november 18, 2014 | best buy | richfield, mn your trusted tax counsel ® baker & mckenzie...

November 18, 2014 | Best Buy | Richfield, MN

Your Trusted Tax Counsel®

Baker & McKenzie International is a Swiss Verein with member law firms around the world.  In accordance with the common terminology used in professional service organizations, reference within the organization to a “partner” means a person who is a partner, or equivalent, in a member firm or its affiliate. Similarly, reference to an “office” means an office of any such law firm.  Baker & McKenzie Consulting LLC provides tax advisory and economic services and does not provide legal advice or services.  Baker & McKenzie Consulting LLC is a subsidiary of Baker & McKenzie LLP, a member firm of Baker & McKenzie International.  

Minnesota Chapter – TEI International Tax Committee

Intangibles: Evolving and Conflicting Definitions and Valuation Techniques

Lisa Parker Gates (Chicago)Holly Glenn (Washington, D.C.)Russ Young (Chicago)

©2014 Baker & McKenzie 2

Presenters

Lisa Parker Gates (Partner – IP, Chicago)lisa.gates@bakermckenzie.com

+1 312 861 8686

Holly E. Glenn (Principal Economist, Washington, D.C.)holly.glenn@bakermckenzie.com

+1 202 835 1679

Russell R. Young (Partner – Tax, Chicago)russell.young@bakermckenzie.com

+1 312 861 2612

©2014 Baker & McKenzie 3

Agenda

Introduction and Background

Intangibles Under U.S. Tax Law

Intangibles Under I.P. Law

OECD Intangibles Guidance

Issues Raised

Intangibles Under U.S. Tax Law

©2014 Baker & McKenzie 5

Definition of Intangible Property: §936(h)(3)(B) & Treas. Reg. §1.482-4(b)– Both definitions are substantially similar and define IP as:

– patent, invention, formula, process, design, pattern, know-how;

– copyright, literary, musical, or artistic composition;

– trademark, trade name, or brand name;

– franchise, license, or contract;

– method, program, system, procedure, campaign, survey, study, forecast, estimate, customer list, or technical data; or

– any similar item, which has substantial value independent of the services of any individual– “Any similar item” is clarified only under the §482 regs as an item

that derives its value not from its physical attributes but from its intellectual content or other intangible properties

©2014 Baker & McKenzie 6

What Is Not Compensable Intangible Property?

– Under US rules, unless the transferred property falls within the intangibles definition, no royalty or other compensation required under the rules. What’s not compensable as IP under current law: – Business opportunity. Hospital Corp. of America, 81 T.C. 520 (1984)

– Advantage resulting from operating within an affiliated group. Merck

– Goodwill or going concern value (“GW/GCV”). VERITAS, 133 T.C. 297 (2009)

– Workforce in place. VERITAS; Newark Morning Ledger, 507 U.S. 546 (1993)

– Most other jurisdictions & OECD rules do not provide a list of what is an intangible– “Non-compensable” is a largely US concept

©2014 Baker & McKenzie 7

– Exempted from royalty imputation (Treas. Reg. §1.367(d)-1T(b))

– Definition: “the residual value of a business operation conducted outside the US after all other tangible and intangibles assets have been identified and valued”

– §367(d) targets abuse of taking R&D deductions by a US taxpayer in creating the IP without recognizing any income attributable to such IP before outbound transfer (e.g., Darvon in Eli Lilly)

– GW/GCV presumed to be attributable to a branch’s earning income on which US taxpayer would have paid US income tax

– Again, this level of specificity is unique to the US rules

Foreign Goodwill/Going Concern Value

©2014 Baker & McKenzie 8

– Disputes frequently accompany items that are difficult to identify and value: – Know-how

– Systems, processes, and procedures

– Skilled workforce

– Marketing intangibles

– Other similar items

– These items may typically fall under GW/GCV in a business valuation

Valuation Methods

©2014 Baker & McKenzie 9

Standards of Value

– What standard of value is appropriate?– Fair market value

– Investment (Strategic) value

– Fair value

– Intrinsic value

– Arm’s length charge

Intangibles Under I.P. Law

©2014 Baker & McKenzie 11

IP and Tax Perspectives – The Same, But Different

‒ Minimum IP value vs. maximized value‒ Economic/beneficial ownership vs. legal title/ownership‒ Multiple beneficial owners vs. multiple legal owners‒ Goodwill: Can it be separated from IP?‒ Tax treaties and IP treaties

11

©2014 Baker & McKenzie 12

Use of IP and Intangible Assets

‒ Intercompany licenses should be in place, from “legal” owner to “beneficial” user

‒ Exclusive licenses allow for lost profits (nonexclusive for reasonable royalty)

‒ “Co-exclusive” and “joint exclusive” licenses‒ Quality control‒ IP maintenance and renewal responsibilities

12

OECD Intangibles Guidance

©2014 Baker & McKenzie 14

The September 2014 Release

‒ New Chapter VI of the OECD Transfer Pricing Guidelines (“TPG”)

‒ Amendments to Chapters I-II‒ Unfinished business

Shaded portions of Chapter VI are not yet fully agreed “Special measures” to be considered in 2015

‒ 33 examples (20 agreed, 13 to be reviewed in 2015)

14

©2014 Baker & McKenzie 15

New OECD Definition of Intangibles

“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.”

The OECD wanted to avoid making a list, because they have seen the outcome in the US, which is to exempt certain intangibles from compensation. They wanted a definition broad enough to encompass “goodwill,” whatever it means. They did not accept input suggesting IP be limited to what can be legally owned or protected.

©2014 Baker & McKenzie 16

Amendments to Chapters I-II of the TPG

‒ Location savings : a comparability factor‒ Synergies may require comparability

adjustments “Deliberate concerted group actions” are

chargeable Example on guarantees “Halo effect” Central purchasing function.

‒ Assembled workforce in business restructurings

©2014 Baker & McKenzie 17

Goodwill / Ongoing Concern Value

• Not defined, but “important and monetarily significant part of the compensation” in asset transfers

• Purchase Price Allocation residual not necessarily appropriate measure

Controversial issues: What is goodwill? To whom does it belong? Is it transferable? How is it measured?

©2014 Baker & McKenzie 18

Policy Concern

Parent IP co

Market Co

High tax; original IP

development

Low tax; intragroup

acquisition of IP

High tax; IP exploitation

R&D

High tax; further IP development

Issues:

Þ Arm’s length remuneration of R&D, marketing and sales functions?

Þ Arm’s length remuneration of IP ownership/funding/risk bearing?

©2014 Baker & McKenzie 19

OECD Valuation Methods

‒ Ch. VI includes the use of appraisal/valuation methods largely based on the use of discounted cash flows (DCF) Purchase price allocations or valuations for accounting

purposes may be a “useful starting point,” but are not controlling for TP purposes

©2014 Baker & McKenzie 20

Unagreed Portions of Chapter VI

‒ Ownership of intangibles: profits of IP owner / role of contracts / funding / risk versus people functions (Sections B.1 and B.2) (Legal ownership and contractual arrangements are the “starting point” for TP analysis)

‒ Interaction with work on risk and recharacterisation “particularly pronounced”

©2014 Baker & McKenzie 21

Special Measures to be Considered in 2015

‒ Providing tax administrations with authority in appropriate instances to apply rules based on actual results to price transfers of hard to value intangibles and potentially other assets “Look-back” rules

‒ Requiring contingent payment terms and/or the application of profit split methods for certain transfers of hard to value intangibles

©2014 Baker & McKenzie 22

Special Measures to be Considered in 2015

‒ Limiting the return to entities whose activities are limited to providing funding for the development of intangibles, and potentially other activities, for example by treating such entities as lenders rather than equity investors under some circumstances Like the “income method” in US cost-sharing

‒ Requiring application of rules analogous to those applied under Article 7 and the Authorised OECD Approach to certain situations involving excessive capitalisation of low function entities “Fat cap” rules

©2014 Baker & McKenzie 23

Valuation of intangibles

• New Chapter VI : Valuation techniques : DCF “yes, but…”.

• Shaded portions not yet agreed, to be finalized in 2015:– Intangibles whose valuation is uncertain at

the time of the transaction (Section D.3.)– Use of “other methods” (TPG 2.9)– Application of profit split methods (TPG 6.145

to 6.149)

Issues Raised

©2014 Baker & McKenzie 25

Issues Raised‒ OECD wants to avoid the US situation in which taxpayers have a

legal basis to argue that GW/GCV, along with certain other IP, is exempted from compensation when transferred IRS likes OECD position, but how can the current US rules be

reconciled?‒ OECD has embraced the IRS notion of “platform intangibles” that

may underlie next-generation IP and be entitled to compensation‒ Key issue is what profit is attributed to legal or economic

ownership (ownership or funding of IP without major strategic functions) Tide has turned against allowing the legal and/or economic owner to

earn the residual Fundamental challenge to “one-sided methods” that set the profit of

“simpler” entities

©2014 Baker & McKenzie 26

Thank You

Pursuant to requirements relating to practice before the Internal Revenue Service, any tax advice in this communication (including any attachments) is not intended to be used, and cannot be used, for the purpose of (i) avoiding penalties imposed under the United States Internal Revenue Code, or (ii) promoting, marketing, or recommending to another person any tax-related matter.