Preparing For Intangibles Transfer Pricing Scrutiny

Jul 8, 2015

To participate in Edgeworth Economics' global survey aimed at understanding trends in how transfer pricing groups, international tax groups, tax directors and chief financial officers are managing and valuing intangible assets for transfer pricing purposes, click here.

In past years, many transfer pricing advisers have taken a wait-and-see approach to tax planning in light of the Organization for Economic Cooperation and Development’s actions on intangibles. More recently, there have been numerous developments on a variety of tax fronts. Given the dynamic environment, it is more important than ever that a company prepare rigorous documentation in support of tax positions, especially if they may change in the coming months. In the face of change, it is better to be prepared with rigorous documentation than to rely on hope. In this article, I discuss why it is important to provide an appropriate degree of transparency and rigor in documentation studies, both in terms of the story a company tells about its arrangements and in the economic analysis.

Transfer Pricing for Intangibles Under Attack?

In the last several months, transfer pricing for intangibles has received a great deal of attention, and much of it has had to do with a perception that companies are paying too little tax on valuable intangible assets. This attention has included developments on several tax fronts, including the following:

The OECD has issued new drafts and/or guidance on intangibles, hard-to-value intangibles, and risk and recharacterization that may allow tax authorities to ignore intercompany contractual terms and re-price transfers of intangibles, providing substantial returns to entities that perform functions (e.g., scientists or risk managers) rather than those that own the assets, provide funding, or bear risk. Moreover, these repricings could potentially occur using a profit split method that employs information from country-by-country reporting.

The Tax Court has heard arguments on the valuation of certain Inc. intangibles under a cost-sharing agreement.

The European Commission has been actively reviewing tax arrangements between companies and European tax authorities, and suggesting that these arrangements may not be appropriate and additional tax revenues may be due.

The Obama administration and members of the U.S. Congress have continued to seek ways to make returns from intangibles more readily taxable.

How should a taxpayer respond? Some taxpayers may be tempted to respond to these challenges by being more guarded in their disclosures in transfer pricing documentation. However, this is a risky decision that could come back to haunt the company during an audit. In my view, the current environment is exactly the time to be more expansive in describing and rationalizing the transfer of intangibles, and more transparent in describing the inputs into and results from the economic analysis.

Time to Tell Your Story

A wait-and-see approach to tax planning may actually make it more important to actively support your current tax positions, as current tax positions may be viewed differently in light of any subsequent changes in tax planning. This may make it more important for the company to demonstrate that its transfer pricing framework is coherent and the economic analysis makes sense.

In addition, the new country-by-country reporting requirements will place a burden on taxpayers to provide more information to more tax authorities, including information on intangible development and royalties paid. A company’s transfer pricing documentation is its opportunity to tell its story, identifying and addressing areas of potential audit risk and discussing the details of the current structure. This includes a discussion of the company’s value chain, including functional and risk analyses, and a description of relevant assets.

A useful value chain description provides a clear, concise road map for tax authorities. If material functions, risks or assets are omitted from the analysis or their roles are not clear, it can leave room for unwelcome interpretation and inference. For example, given the OECD’s guidance on intangibles, it will be important for companies to clearly identify where decisions on intangible development are made, where actual development is done, and the risks borne and assets employed by each entity. There may be good support for a company’s current arrangement and pricing, and that support should be clearly communicated to the tax authority.

What Story Are You Telling with Data?

While a comprehensive analysis of functions, risks and assets may tell a company’s story, in transfer pricing it is the data that provide the picture that is worth a thousand words. Financial analyses that tell a story that is substantially different from that described in the value chain analysis provide a recipe for trouble. Some of these issues can be readily avoided through critical thinking about choice of data sources and analyses.

For example, in my experience the best source of financial projections for valuing intangibles are often internal company documents prepared during the ordinary course of business for management to review when making decisions. This is the same type of document one might consider using for patent litigation, as it will enhance the credibility of the analysis — is a trier of fact likely to trust a business document prepared in the ordinary course of business or an analysis prepared for litigation? Tax authorities are no different. Source documents that are prepared specifically for the tax department or for a transfer pricing study are likely to invite additional scrutiny and are more likely to be reviewed negatively in hindsight at audit.

One way to avoid these types of conflicts is to coordinate with other departments in the company. R&D personnel, financial analysts, sales personnel and other similar departments may have relevant information contained in internal company documents prepared in the ordinary course of business. If a financial analysis prepared for financial statements is inconsistent with a transfer pricing analysis, either in terms of sales or cost projections or assumptions, the company should have an explanation at the ready.

Finally, the economic analyses that are prepared should be rigorous and consistent with the company’s ordinary business practices. If a company regularly licenses intangibles, then there may be a readily available framework for valuing intangible transfers. An analysis might ask, what kind of financial analyses does the company prepare to make its licensing decisions? What discount rates are used for internal decisions on intangible development or licensing? Are different valuation methods applied or different discount rates used for different types of intangibles or intangibles at different stages of development? Is there a particular profitability measure that is used? Answers to these questions may provide a guide to a rigorous, defensible methodology and/or assumptions for an economic analysis.


Given the dynamic environment for tax planning for intangibles, companies and their advisors must carefully balance providing relevant information with the desire to provide only the necessary information. Tipping the scale too far in either direction, however, may result in unnecessary controversy. A key to achieving the right balance is to ensure that the company provides a convincing, coherent and concise explanation of its value chain and economic analyses, backed up by rigorous pricing analyses based on reliable data.

This was originally published in Law360 on July 2, 2015. 


Practice Areas

This website uses cookies to improve functionality and performance. By continuing to use this website, you agree to the use of cookies in accordance with our Privacy Policy. Ok