3. Context and setting
The tax treatment often follows the asset identification used for accounting purposes, provided that generally accepted accounting principles have been adopted. However, the value brought into account under accounting standards is generally overridden by specific tax provisions.
The valuation requires analysis of the tax treatment, which governs whether the accounting treatment is overridden for tax purposes, and if so, by which definition of value.
It is important to determine which piece of legislation applies to each intangible. This will dictate which definition(s) of value will be in point. It is often a key focus in any valuation negotiation.
The primary legislation governing the taxation of transactions in intangibles for companies is Part 8 of the Corporation Taxes Act 2009. Where this does not apply, the transaction may be taxed under Part 9 of the Corporation Taxes Act 2009 (for patents and know-how only), section 178 of the Corporation Taxes Act 2009 (for know-how only), or, if neither of these sections apply, the Taxation of Chargeable Gains Act 1992.
The categorisation is critical to the valuation. It affects the ability of an entity to use losses and/or access tax deductible amortisation and it drives the occasions on which the transaction involving an intangible asset may be adjusted. Transactions involving assets taxed under Part 8 of the Corporation Taxes Act 2009 (“Part 8 assets”) may be adjusted by reference to two potential bases of valuation. These bases of valuation can lead to very different outcomes.
It is possible for the same transaction to be taxed under a number of different regimes – for example, because it involves assets which are Part 8 assets and assets which are not. When this happens, a ‘just and reasonable’ apportionment of value is required.
There can be significant differences between the Market Value of an asset that is sold as part of business reorganisation and the Arm’s Length Provision in respect of that business reorganisation.
Best price achieved on the sale of the subject asset
Compensation for agreeing to a change in business arrangements, which results in a reduction in profit potential that would be compensated, were the parties independent
Follows legal title of the asset
Economic substance of transaction including Development, Enhancement, Maintenance, Protection and Exploitation of Intangibles (“DEMPE”) functions
Only identifiable characteristic of the vendor is ownership of the asset in question and wider business arrangements are disregarded
All characteristics of the actual parties taken into consideration (e.g. taxes, Tax Amortisation Benefit (“TAB”), synergies)
Reflects the highest and best use of the asset
Reflects how the actual parties to the transaction exploit the asset and conduct their business arrangements
Defined in statute and supported by case law
Defined by legislation, OECD Model Tax Convention and related guidance
A Hard to Value Intangible (‘HTVI’) is defined as an intangible for which, at the time of the transaction, no reliable comparables existed and projections of future cash flows were very uncertain.
The HTVI guidelines mandated by BEPS Action 8 permit tax authorities to make ex-post adjustments to the pricing of intra-group intangible asset transfers, based on actual financial outcomes. The tax consequences of such adjustments can be substantial.
A valuation that comprehensively reviews the forecasts and reflects different outcomes for the asset(s) in question should maximise the likelihood of a successful rebuttal to any possible HTVI adjustment.
Chapter IX of the OECD Guidelines states that the following transfer pricing aspects of a business restructuring should be analysed as part of assessing the arm’s length compensation due:
- Understanding the business restructuring – delineate the transactions that comprise the business restructuring by identifying the commercial or financial relations and the conditions attached to those relations that lead to a transfer of value;
- Recognition of the business restructuring – consider how the business reorganisation should be recognised for tax purposes; and
- Reallocation of profit potential – determine whether there is a transfer or a termination or a substantial renegotiation of existing arrangements, which would be compensated between independent parties in comparable circumstances.
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