The OECD has released a discussion draft on arm’s length pricing of intangibles when valuation is highly uncertain at the time of the transaction, with special consideration of hard to value intangibles (HTVI).
When the valuation of an intangible at the time of the transaction is highly uncertain, the draft suggests that the question should be resolved by reference to what independent enterprises would have done in comparable circumstances to take account of the valuation uncertainty in the pricing of the transaction.
In some cases this might be simply to take the view that subsequent developments are sufficiently predictable and therefore the projections of anticipated benefits are sufficiently reliable to fix the pricing for the transaction at the outset on the basis of these projections.
In other cases such pricing might not provide protection against the high uncertainty in valuing the transaction, such that shorter term agreements may be appropriate, perhaps with a price adjustment clause or milestone reviews.
On the other hand, independent enterprises may decide to bear the risk of unpredictable subsequent developments, but then renegotiate in the event of major unforeseen developments.
The OECD discussion draft states that if the above can apply to independent enterprises acting at arm’s length then tax authorities should be permitted to determine pricing or revisit pricing on the same basis.
The Discussion Draft asserts the difference between valuations based on projections and on actual results would normally be claimed by the taxpayer to be due to more favourable outcomes than anticipated and tax authorities may not have the expertise or access to the relevant information to examine such a claim and potentially demonstrate that the difference was actually down to mispricing by the taxpayer.
Therefore it suggests that actual results can be used by tax authorities as an indicator of the arm’s length nature of the original pricing. However, the Draft makes the distinction between this and the inappropriate use of hindsight.
HTVI is considered a specific category of intangibles where there are no reliable comparables and no reliable projections of future benefits.
The Draft suggests that for such intangibles “information asymmetry” may adversely affect tax authorities and risk assessment may not be possible until outcomes are known years after the transaction.
In these circumstances the Draft states that tax authorities may also consider actual outcomes when determining the validity of the original pricing arrangements.
The Draft does incorporate some exceptions as safeguards for taxpayers, provided they give full details of their forecasts at the time of the transaction and provide evidence that any differences between forecasts and actual outcomes are due to unforeseeable or extraordinary events that could not have been anticipated at the time of the transaction.
Some commentators fear that this Draft approach may lead to the use of hindsight, depending on how the “exceptions” work out in practice. Others question the fundamental assumptions on how independent enterprises set their prices in such situations to mitigate the uncertainties. However, others feel that the protections for taxpayers are robust and helpful but would prefer certainty that variations between forecasts and actual outcomes should not automatically trigger an adjustment.
Public comments are invited on the discussion draft.
The discussion draft is here: http://www.oecd.org/ctp/transfer-pricing/release-discussion-draft-beps-action-8-hard-to-value-intangibles.htm
Comments should be submitted by 18 June 2015 by email, in Word format to Andrew Hickman at TransferPricing@oecd.org.