into the future the intangible in question can be expected to produce positive cash flows, the less reliable projections of income and expense are likely to be

      • A further consideration in evaluating the reliability of projections involves whether the intangibles and the products or services to which they relate have an established track record of financial performance. Although past performance may not be a reliable guide to the future, as many factors are subject to change, they can provide some useful guidance as to the likely future performance of products or services that rely on intangibles. Projections with respect to products or services that have not been introduced to the market or that are still in development stage are inherently less reliable than those with some track record.

      • When deciding whether to include development costs in the cash flow projections it is important to consider the nature of the transferred intangible, whether the transferred intangibles are fully developed or the intangibles have indefinite useful lives and may be continually developed

    2. Assumptions regarding growth rates.

      Projections of future cash flows are often based on projected growth rates. A reliable application of a valuation technique based on projected future cash flows would examine the likely pattern of revenue and expense growth based on industry and company experience with similar products. Simple models containing linear growth rates without reasonable justifications should not be accepted.

    3. Discount rates
      • The discount rate is a critical element of a valuation model. The discount rate takes into account the time value of money and the risk or uncertainty of the anticipated cash flow used in converting a stream of projected cash flows into a present value. A small variation in the selected discount rate can generate a large variation in the calculated value of intangibles using these techniques. Therefore, it is essential for taxpayers to justify the assumptions made in selecting the discount rate or rates utilized in the valuation model.

      • There is no single measure for a discount rate that is appropriate for transfer pricing purposes in all instances. The specific conditions and risks associated with the facts of a given case and the particular cash flows in question should be evaluated in determining the appropriate discount rate.

      • It should be recognized that some businesses are inherently more risky than others and some cash flow streams are inherently more volatile than others. The discount rate or rates should reflect the level of risk in the overall business and the expected volatility of the various projected cash flows under the circumstances of each individual case.

      • Since certain risks can be taken into account either in arriving at financial projections or in calculating the discount rate, care should be taken to avoid double discounting for risk.

    4. Useful life of intangibles and terminal values
      • Valuation techniques are often premised on the projection of cash flows derived from the exploitation of the intangible over their useful life. The useful life of a particular intangible can be affected by the nature and duration of the legal protections afforded to the intangible, the rate of technological change in the industry, and by other factors affecting competition in the relevant economic environment.

      • Where specific intangibles contribute to continuing cash flows beyond the period for which reasonable financial projections exist, it will sometimes be the case that a terminal value for the intangible related cash flows is calculated. Where terminal values are used in valuation calculations, the assumptions underlying their calculation should be clearly set out and the underlying assumptions thoroughly examined, particularly the assumed growth rates.
    5. Assumptions regarding taxes

      Where the purpose of the valuation technique is to isolate the projected cash flows associated with an intangible, it may be necessary to evaluate and quantify the effect of projected future income taxes on the projected cash flows. Tax effects to be considered include:
      1. taxes projected to be imposed on future cash flows;
      2. tax amortization benefits projected to be available to the transferee, if any; and
      3. taxes projected to be imposed on the transferor as a result of the transfer, if any.

    6. Form of payment
      • In evaluating the provisions of taxpayer agreements related to the form of payment, it should be noted that some payment forms will entail greater or lesser levels of risk to one of the parties. For example, a payment form contingent on future sales or profit will normally involve greater risk to the transferor than a payment form calling for either a single lump-sum payment at the time of the transfer or a series of fixed instalment payments. The chosen form of the payment must be consistent with the facts and circumstances of the case, including the written contracts, the actual conduct of the parties, and the ability of the parties to bear and manage the relevant payment risks

      • In particular, the amount of the specified payments should reflect the relevant time value of money and risk features of the chosen form of payment. For example, if a valuation technique is applied and results in the calculation of a lump-sum present value for the transferred intangible, and if a taxpayer applies a payment form contingent on future sales, the discount rate used in converting the lump-sum valuation to a stream of contingent payments over the useful life of the intangible should reflect the increased risk to the transferor that sales may not materialize and that payments would therefore not be forthcoming, as well as the time value of money consequences arising from the deferral of the payments to future years.