Two publications are considered the primary resource in the area of international tax and transfer pricing.
International Transfer Pricing
Transfer Pricing Guidelines for Multinational Enterprise and Tax Administration
The transfer pricing guidelines provides guidance to both taxpayers and tax administration over the issue of transfer pricing. This publication covers different aspects of transfer pricing. In the early chapters, the guideline sets out the principles and general methods to determine the transfer price between related parties. Intangibles and the transactions of intangible property are discussed specifically in Chapter VI. Chapter VI is widely referenced when dealing with intangibles in the context of international transfer pricing.
According to the OECD guidelines, intangible property is defined as rights to use industrial assets such as patents, trademarks, trade names, designs or models. It also includes literary and artistic property rights, and intellectual property such as know-how and trade secrets.
Chapter VI titled--Special Consideration for Intangible Property--discusses about intangible that are associated with commercial activities. It states that intangible, such as marketing intangible may have no book value in the company’s balance sheet but considerable risks may actually associated with them (e.g. contract or product liability and environmental damages), which casts additional difficulties to set up an appropriate transfer pricing based on arm’s length standard. However, OECD states that the transfer of intellectual property should reflect arm’s length standard and then it further discusses the application of appropriate methods under the arm’s length standard. Due to the wide scope of intangible, OECD categorized intangibles into trade intangibles and commercial intangibles.
International Taxation
OECD Model Tax Convention
Model Tax Convention, published by OECD, discusses about different aspects and issues of international taxation. Article 9 and Article 12 of this publication specifically discuss about intellectual property in the international tax regime.
Article 9 deals with adjustments to profits for transactions between associate companies that may be made for tax purpose. Although this chapter discusses the transactions between associate companies from a general perspective, this article specifically addresses the intellectual property transfer between associate companies. The article states that “the tax authorities of a Contracting State, for the purpose of calculating tax liabilities of associated enterprises, re-write the accounts of the enterprises if, as a result of the special relations between the enterprises, the accounts don’t show the true taxable profits arising in the State”, that is, if the tax authority of State A believes that the transfer of intangibles between associate companies doesn’t reflect the true value of the underlying assets, the taxation authority of State A has the rights to revise the value.
Different from Article 9, Article 12 discusses about the taxation of royalties. Based on Article 12, royalties isdefined as payments of any kind received as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work including cinematograph films, any patent, trade mark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience.
According to article 12, only the State of the beneficial owner’s residence has the exclusive rights to tax the royalties. That is if the owner lives in Country A but his residence is Country B, only Country B has the right to tax the royalties. Nevertheless, if the beneficial owner of royalties arising in one state is resident in other state, it is appropriate to use bilateral negotiations, if there is any, to agree upon special exceptions to the taxing rule laid down in the Article.
It is important to consider situations that the payments for the patents or other intangibles are not ‘for the use of, or the right to use”. Then it is important to examine the characteristics of the intangible and the rules of the source country to define the transactions.
