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HMRC internal manual

International Manual

Transfer pricing: Types of transactions: intangibles: establishing an arm’s length price for valuable intangibles

What is the intangible worth?


All businesses own intangibles, which can take many forms. Some of it is very valuable, such as the patent for new drug that effectively treats a medical condition that has formerly been untreatable. Some intangibles may be worthless. Some intangibles may once have been revolutionary and very valuable, but now have only minimal value.


Valuation of intangibles is a genuinely difficult area. Start by considering the following fundamental points:

  • What is being paid for?
  • Is it likely that these things would be paid for at arm’s length?
  • How much would an independent pay?
  • How does the amount of the payment affect the level of profits enjoyed by each party?
  • Would the level of profits accruing in each party be seen between independents?
  • Is the company paying for something it has helped to create in the first place?


Consider a few examples of different types of intangibles and expenditure that may create an intangible that an independent would or would not be prepared to pay to use:

  1. A patent which will provide the exclusive right to exploit a particular process or invention for a set period, such as a revolutionary new drug with no competitors. During the period of patent protection the company can market the product in the knowledge that there may be no direct competitor in key markets. The company can both generate volume of sales and may be able to charge a high price.
  2. A large multinational with a number of retail stores in a number of countries sets up a subsidiary in the UK (where there was no presence previously), which then establishes retail stores across the country. The group sells a small range of its own products, but in the main sells branded goods. The parent charges the subsidiary a royalty for using the group name. At arm’s length a company is not going to pay for the use of a name that has no or very little recognition in the UK.
  3. A new bespoke computer system for a group helps streamline and rationalise business activities. While it might deliver tangible benefits to members of the group, the expenditure doesn’t necessarily create an intangible asset that an independent would pay a royalty for. A recharge of the costs of commissioning the system from the (independent) contractor would be more appropriate.
  4. A company engages a firm of consultants to advise on establishing an overall theme and set of values by which the company and its employees will operate, both internally and with its customers. While this may have some indirect benefits it would be very difficult to try to identify or put a value on any intangibles created. Would a third party pay for any such intangibles?


There will be situations where although an intangible may be identified, it is very unlikely that anyone would want to pay for it. Alternatively, part of the group may own intangibles that are so key to the business that they would not be licensed or, if they were to be licensed out at arm’s length, the form of the license would be markedly different. As recognised by the OECD Guidelines (paragraph 6.10) the identification of an intangible is separate and distinct from the price for the use or transfer of that intangible.


Particular comparability factors for intangibles


As with any consideration of the transfer pricing of transactions between associated parties, a comparability analysis which identifies the economically significant circumstances and characteristics is essential when considering a transaction involving intangibles.


Factors which are likely to be particularly relevant with regard to intangibles transactions are detailed at paragraphs 6.116 et seq of the Guidelines and include:

  • exclusivity
  • the extent and duration of legal protection
  • the geographic scope
  • the useful life
  • the stage of development


of the rights granted or transferred, plus:

  • rights to future enhancements, revisions and updates of the intangibles in question
  • the (reasonable) anticipated future benefits to be derived from use of the rights in question.


What is the value of the business name?


Charges for the use of a business name may sometimes be seen. Guidance on this issue is provided at paragraphs 6.81 to 6.85 of the Guidelines.


The questions to be asked in considering determining whether a payment would be made at arm’s length and the amount that would be paid are:

  1. which group member(s) owns and controls the trade mark, trade name and associated intangibles such as goodwill or reputation
  2. the extent of any financial benefit to other group members deriving from use of those intangibles.


First of all the name and/or logos and trade names and associated intangibles of the business and by which group member each is owned must be specifically identified. A trade name will usually consist of the product (or service) itself, the brand name together with probably an associated logo or trademark and the ‘packaging’ for the name (e.g. a drink may be presented in a particular style of bottle). Importantly, it will be the goodwill or reputation of the relevant business, product or service which gives the trade mark or name its apparent value and it is not necessarily the case that the party which owns the registration of the trade mark in a particular territory also owns the goodwill or reputation in that territory. A licence of a trade mark at arm’s length is implicitly also a licence of the goodwill or reputation associated with that trade mark as ownership of the different intangibles is rarely separated. In group situations, however, it might be that the trade mark is registered with a party other than that which has carried on the business that has produced the goodwill or reputation (and consequently owns that goodwill or reputation) which gives the trade mark its apparent value. It would not be appropriate for a significant payment to be made in such circumstances to the party which owns only the trade mark or name but not the associated intangibles.


The name may have nothing that immediately visibly connects it with the business. A trade name introduced to a new market may well have no value there (i.e. have no goodwill or reputation associated with it in that market), even if it is well known in other countries.


MNEs develop their names and reputations though a variety of means. It may be through the exceptional high quality of the products an MNE makes and sells - customers will have a perception that whatever the business produces will be high quality and worth paying more for. The MNE may have captured a significant proportion of the market and so can charge high prices for its products or services. Equally the MNE may invest very heavily in marketing so customers will associate it with particular products or services.


Always take care to clarify what activity generates the profits: marketing or innate quality of product or where, as is usually the case, a combination of both, the relative importance of each.  This is frequently not a straightforward exercise but will lead to an informed view of what the arm’s length reward for the activities would be.


Who the customer is will reflect why a trade name has value. Consumer brands and business names are generally promoted to attract ‘high street’ customers. A commercial organisation on the other hand may not be interested - they will be concentrating on the product or service that is being sold to them. An associated enterprise should only be charged for use of the business name if the group can demonstrate that the use of the name and any associated intangibles owned or controlled by the licensor provides a financial benefit for the licensee, either by allowing a premium price to be charged or being able to secure a definite advantage in obtaining and maintaining market share.


Case teams should consider whether a charge would exist from the perspective of the user of the name, as well as the owner.


In some cases a charge might not be appropriate as an associated enterprise is merely obtaining the incidental benefit of belonging to a large MNE Group with the trade mark or name concerned merely signifying membership of that MNE group.


If a charge is appropriate, check that there is not already a charge for the name and associated intangibles incorporated in the transfer price of goods or services.


It may be that past efforts of associated parties have contributed considerably to any value the name and associated intangibles may have. Where this is the case, consideration should be given as to whether those parties have been adequately recompensed for those efforts.


Complex issues of Intellectual Property law concerning trade marks, ‘passing off’ (in respect of goodwill), misrepresentation and unfair competition potentially arise in respect of the use of and payment for business names. Where issues of dispute and difficulty occur with respect to such matters, referral should be made to the Transfer Pricing Team at CSTD Business, Assets & International.


OECD Transfer Pricing Guidelines - comments on valuation of intangibles


The OECD Transfer Pricing Guidelines devote a complete chapter to intangibles (Chapter 6), recognising that transactions involving intangibles are present particular difficulties in pricing for tax purposes. As well as looking at different types of intangible property, the Guidelines also offer advice on how to establish an arm’s length price on transactions involving intangibles.


The Guidelines state that both parties to the transaction must be considered. Applying the arm’s length principle to the owner of the intangibles means looking at the price an independent would be prepared to accept for carrying out the transaction. From the point of view of the person paying to use the intangibles, an independent party acting at arm’s length would consider the value and usefulness of the intangibles to their business when deciding what price they would be prepared to pay. It is not a case of ‘one size fits all’ - one person may be prepared to pay more than another, if they think they can derive more benefit from using the intangibles.


The various OECD pricing methodologies is discussed in detail at INTM421010 onwards.


Establishing an arm’s length price when the intangibles are owned by someone else


Cases will often be encountered where the intangibles in question are owned by someone else, but are either:


  • used by a group company in the UK - for example by a UK manufacturer - in the manufacture of goods using a patent. In such cases, at arm’s length, payment by the UK manufacturer is likely to be in the form of a royalty or similar form of compensation because the UK manufacturer is directly using the rights under the patent.
  • or have been used - for example, by an offshore manufacturer - in the manufacture of trade marked goods by which are then sold to a UK distributor for resale. In these cases payment by the UK distributor would be more likely to be made, at arm’s length, by means of a premium in the price charged to the distributor for the goods as the UK distributor is not directly using the rights under the patent in its business (and a principle of intellectual property law known as the ‘exhaustion’ or ‘first sale’ doctrine is likely to apply).


Valuation techniques


There are three main approaches or techniques used by valuation professionals to value assets including intangibles:


Cost Approach


This approach uses the costs involved in producing an intangible as a measure of its value. The most common types of cost used are:

  1. Reproduction costs – the current cost of producing an exact replica of the subject intangible
  2. Replacement costs – the costs of producing an intangible of similar utility or functionality but using current techniques


The OECD Guidelines generally caution against using transfer pricing methods or valuation techniques based on the cost of development to price or value an intangible (paragraphs 6.142 and 6.156) as there is rarely significant correlation between such costs and the value of the intangible developed.


However, it is recognised (paragraph 6.143) that in limited circumstances - for example in the case of an intangible used for internal business operations such as an internal software - a cost-based method may be appropriate or the only option available (as it may be impossible to identify a specific income stream arising from the use of the intangible).


Market Approach


This approach involves identification of a similar intangible and is equivalent to a Comparable Uncontrolled Price transfer pricing methodology.  Due to the fact that it is usually the uniqueness of an intangible that gives it any significant value, the market approach is rarely appropriate with respect to the valuation of an intangible likely to be the subject of consideration for transfer pricing purposes.


Income Approach


Due to the particular restrictions and limitations of the application of the cost and market approaches, the income approach is the valuation technique most likely to be encountered and to be the most appropriate technique to be applied in the majority of situations in practice.


Most commonly an income approach will involve the production of a discounted cash flow (‘DCF’) model to calculate the Net Present Value (‘NPV’) of the intangible in question at the time of the transaction.


Factors that are particularly important when reviewing a DCF model include:

  • Accuracy and reasonableness of financial projections
  • Assumptions regarding growth rates

(see the guidance on Uncertainty in Valuation and Hard to Value Intangibles at INTM440175 and INTM440176 with respect particularly to these first two factors)

  • Discount rate
  • Useful life and terminal value
  • Assumptions regarding tax rates


Purpose of Valuation


As stated in paragraph 6.155 of the Guidelines, valuations of intangibles can be undertaken for a number of different reasons. It is important, when reviewing a valuation supplied in support of the transfer pricing of a transaction involving an intangible, to consider the purpose for which any particular valuation was undertaken and the instructions given to the person(s) who prepared the valuation.


For instance, some valuation standards, such as fair market value, assume a transaction between a (hypothetical) willing buyer and willing seller (for the purposes of establishing, for example, a balance sheet value where no actual transaction has occurred). However, in a transfer pricing situation a transaction has actually taken place and the identity of the transacting parties is known. Consequently, the economically relevant circumstances including the perspectives and options realistically available to each of the transacting parties can be taken into account.


Rules of thumb


The Guidelines caution against the use of ‘rules of thumb’ for determining arm’s length transfer prices both generally (paragraph 2.9A) and specifically for transactions involving intangibles (paragraph 6.144) as they by their very nature do not take into account the specific economically relevant circumstances of the situation in question and do not provide an adequate substitute for a thorough comparability analysis.


Shares and Assets Valuation


Assistance should be sought from Shares and Assets Valuation, Intellectual Property Team for any issues in respect of the valuation of significant intangibles for transfer pricing purposes.