In today’s globalised economy, intangible assets play a critical role in driving business value, particularly for multinational enterprises (MNEs). Intangibles such as patents, trademarks, copyrights, proprietary technologies and customer relationships often account for a significant portion of profitability for MNEs. However, their unique characteristics, including their non-physical nature, difficulty in valuation and role in business operations, present complex transfer pricing challenges.
As such it is not surprising that transfer pricing has increasingly come under scrutiny from tax authorities worldwide, especially regarding intangibles. The potential for base erosion and profit shifting (BEPS) through mispricing of intangibles has led organisations such as the Organisation for Economic Co-operation and Development (OECD) and the United Nations to provide extensive guidelines to ensure that MNEs allocate income arising from intangibles to jurisdictions in which economic activities that create value take place.
This article provides a general examination of intangibles in transfer pricing, covering their definition, classification, transfer pricing methods, the application of the arm’s length principle, and practical challenges faced by MNEs in compliance.
2. Defining intangibles in transfer pricing
The OECD Guidelines define an intangible as “something that is not a physical or financial asset but is capable of being owned or controlled for use in commercial activities.” This definition emphasises control and economic ownership rather than legal ownership. This is a key concept in transfer pricing for intangibles.
2.1.Types of intangibles
Intangibles are broadly classified into two categories:
2.1.1 Trade intangibles
These are commercial intangibles which are directly linked to the production of goods and services. They include patents, trade secrets and know-how and software and proprietary technology.
2.1.2 Marketing intangibles
These relate to marketing activities that support the commercial exploitation of products or services and have important promotional value for the products or services. Marketing intangibles include trademarks, trade names, brands, customer lists, customer relationships, and proprietary market and customer data that is used in marketing and selling goods or services to customers.
The term “brand” is sometimes used interchangeably with “trademark” or “trade name” as a brand is sometimes considered as a trademark or trade name imbued with social and commercial significance.
2.2. Group synergies
Group synergies and market specific characteristics are not considered as intangibles as they are not owned or controlled by an individual enterprise.
3. Ownership of intangibles and the Dempe framework
3.1. Economic vs. legal ownership of intangibles
One of the most contentious areas in transfer pricing is the distinction between legal ownership and economic ownership of intangibles.
Legal ownership refers to the entity that holds formal title rights over an intangible while economic ownership is determined based on the entity that contributes to the development, enhancement, maintenance, protection, and exploitation (Dempe) of the intangible.
The OECD Transfer Pricing Guidelines (2022) emphasise that economic ownership of intangibles should be attributed to the entity that performs and controls DEMPE functions, rather than the entity that merely holds legal ownership. This prevents companies from shifting profits by simply holding legal title to intangibles in low tax jurisdictions while actual value creating activities occur elsewhere.
3.2. The Dempe framework
The DEMPE framework, introduced by the OECD, identifies the key functions determining economic ownership of intangibles:
3.2.1 Development
The creation or improvement of an intangible asset, including R&D activities, product design, brand establishment, and initial software development.
3.2.2 Enhancement
Improving an existing intangible through modifications, refinements or ongoing investments in a brand, technology or process.
3.2.3 Maintenance
Ensuring that the intangible remains valuable over time, which may involve brand promotion, software updates, regulatory compliance and ongoing R&D activities.
3.2.4 Protection
Securing intellectual property rights through patents, copyrights, trademark, and legal enforcement.
3.2.5 Exploitation
Commercialising intangibles through licensing, franchising, or direct use in business operations to generate revenue.
Tax authorities around the globe use the Dempe analysis to allocate income from intangibles to the entities that contribute to the value creation.
4. The arm’s length principle and intangibles
The arm’s length principle requires that intercompany transactions be priced as if they were between independent entities.
4.1. Factors influencing the arm’s length price of intangibles
In determining whether the pricing for intangibles is at arm’s length, the following are considered: the specific intangibles involved; risks associated with Dempe of the intangibles; functional analysis pertaining to Dempe of the intangibles; contractual terms vs. conduct of parties; and determine whether the enterprise assuming the risks, controls the risks and has the financial capacity to assume
the Dempe risks.
4.2. Comparability challenges for intangibles
Unlike physical goods, intangibles often lack direct market comparables due to their uniqueness. This makes transfer pricing analysis for intangibles more complex than for tangible goods.
5. Methods for pricing intangibles
The OECD Guidelines recommend the following methods for determining the arm’s length price of intangibles:
• Traditional transaction methods: Comparable uncontrolled price method which works well for standard licensing agreements but is difficult to apply for unique intangibles; resale price method which is applied when an entity resells a product using a trademark or brand; and the cost-plus method which adds a mark-up to the costs incurred in developing an intangible.
• Transactional profit methods – Transactional net margin method (TNMM) and profit split method (PSM): The TNMM is more commonly applied where intangible valuation is difficult while the PSM is suitable for cases involving joint development of intangibles.
The other valuation techniques include the income approach which estimates value based on the present value of expected future income attributable to the intangible; market approach which relies on market prices for comparable transactions as benchmarks; and the cost approach which estimates the value based on historical costs incurred to develop the intangible.
6. Challenges in transfer pricing of intangibles
6.1. Identification issues
Determining what qualifies as an intangible can be subjective. Some business advantages (e.g., workforce expertise) are difficult to classify.
6.2. Valuation difficulties
Intangibles often have unique attributes, making valuation highly uncertain. Future earnings forecasts may be speculative.
6.3. Legal vs. economic ownership conflicts
Companies often register intangibles in low tax jurisdictions, while economic activities occur elsewhere. OECD’s BEPS Action Plans aim to combat this mismatch.
