When Paul Simon sang the hit Slip Slidin’ away, he had in mind a girl called Delores.
When the OECD comments on intangible assets sliding away, they have in mind Dollars and Euros – in the OECD Transfer Pricing Guidelines, and Guidance for Tax Administrations of the Approach to Hard-to-Value Intangibles (HTVI).
The guidance clarifies certain aspects of the OECD’s Action 8 dealing with transfer pricing between related parties as part of the OECD BEPS initiative of 2015. BEPS is short for base erosion and profit shifting.
OECD member countries have begun adopting the OECD guidance.
The guidance says that tax administrations may sometimes be justified in using hindsight to increase a tax assessment if intangible assets (=intellectual property) are shifted offshore.
What’s the issue?
Suppose an onshore company, Eureka Ltd, discovers a way of making a perpetual motion machine. Eureka Ltd straight away sells the idea to a related offshore company Kayman Ltd, for $100. In the next two years Kayman Ltd pays Eureka Ltd NIS 10 per year (cost plus 10%), total $20, to develop the idea into a working device than can be produced and sold. Kayman Ltd then goes on to generate a billion dollars of sales of this device, resulting in profits of $900 million of profits in total in the next five years. After that the device is obsolete.
The onshore tax administration finds this a but fishy and assesses in year 8 capital gains tax and royalty taxes on the entire $900 million. Can it do so?
What the OECD report says:
The OECD says that hindsight taxation based on “ex post” evidence is appropriate in cases of hard-to-value intangibles (HTVI). The usual suspects are hitech companies.
What are HTVI?
The term HTVI covers intangibles or rights in intangibles for which, at the time of their transfer between associated enterprises, (i) no reliable comparable transactions exist, and (ii) at the time the transactions was entered into, the projections of future cash flows or income expected to be derived from the transferred intangible, or the assumptions used in valuing the intangible are highly uncertain.
Typically, the intangible is only partially developed and/or novel at the time of the transfer.
What is the issue:
In such cases, the OECD thinks the taxpayer may know more than it lets on to the onshore tax authority especially in hitech cases. This is referred to as “information symmetry”
What the OECD recommends:
The OECD focuses on actual income or cash flow outcomes after the original HTVI transfer.
The OECD says that tax administrations can consider ex post (hindsight) outcomes as presumptive evidence about the reliability of the assumptions of the ex ante (upfront) HTVI pricing arrangements.
This approach should not apply according to the OECD (see OECD 2022 Transfer Pricing Guidelines Para 6.193) when at least one of the following “exemptions” applies:
- Details of ex ante projections and risk accounting are provided AND reliable evidence that any differences between projected and actual outcomes could not reasonably be foreseen OR that probabilities of outcomes were not significantly overestimated or underestimated, OR
- There was a bilateral or multilateral advance pricing agreement in place with tax authorities, OR
- Any significant difference between projected and actual outcomes would not have changed the HTVI transfer compensation by more than 20% OR
- In a 5 year commercialization period after the HTVI transfer, actual third party revenues were not more than 20% greater than projected.
What should a company do?
A company should consider whether it’s worth transferring undeveloped intangibles offshore. Some countries offer onshore tax breaks through “patent box” tax regimes, e.g. the UK, Cyprus. The UK also offers R&D tax credits if certain conditions are met. The US has adopted somewhat similar tax breaks through its foreign derived intangible income (FDII) measure, and a converse measure that penalizes non-US “global intangible low tax income” (GILTI). Israel offers lower tax rates for preferred tech enterprises that retain their intangibles in Israel.
But the OECD indicates that if a company does transfer intangibles abroad, it should prepare cash flow or income projections at the time with very detailed assumptions including probability estimates.
Comment:
It is still possible to optimize but the methods have changed.
We will be happy to point out different courses of action and help you evaluate them, having regard to the OECD rules.
Next Steps:
Please contact us if you need to discuss the above or any other business matter.
Always consult experienced professional advisors in each country concerned – we can help arrange this.
© November 15, 2024