Intangibles constitute a substantial and major portion of transfer pricing issues on hand. They are extremely crucial in a Multinational (MNE) environment, however, their importance is often undermined to their inherent characteristics which may include easy mobility, misidentification and most importantly non-availability of set principles to assign values to such intellectual properties.
Supply Chain and Value Chain are the same terms used often by MNEs while doing business, yet there is a significant difference. The supply chain is the relationship between the associated enterprises in terms of functions performed from the initiation until the product or service is enjoyed by the end consumer. Whereas, the value chain is the analysis of value derived at every juncture of the supply chain which is directly proportionate the risk, control and reward theory. In short, the value chain sits on top of the supply chain to evaluate the values created by each and every stage of a supply chain. To give an example, for the purpose of an MNE, an entity could be undertaking a function of manufacturing in China and accordingly contributes to manufacturing silo of the supply chain. On the contrary, when such manufacturing is further characterised and analysed as a contract, full-fledged or licensed etc, such manufacturing is being assigned a value according to the risk and control that is undertaken by the entity undertaking such manufacturing. Higher the risk and control over the intangible, higher the possibility of making a greater return. Accordingly, the value chain analysis could highlight that a contract manufacturer would earn limited returns and full-fledged manufacturer could earn entrepreneurial returns tagging the right profitability in the respective jurisdictions.
As stated by the BEPS project, in a value chain, profits should be taxed where the value is created. With the visibility brought in by a transparent global transfer pricing regime, it is not only the country’s profitability that is of interest to the tax authorities, but also the global profitability balance maintained by the MNE group. Intangibles transparency through the global reporting of CbCr finds special interest in bringing in such clarity to the MNE group as well as to the tax authorities. Gone are the days when a legal owner of a patent, used to enjoy all economic benefits. The concept of DEMPE in intangibles is well proposed and accepted by several nations, bringing in some certainty in an analysis of value chain in transfer pricing for intangibles.
Here are the possible steps that one may like to follow while undertaking a transfer pricing value chain analysis involving intangibles
- Identification of the intangibles itself. All intangibles are not recorded in the books of accounts. Assets like brands, trademarks, customer lists, secret know-hows would never find a mention in the books of accounts. Therefore, the step of identification of the right intangibles is of crucial importance.
- Post identification, one has to ascertain how, when and manner in which such intangibles are adding to the value of the entire business of the enterprise.
- To dissect every element of the intangibles into the Development, Enhancement, Maintainance, Protection and Exploitation functions (DEMPE) and assign values to every such function with respective AEs in the group.
- To understand how such intangibles create value in the local as well as the global business. Also, to understand how the proceeds against such intangibles are tagged to respective jurisdictions.
- Further to analyse how other members of the group perform such DEMPE function for the intangibles under consideration and accordingly tag the respective remuneration and price setting mechanism for such service provided.
The remuneration over an intangible is linked to DEMPE function and further tagged to the Significance of contribution to the DEMPE function and control over such functions undertaken. For example, an entity that merely funds research and development (R&D) project could expect a return equivalent to a finance function and not an R&D function. On the other hand, if such entity controls, funds and also contributes to the process of R&D while the function of DEMPE is performed by the other entity, the earlier entity is entitled to a higher rate of return on intangibles.
Although there are a plethora of thoughts to write on the topic, one can take a cue from the write up on the complexity involved in the value analysis of intangibles. A detailed documented analysis is of utmost importance, as no piece of guidance would be enough to cover all the possible permutations and combinations on the value that could be created by intangibles for an organization.
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