Transfer Pricing & Intangibles

Key challenges
Rezan Ökten (Dentons Transfer Pricing)

Grow | Protect | Operate | Finance

Agenda
1. What are intangibles?

2. Analyzing intangibles

3. Returns from intangibles

4. Value Chain & Functional analysis

5. Intangibles valuation approaches

6. Case studies
What are Intangibles?

Infrastructure
Customer Corporate
relationships culture
Technology in
Goodwill
Supplier and development Corporate
distributor Marketing strategy
relationships intangibles Business
know-how and
Trademarks, patents,
best practice
designs and copyrights
Training / Decision-
Network effects show-how Customer making and
(sum vs. parts) lists direction
Business Trade
model secrets
Employee Quality control
relationships
Employee know-how
and innovation

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What are Intangibles?
OECD TP Guidelines / Brazil TP Rules

Intangibles are: Hard-to-value-Intangibles (HTVIs) are:

• Not tangible or financial assets
Intangibles or rights in intangibles for which,
• Capable of being “owned” or “controlled” at the time of their transfer to a controlled
• For use in commercial activities
party:

• Something which commands • No reliable comparables exist

compensation upon its transfer to, or use
by, an uncontrolled person • The projections of future cash flows or
income, or the assumption used in valuing
the intangible are highly uncertain

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Analyzing intangibles
Transactions

Delineation of the Profit allocation / pricing

Ownership of intangibles
transaction of intangibles

Delineation: Ownership: Remuneration:

• Identification of intangibles • Identified as the legal owner of the • Contributions of the parties
• Determination of ownership of intangible intangible, or • Relevant functions performed
• Determination of the parties responsible • Capable of exercising control over • Economically significant risks
for financing, assuming risks and decisions on the exploitation of the assumed
exercising control intangible and to restrict its use

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Returns from intangibles
DEMPE/Value creation concepts

Develop Enhance Maintain Protect Exploit

Creating a valuable Improving the asset to Ensuring the asset Preventing and tackling Maximising the use and
asset from an idea increase its value remains in good infringement of the IP potential of the asset
working order

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Legal & economic ownership vs returns

Risk-free return

Passive investor

Legal
Funding return
IP ownership (risk-adjusted) return
– financial investor

Economic
Entrepreneurial return

(whole or partial) return

– active investor

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Value Chain Analysis
• OECD TP method
• Identifying contributing selection
functions / processes and
• Identify key value drivers their relative value • Identification and
• Which entities performs splitting of profits
• How is value created?
those functions? amongst group entities
on an economically valid
• Use of RACI matrix
basis

Design
User experience/ Brand identity
customer needs Brand communication

Customer
Technology Product GTM Branding
services
Software development GTM strategy After-sale customer
support
Interconnection within Product preposition
ecosystem Addressing requests
Successful launch

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Functional Analysis
Expected returns

FUNCTIONS ASSETS RISKS

Classification based on function and risk profile

VALUE CHAIN
Profit/Loss

Routine Entrepreneur
Entity

1 2 3 4

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Functional Analysis
Ownership and allocation of returns

VALUE CHAIN

Value chain 1 Value chain 2

A Co B Co C Co D Co E Co

R&D X X
FUNCTIONS Manufacturing X X X C Co
Sales & marketing X X X X X
Patents X X X D Co
ASSETS
Brand X X

Inventory risk X X X X X
E Co
RISKS Market risk X X X X
FX risk X X X

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Functional Analysis
Functions performed / risks managed

C-level
Strategic level

Non-routine

VPs / MDs
Strategic
meetings Tactical level
Managers / Directors

Mid-Management
Routine

Routine Operational teams (Various Countries)

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Relevance of TP specific IP valuation

Relevance for • Increased importance of IP

multinationals • Main driver for “non-routine” profits

• What are potential differences in valuing intangibles?

• When are IP valuation for financial reporting purposes applicable and what
adjustments are needed?
Objective
• In which scenarios are alternative valuation methods applicable and how to
bridge the gap?
• What are the pressure point?

• DEMPE/functional requirements assumed to be fulfilled

Limitation • Definition of different types of IP not addressed
• Examples are highly simplified for presentation purposes

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The ‘valuation gap’

Fair (market) value IP Arm’s length value

Cost Approach
• Reproduction cost method
• Replacement cost method

Market Approach
• Direct method
• Indirect method

Income Approach
• DCF-based methods (+ real options)
• RFRM, MEEM, ICFM, RPSM
 Traditional IP valuation methods

𝑅𝑒𝑣𝑒𝑛𝑢𝑒 𝑡 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 −
𝐸𝑥𝑝𝑒𝑛𝑠𝑒𝑠 −
𝐹𝑉 = 𝑃𝑉(𝑟) σ𝑡𝑡=0 ∗ 𝐹𝑉 = 𝑃𝑉(𝑟) ෍ + 𝑃𝑉 𝑟 𝑇𝐴𝐵
𝑅𝑜𝑦𝑎𝑙𝑡𝑦 (1 − 𝑡𝑎𝑥) 𝐶𝐴𝐶𝑠 −
𝑡=0
+ 𝑃𝑉 𝑟 𝑇𝐴𝐵 𝑇𝑎𝑥𝑒𝑠

RFRM MPEEM
Relief-from-royalty method Multi-period excess
earnings method

Incremental cash flow method Residual profit split method

ICFM RSPM
𝑡 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 − 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 −
𝐸𝑥𝑝𝑒𝑛𝑠𝑒𝑠 − 𝑡
𝐸𝑥𝑝𝑒𝑛𝑠𝑒 −
𝐹𝑉 = 𝑃𝑉1 𝑟 ෍ 𝐹𝑉 − 𝑃𝑉 𝑟 ෍
𝐶𝑎𝑝𝑒𝑥/𝑊𝐶 −
𝑡=0 𝑡=0 𝑅𝑜𝑢𝑡𝑖𝑛𝑒 𝑟𝑒𝑡𝑢𝑟𝑛𝑠 −
𝑇𝑎𝑥𝑒𝑠 𝑇𝑎𝑥𝑒𝑠
−𝑃𝑉2 𝑟 + 𝑃𝑉3 𝑟 𝑇𝐴𝐵 +𝑃𝑉 𝑟 𝑇𝐴𝐵
Potential IP valuation issues

• Remaining useful life (RUL) vs terminal value

Useful life • Economic benefits / attrition rates

• Accuracy projections
Forecast data • Identification IP income/expense WACC

• WACC-to-WARA analysis
Discount rate • Dynamic vs static WARA

• Impact on future cash flows Discount

Taxes • Inclusion of tax amortization benefit (TAB) rate

• Growth rates
Others • Capex / WC profile
Appendix
Case studies
1. Case study 1: IP ownership

2. Case study 2: IP ownership and pricing

3. Case study 3: Transfer of IP post-acquisition

Case study 1
Ownership of intangibles

• Who owns the intangibles?

• What are the results of the Functions, Assets and • Treasury function
• Funds R&D in B Co. • R&D function
• Marketing functions
Risks analysis? • Sales functions
A Co B Co
• Who performs DEMPE functions?

• What should the arm’s length remuneration of the

Exclusive royalty
different entities be? Assignment of patent for
free license
1000

C Co

• IP holding company
• Employs a number of lawyers

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Case study 2
Ownership of intangibles 3rd party TestCo

• Payment for the sale of Product A intangibles is based on the

valuation of anticipated future cash flows. Service fee
Carries on Blue
• R Co has no technical personnel capable of conducting or Sky R&D
supervising the ongoing research activities related to Product A.
M Co
• M Co contracts with a third-party, TestCo to perform testing in the
ongoing development of Product A.
Sale of Product A
• R Co contracts with M Co to carry out the research programme for intangibles
Product A prior to the transfer of the intangibles. R Co provides
Commercial
funding, assumes the financial risk and remunerates M Co on a
R Co activities of MNE
cost-plus basis. group
• Can the service fees to third-party TestCo be used as a
benchmark?
Sale of Product X
• What should the arm’s length remuneration of the different entities
be?

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Case study 3
Transfer of IP post-acquisition

IP Sale Issues
Observed method
• Often an acquisition price method • Is the acquisition price a good
BuyerP TargetP (APM) is observed / requested, where: indication for the enterprise value?
IP, M, D
• What value should be allocated to
TargetP?
Sub Sub Sub Sub Sub Sub
• Can we rely on the PPA?
1 2 3 A B C Acquisition price
• How to consider tax implications /
+/- Adjustments (cash, liabilities, etc.) NOLs?
- Remaining value • What discount rates to apply?
Assumptions = Transferred value / package • Time gap and change in level of
• Buyer acquired TargetGroup for knowledge
EUR 1bn
• Restructuring event turns TargetP
into a routine entity with only EUR
100m enterprise value
Team

Rezan Okten
Partner
+31 20 795 39 41
Sebastian.Frankenberg@dentons.com

Sebastian Frankenberg
Counsel
+31 20 795 39 92
Sebastian.Frankenberg@dentons.com

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