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HMRC internal manual

International Manual

Transfer pricing: Types of transactions: intangibles: fragmentation

Fragmentation of functions

The fragmentation of the functions of a trade or intangibles between different members of a multinational enterprise (‘MNE’) may lead to pricing issues. It would be necessary to review the full facts, taking into account how a third party would have acted before reaching any conclusion. In the classic form of fragmentation, valuable and necessary intangible assets of a trade are split from the functions that have created the intangible in the first place, in a way that would not happen between third parties. The intangible owner then charges the party carrying on most of the functions relating to exploitation of the intangibles. A royalty stream is created which moves profit and generates a favourable tax effect.


There are a number of possible variations on this theme.

  • A company carrying out an ongoing trade sells a necessary intangible to an affiliate and then licenses back the intangible that it still needs to conduct the trade.
  • A group acquisition vehicle acquires a company and the ownership of the intangible and tangible assets belonging to the company is then split between different affiliates.
  • Perhaps different group companies acquire the intangible and tangible assets from a single independent in the first instance.


It is entirely reasonable to call for evidence that this would have happened between independents. Commercially, would a business have surrendered an intangible asset that it intended to continue using? Possibly, but the benefits would be expected to outweigh the undoubted costs. It is more likely that an independent would only surrender an intangible asset if it had no wish to continue using that asset. The company has exploited its asset by disposing of it. A business who had to continue using an intangible asset would only dispose of it if that made financial, commercial sense.


If the fragmentation has arisen after an acquisition, there are more considerations. What was the real target of the acquisition? The apparent value of the various parts of the acquisition may not tell the whole story even if the deal was struck between third parties since the seller will have been mainly interested in the sum total of what he was going to receive, not how it was allocated between the various tangible and intangibles sold (capital gains tax considerations aside).


The buyer may have been able to arrange that smaller or larger amounts were allocated to the intangible. Scrutinise carefully arrangements that leave one affiliate with a newly-acquired trade but another affiliate in possession of an intangible necessary to the pursuit of that trade and in receipt of a newly-generated royalty stream. All the transactions that have led to this situation should be examined, considering whether any of them would have arisen commercially. Always look at the actions and try to assess commercial rationality of the transactions from the perspective of each party involved.


Examine critically the prices of transactions resulting from fragmentation to weigh up whether an arm’s length price is being charged. The extent to which OECD Transfer Pricing Guidelines allow the setting aside of actual transactions is considered at INTM440200.