Understanding Intangibles in Transfer Pricing

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The treatment of intangibles in Transfer Pricing (TP) is a complex and critical area, given their unique nature and the difficulty in finding comparable transactions. The FTA’s Transfer Pricing Guide can be a useful reference documents for taxpayers in the UAE. 

This article provides an overview of how intangibles are identified, valued and treated under the arm's length principle (ALP).

Defining Intangibles

Intangibles are assets that are neither physical nor financial but are capable of being owned or controlled for use in commercial activities. These assets would command compensation if transferred between independent parties under comparable circumstances. Examples of intangibles include patents, trademarks, trade secrets, and licenses. It is essential to distinguish these assets from non-intangibles like group synergies and market-specific characteristics, which are not considered as intangibles. Further, intangibles can be categorized into different types, such as trade intangibles and marketing intangibles, or routine and non-routine intangibles. 

Applying the Arm's Length Principle to Intangibles

Generally, there are two kinds of transactions pertaining to intangibles between related and connected persons:

• Transactions involving the transfer of intangibles or rights in intangibles; and 
• Transactions involving the use of intangibles in connection with the sale of goods or the provision of services.

Applying ALP to these transactions requires a systematic approach as discussed below:

• Determine the specific intangibles involved in the transaction; 
• Examine contractual arrangements between the parties in terms of legal ownership, registrations, and other relevant agreements; 
• Identify the parties performing functions, using assets, and managing risks related to DEMPE (Development, Enhancement, Maintenance, Protection, and Exploitation) to determine economic ownership of the intangible; 
• Ensure that the contractual terms align with the actual conduct and risk control by the parties; and 
• Determine the ALP based on the accepted TP methods and the comparables available, if any. 

The FTA’s guide discusses this with the help of examples. Say Company X funds the development of an intellectual property (IP) asset, while Company Y, a related party, performs all DEMPE functions. Although Company X is the legal owner, the functional analysis reveals that Company Y, which controls the DEMPE process and manages the associated risks, should be entitled to a significant portion of the profits generated from the IP. In this case, the arm's length profit for Company X would be a risk-adjusted return on capital, with the remainder of the profits allocated to Company Y.

Valuation of Intangibles 

One of the major challenges in valuing intangibles is the lack of comparable uncontrolled transactions. The unique nature of many intangibles means that finding a comparable market transaction is often difficult. In such cases, alternative methods, such as market appraisals or valuations, may be necessary to determine an appropriate arm's length price.

Conclusion 

The value of transactions pertaining to intangibles is often substantial. The onus of proving authenticity and necessity of the transaction as well as substantiating the ALP primarily rests with the taxpayers. Transfer pricing practitioners can provide the right guidance right from the transaction stage till the reporting stage. 

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