Managing IP’s guide to transfer pricing and IP

How does transfer pricing work?

Multinational companies need to set the prices that one part of the business pays for goods and services bought from another part. In theory, if a subsidiary in a high-tax jurisdiction pays a high price for the right to use, say, a trade mark owned by a subsidiary in a low-tax jurisdiction, then its own taxable profits will be reduced. The OECD itself says that transfer pricing can have a “dramatic impact” on the allocation of a multinational company’s taxable profits among the countries in which it operates.

It doesn’t sound like the tax authorities will like that

Transfer pricing has been around for a while, but in 1995 the OECD approved a set of guidelines setting out how multinational companies should arrange their internal pricing structures and how tax authorities should treat transfer pricing arrangements. These were updated in 2010. The key principle is that transactions should be conducted at so-called arm’s length. Many countries now have rules on governing the way that businesses price their internal transactions.

Where does IP fit in?

Intellectual property rights are playing an increasingly large role in companies’ transfer planning strategies. One tax-planning technique is to transfer a company’s IP rights to a subsidiary in a low-tax jurisdiction and then license those rights to subsidiaries in other parts of the business.

This can create a particular headache for tax officials: establishing the correct arm’s-length price for the use of an IP right that is never licensed outside the company is a more difficult task than it is for setting the market price for a commodity input.

Why all the recent fuss?

Companies’ balance sheets are taken up with a bigger proportion of intangible assets than ever before. That makes it easier for them to use clever intra-company arrangements to license their IP as part of tax-minimising strategies. That, combined with budget slashing by austerity-minded governments in developed countries, has focused attention on high-earning, low-tax-paying companies.

Transfer pricing is not an exact science: the OECD’s guidelines are guidance rather than law, and not all countries have adopted legislation that works in harmony with best practice. The resulting ambiguity about what businesses can and can’t do it makes transfer pricing an attractive target for tax office auditors.

Who’s upset about it?

There’s a growing list, and the issue has hit the mainstream press. While public awareness of tax policies has to be welcomed, some professionals are concerned that it will lead to a perception that transfer pricing itself is illegal, rather than a requirement of business.

Now policy makers are considering action. In September, the US Senate’s Permanent Subcommittee on Investigations held a hearing on “Offshore Profit Shifting and the U.S. Tax Code”. The subcommittee’s chair Senator Carl Levin claimed that multinational companies shift profits to foreign subsidiaries in low-tax jurisdictions by selling or licensing IP to them at artificially low prices. The subcommittee listed a series of IP transactions done by Microsoft. Levin described the deals as complying with the letter of the law, but violating the intent of the law.

In June, the OECD issued a draft document on the transfer pricing aspects of intangibles. Next week it will hold public consultations on the document in Paris.

Last week the finance ministers of the UK and Germany have urged governments to do more to tax multinational companies. George Osborne and Wolfgang Schäuble described on Monday how “some multi-national businesses are able to shift the taxation of their profits away from the jurisdictions where they are being generated, thus minimising their tax payments compared to smaller, less international companies” and urged G20 members to back the OECD’s work to deal with profit shifting.

On Monday, senior staff from Google, Starbucks and Amazon are set to explain their companies' tax arrangements to politicians on the UK Parliament's Public Accounts Committee. Starbucks was recently forced to defend its tax policies after Reuters published an investigation into its tax record in the UK.

What else do I need to know about transfer pricing?

In addition to the risk of having politicians raise questions about your company’s tax policies and campaigners marching on your corporate headquarters, in-house lawyers need to be aware of the risks of IP transfer pricing on their litigation strategies.

In an article for Managing IP, Phillip Beutel, Bryan Ray and Steven Schwartz highlighted the problems a multinational company might face if it wants to claim damages for infringement of IP rights that have been shifted offshore.

You can read more about transfer pricing, including updates from the OECD’s Paris meeting on Managing IP’s sister site TP Week.