Transfer Pricing & Intellectual Property
(Post Budget 2012-13 Review)
-Gowthami Reddy, IP Dome
Introduction
The Budget 2012 has extended the applicability of TP
Regulations to specified domestic transactions, in excess of Rupee Fifty
Million with effect from Financial Year 2012-13. This will have
a different effect on sharing of IP between affiliated companies.
In accordance with budget 2012 provisions, the following domestic
transactions would be under the Purview
of the Indian TP Regulations:
·
Taxpayers
operating in Special Economic Zones (U/S 10AA of ITA);
·
Taxpayers having domestic transactions with certain related
parties (U/S 40A(2) of ITA); and
·
Taxpayers
claiming deductions for undertaking specified business activities (U/S 80A,
80-IA of ITA)
Prior Budget 2012, two affiliated companies
need not pay a transfer price at a arm’s length royalty rate for use of the
intellectual property and can be internally managed from the parent to the
subsidiary. Extension op TP rules
curbs false invoicing and will improve transparency.
Transfer Pricing and
M&A
M&A is a constant activity by
enterprises to expand their business. M&A alters inter- company
transactions which have a dramatic effect on transfer of assets between
affiliates including transfer of IP. Companies should bear in mind, among other
things the difference between the legal and economic ownership of IP. There may
be legal, accounting, tax, and other formal constraints on moving IP from one
place to another. TP analysis can allow the new business to integrate TP into
its business plans and anticipate adversities. Very importantly, the early
documentation of TP policy is an essential basis for effective TP risk
management. TP risks can be managed effectively through strict compliance of
concerned laws, timely TP documentation, clear intercompany agreements, APAs
(Advance Pricing Agreements). It is
further advisable for the companies to follow consistent TP policies.
Accounting Standards
There are three standards in IFRS
that play a significant role in valuation of IP for the purpose of TP. They are
IFRS -3(relating to business combinations), IAS -38 (relating to
intangibles) and IAS 24 (related party transactions).
The standards require all listed
companies to report the value of their acquired intellectual property on their
balance sheet. The standards state that any
identifiable and measurable intangible asset acquired as part of a business
combination after the company's transition date after 31 March 2004, needs to
be recognized on the balance sheet from 2005. With
a more common accounting standard the amount of revenue generated by
subsidiaries will be more comparable. IFRS will also help highlight which
intangible assets are generating most revenue and from which subsidiary. Having the value of the intangibles already
on the balance sheet in mergers or acquisitions makes it lot simpler for
valuing tp.
Valuation of IP
Valuing
of IP identifies the value it contributes to the business which is very
important to determine the TP to be paid in accordance with the arms length
principle. Exact IP valuation is the key
to determine the accurate IP owned
Transfer Pricing - It
is the practice by which the price or fee for use of an asset is established for transfer from one
affiliated company to another.( asset includes IP).
Arm’s
Length Price - It’s the price,
which is applied in a transaction between persons other than related party in
uncontrolled conditions.
The new domestic TP provisions would have significant anti abuse
effects to redress any non-arm's length pricing of domestic transactions.
The arm’s length price shall
be determined by any of the following methods having regard to the nature of
transaction namely :-(1) Comparable Uncontrolled Price Method(2) Resale Price
Method (3) Cost Plus Method (4) Profit Split Method (5) Transactional Net Margin Method.
Fair Market Value –
These the three universal approaches used in valuation of IP;
(1)The Cost method (2) Income method (3) Market method.
Cost Approach
The Cost Approach is based on the presumption that a willing buyer
would pay no more for an intangible asset than the cost to produce such asset.
Rather on the other hand while considering market conditions, time and value of
money, it may be wiser to purchase the asset.
In the long run the long run the cost to develop it may prove higher
than the purchase price. This approach also helps to know how much it would
take to “re-create” the asset, thereby giving an indication of the value.
Market Approach
The Second approach to valuing intangibles is the market approach.
It is based on examination of similar
intangible assets that have been transacted in the Marketplace. This method depends heavily on the
availability and comparability of data. In TP
analysis companies are often required to justify intercompany royalty
payments for the use of intellectual property. A market approach could
incorporate an analysis of functionally similar licensing agreements for the
use of the intellectual property.
Income Approach
The most relied approach in valuing intangible assets is the Income
Approach. This approach determines the value of IP by examining the future or
expected income the IP will generate. There are two main types of income
approaches, the yield capitalization approach and direct capitalization
approach. Both are closely based on four steps: (1) the determination of an
appropriate income measure, (2) the estimation of a time period, (3) the
projection of the income, and (4) the appropriate determination of a
capitalization rate.
In addition to these two income approaches there are various other
approaches that can be referred to as “Income
“or “Market” approaches; they are incremental
income approaches, the profit split
method, and royalty analyses.
The Incremental Income approach is based on examination of the additional income accrued
by the existence of the IP.
The Profit Split method splits the income between the IP and other tangible and
intangible assets associated with it. Finally,
The Royalty Analyses examines the payment a licensee pays a licensor for use of a discrete
intangible asset.
Each method has its pros and cons, given the often subjective and
data-intensive nature of valuation.
Points to remember:
§ When a IP is transferred from I affiliate to other affiliate
company;
§ The relevant IP to be transferred to be identified.
§ IP to be valued using one or more of the methods to determine
its value.
§ Evaluate the transfer price based on arms length standard using
any one of the above methods to determine the Arms Length Price.
§ Transfer it to the subsidiary at the price arrived at.
§ Relevant entry to be made in the balance sheets
§ These are some documents which have to be maintained:-
Certification
of Related Party Transactions:- A report on the compliance of the transfer pricing guidelines in respect of transactions with related parties shall be obtained
from an Chartered Accountant.
Statement of Policy:-
For each related party, a statement shall be recorded disclosing the
basis/methodology for various transactions and shall form the basis on which
transactions are entered into.
The Union Budget 2012 is has introduced a
dispute-resolution mechanism called the APA (advance pricing agreements). It is an agreement that sets transfer price
of the covered transactions prospectively between the taxpayer and tax
authorities. APAs are generally entered into with a five-year lock-in
period. Any TP issue is possibly capable of being covered by an APA. The
companies and tax authorities can mutually agree on the TP method to be applied
and its application for a certain period of time. Further, bilateral
APAs are likely to be introduced. The forseeing nature of APAs would lessen the
burden of compliance by giving taxpayers greater certainty regarding their
transfer-pricing methods and promote decent resolution of issues.
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