INTM489425 - The Unassessed Transfer Pricing Profits Examples: Example 8 - Intangible assets

Facts

  • Company A is UK resident, it trades across Europe in the development, manufacturing and selling of unique and valuable pharmaceuticals. Company A owns all patents, manufacturing licenses and other intellectual property relating to the pharmaceuticals.
  • Company A jointly develops a new patentable drug with a third-party company in the UK. Under the terms of the development agreement, Company A has the opportunity to buy out the third party once the patent is awarded and the drug receives regulatory approval.
  • A group decision is made to establish a new connected company in a low tax jurisdiction, Company B. Funds are made available to Company B to acquire the drug patent at an arm’s length price, the patent will subsequently be licensed back to Company A for a royalty fee.
  • Company B’s only employees are two part-time administrative staff. It has insufficient functionality to manufacture or sell the drug.
  • Company A’s profits from the new drug are substantively reduced by the royalty fee it pays to Company B, which is subject to a low rate of tax.

 

Analysis

  • The provision is the licence of patent rights from Company B to Company A.
  • HMRC considers that under the transfer pricing requirement, Company A should receive the proceeds from the exploitation of the rights. Company B should be rewarded a nominal amount as the legal owner.
  • The fact that the drug patent was originally developed in the UK before the rights to it were transferred to another group company does not in itself mean that unassessed transferpricing profits arise, even if the transfer results in payments being made from the UK in respect of that patent.
  • However, in this case there has been a separation of ownership from the functions needed to properly manage and exploit the asset. Company B’s staff have insufficient capability to manage the asset and assume the economically significant risks associated with the IP. At arm’s length it is very unlikely Company A would have transferred the drug patent to another company and paid a royalty fee to access it, which effectively eliminated its profits.
  • The unassessed transfer pricing profits is the difference between the royalty fee paid by Company A, and the nominal amount Company B would be entitled to retain as the legal owner.
  • There is an ETMO due to the difference in corporation tax rates between the UK and the jurisdiction in which Company B is resident.
  • The TDC is met. Taking into account the broader arrangements involving the transfer of Company A’s right to purchase the drug patent to Company B, it is reasonable to assume that if it were not for the UK tax reduction that occurs as a result of the patents being owned by Company B then the acquisition of the patents would have been made by Company A so that it benefits from the full reward of its activities. There are no commercial or cost-saving benefits to holding the patent in Company B, other than the UK tax reduction.