OECD adds complexity and uncertainty to intangible property pricing

Tax Alert - October 2017

By Bart de Gouw and Jennie Yao

The new Transfer Pricing Guidelines (2017) on the arm’s length principle will drive significant changes to current practices in relation to the transfer pricing outcomes for members of multinational enterprise (MNE) groups in respect of intangibles.

There are increased reporting requirements (in the form of the master file and the local file) in respect of ownership and exploitation of intangibles, and these transactions will be scrutinised by tax authorities in ever more detail.

The changes to the treatment of intangible property transfer pricing will have far-reaching consequences and apply broadly, as intangibles are widely defined. Intangible property can include things like marketing materials, branding, technical know-how and software, amongst other items.

If your business has valuable intangibles, now is the time to evaluate who carries out the important functions involved, assets used, and risks associated with the development, enhancement, maintenance, protection and exploitation (the so called “DEMPE functions”) related to the intangibles, and review the legal contracts in place.

It is not enough to simply have legal contracts in place stating the ownership of the intangibles – contracts also need to clearly delineate the functions and risk allocations of the parties and ensure that the contracts are aligned with the actual performance and control the parties have in respect of the intangibles.

There are practical steps that companies can undertake to ensure that their intercompany transactions in respect of intangibles are appropriately documented and supported. The risk of not aligning profits associated with the transfer and use of intangibles with value creation (i.e. significant people functions) is the exposure of the transactions to challenge and potential reconstruction by some tax authorities.

Legal form vs. economic substance

The Transfer Pricing Guidelines recognise that payment for use of an intangible should be made to the party having the legal rights to such intangible. Intercompany contracts are a useful way to describe the roles, responsibilities, and rights of the relevant associated enterprises, and a way for the associated enterprises to express and agree their intentions. However, if the actual assumption or control of risk, and performance of the development, enhancement, maintenance, protection and exploitation functions in respect to the intangible differs from those stipulated in the contractual agreement, then the transactions must be assessed based on the actual activity carried out by the related parties (i.e. the economic substance rather than the legal form).

When a related party other than the legal owner participates in the development, enhancement, maintenance, protection and exploitation activities, provides funding, or assumes various risks, a separate transaction dealing with that activity must also be considered. In many MNE groups these activities may currently be treated as routine service arrangements (often with a routine cost plus return) with the intangible owner receiving the remainder of the profits derived from the intangible.

There is no intention under the new guidance to divert the income stream arising from use of the intangible away from the legal owner, but instead the guidance recognises that the legal owner has a transfer pricing obligation to pay for those activities that it does not perform. Under the guidance, a legal owner of intangible property who simply owns the intangible, but does not undertake or control the wider DEMPE functions, may only be entitled to a risk-adjusted or risk free return after compensating other members of the group for their respective contributions. In many cases such an approach is a marked change from current practice and may mean a party formerly thought of as a “service provider” would receive materially greater remuneration.

DEMPE functions and control

The guidelines acknowledge that the legal owner of the intangible does not need to be the one to carry out all the development, enhancement, maintenance, protection and exploitation functions itself and that independent parties do sometimes engage others to perform such functions. However, for an outsourced activity to be priced as an “outsourced service”, the legal owner (or someone other than the service provider) should exercise control over its performance. Where the legal owner does not adequately control the outsourced activity, the party that in practice controls the outsourced activity should be appropriately compensated.

Companies will need to identify and obtain a deeper understanding of how value is created with respect to the development and exploitation of its significant marketing and technology intangibles. The functions performed, assets used and risks assumed in relation to the development, enhancement, maintenance, protection and exploitation of the intangibles should be analysed in detail to ensure that associated enterprises are appropriately remunerated for their value-creating functions.

Step by step analysis

We have set out below steps for companies to follow in aligning their intangible transactions with the new OECD Guidelines.

  1. Determine the cross border related-party transactions involving intangibles, and any legal contracts in place (e.g. software licence agreements, contract research and development agreements, sales and distribution agreements).
  2. Identify the significant functions performed, assets used and risks assumed (including the control and capacity to fund those risks) in the development, enhancement, maintenance, protection and exploitation of the intangibles.
  3. Compare the contractual allocation and the function and risk analysis to the actual activities performed by each entity in respect to the intangibles.
  4. Determine the appropriate allocation of intangible returns among related parties following the functional analysis, and consider if any changes of profit allocation is required to align profits earned with value creation.
  5. Appropriately document the important functions and risks and the parties assuming and controlling those functions and risks, including tracking significant intangible-creation activity in real time.


The increased disclosure required under the OECD’s master file and local file requirements will highlight any discrepancy between conduct and remuneration. The master file specifically provides for information to be disclosed in respect to intangible property of MNE groups.

Additionally, NZ Inland Revenue have released proposals that shift the burden of proof from Inland Revenue to the taxpayer in a dispute for years commencing on or after 1 July 2018, so this will require that MNEs pay far greater attention to substantiating their arrangements in both legal and economic terms.

It is important that companies ensure that profits associated with intangibles are appropriately allocated in accordance with value creation as any discrepancy may be challenged.

If you need advice in considering whether you comply with the new Transfer Pricing Guidelines, or you need assistance in documenting your intangible transactions or master or local file, contact your usual Deloitte advisor.

October 2017 Tax Alert
Did you find this useful?