Intangible assets are a crucial aspect for multinational enterprises for they represent a significant proportion of value in the balance sheets of these enterprises. Their lack of physical existence and high mobility makes them susceptible to transfer pricing risk especially in transactions involving their sale or licensing between associated enterprises. For these reasons most revenue authorities are ranking
them high on the list of items used by multinational enterprises in profit
shifting. In order to mitigate this risk, the Organisation of Economic Cooperation Development (OECD) in their Transfer Pricing Guidelines for Multinational and Administrators 2017 has established a transfer pricing
framework for intangibles that ensures appropriate allocation of profits
associated with the use or transfer of intangibles. The legal ownership of intangibles is no longer regarded as the determining factor for one to be entitled to profits accruing from transactions involving the use or transfer of intangibles. It has to be ascertained that the legal owner assumed all risks associated with the development, enhancement, maintenance, protection or exploitation of the intangibles. This is commonly known as the DEMPE function and it seeks to ensure that profits associated with the transfer pricing of intangibles are appropriately allocated in accordance with value creation in
accordance with OECD’s approach. Accordingly, revenue authorities have an interest in the significance of various functions and their
relevance to the determination of the allocation of profits among different entities that contribute to the creation and exploitation of intangible assets as opposed to allocating profits on the basis of the title held by a person in the intangible asset.
Where an entity is the legal owner of an intangible asset and its associated enterprise contributes to the value of that intangible asset, the entity will be obliged to fully compensate such associated enterprise on an arm’s length basis. It will be compensated for the functions performed, assets contributed and risks assumed in order for the entity, as the legal owner of the intangible property, to retain all rights to the profits associated with the exploitation of the intangible property. This, therefore entails that profit retention is not solely based on legal ownership but economic ownership as well. The economic ownership is determined by the person’s contributions towards the DEMPE functions of the intangible assets. The OCED in its BEPS final report stated that:
“While determining legal ownership and contractual arrangements is an important first step in the analysis, these determinations are separate and distinct from the question of remuneration….The return ultimately retained by or attributed to the legal owner depends upon the functions it performs, the assets it uses, and the risks it assumes, and upon the contributions made by other MNE group members through their functions
performed, assets used, and risks assumed…. It is therefore necessary to
determine, by means of a functional analysis, which member(s) perform and exercise control over development, enhancement, maintenance, protection, and exploitation functions, which member(s) provide funding and other assets, and which member(s) assume the various risks associated with the Intangible.”
Accordingly, emphasis is now placed on economic ownership more than legal ownership of the intangible assets. If the legal owner of intangible property wants to retain profits that flow from the exploitation of such intangible property he/she should equally contribute to the value thereof. The OECD Guidelines on Transfer Pricing are relevant for the purposes of interpreting transfer pricing laws in Zimbabwe. Accordingly, entities that legally own intangible assets should be reminiscent of the recent developments mentioned above pertaining the DEMPE concept.
Whilst emphasis is placed on development, enhancement, maintenance, protection and exploitation of the intangible property, the legal owner may outsource some of its functions. The OECD Guidelines, however, outline that payment of an “important function” of the intangible that has been outsourced by the legal owner to a related party shall be in accordance with the appropriate share of the returns derived from exploitation of the intangible. It follows therefore that a legal owner of an intangible property risks losing profits if he or she outsources its important functions to a member of the group.
Regarding application of the arms-length principle to the exploitation of intangibles, the legal owner is also obliged to have financial capacity to assume risks associated with the development, enhancement, maintenance, protection and exploitation of the intangible. The legal owner is also entitled to claim all profits if he or she or it bears responsibility for costs incurred in the event that risk materialises.
In conclusion, entities should be cognisant of the recent development of transfer pricing guidelines, particularly for intangible assets. Legal ownership alone does not entail entitlement to all profits. There is need for the legal owner to contribute to the development, enhancement, maintenance, protection or exploitation of the intangible asset. Profit is now interlinked with assumption of risk and contribution to the aforesaid aspects. With this in mind entities will also need to evaluate whether the licensing fees they pay to legal owners of the intangible are at arm’s length especially where they are also performing functions, use assets and assumes risks to the marketing of the intangible e.g the brand. If the marketing efforts done by the payee of the licensing fees are the determining factor in the success of the brand, then it can be argued that the licensing fees paid to the legal owner of the intangible property is a donation. Taxpayers are advised to arrange their affairs to ensure they do not end up having disputes with tax authorities. In so doing they should reconsider their transactions involving sale or licensing of intangible assets in light of these developments.