Often multi-national companies contemplate making an intercompany transfer of an asset, commonly for operational or tax planning purposes. Intercompany transfers frequently include the sale of an entity for restructuring purposes, a trademark or patent sale, or customer relationships, among others. When such a transfer is contemplated, the company will often question whether a sales transaction needs to take place, particularly since the asset(s) is (are) remaining “in the family.” This most commonly occurs when there is a transfer of intellectual property.
BRITCO is a food and beverage company with global headquarters in the United Kingdom. BRITCO has subsidiaries throughout the world, including in the United States (USCO) and Canada (CANCO). BRITCO’s products are primarily pre-packaged consumables, such as candy, soda, frozen dinners, snacks, etc. BRITCO diversified into the kitchen appliance category, and recently introduced a juicer appliance that extracts the nutrients out of fruits and vegetables. The United States was used as a test market for the juicer, and USCO began selling the product to retailers throughout the U.S. The U.S. sales team began to expand into the Canadian market because they had relationships with some U.S.-based big box retailers that also had retail operations in Canada. The juicer became very successful in Canada, and BRITCO decided that in order to meet the consumer demand in Canada, a warehouse needed to be opened in Toronto. USCO ceased selling the juicer products to Canadian customers, and CANCO began selling the juicers to USCO’s customers in Canada. This scenario raises the obvious question: can the Canadian subsidiary of BRITCO simply take on USCO’s former customers without a sales transaction taking place?
If these entities were not related (at arm’s length), BRITCO would not let a competitor take its customers without receiving some sort of remuneration. In addition, since the loss of customers to the U.S. entity will result in less taxable income in the United States, the IRS may take interest in the loss of customers.
Section 482 of the Internal Revenue Code (“IRC”) generally requires that exchanges of intangible property among related parties take place at the same prices as would be expected in similar transactions among unrelated parties. The same would be true of any asset transfer amongst related parties. Therefore, CANCO would have to pay an arm’s length price to USCO for the customer relationships.
IRC Section 482 defines the arm’s length standard as follows:
“In determining the true taxable income of a controlled taxpayer, the standard to be applied in every case is that of a taxpayer dealing at arm’s length with an uncontrolled taxpayer. A controlled transaction meets the arm’s length standard if the results of the transaction are consistent with the results that would have been realized if uncontrolled taxpayers had engaged in the same transaction under the same circumstances (arm’s length result).”
Hence, an arm’s length price is the price an unrelated company would pay for the subject asset(s). Under IRC Section 482, an arm’s length price conforms with the concept of “fair market value”, which is defined by the IRC as “the price at which the property would change hands between a willing buyer and a willing seller when the seller is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts.”
Intangible asset valuations are frequently performed for financial reporting purposes. We often encounter the question of whether the value determined for financial reporting purposes can be used in the context of transfer pricing. Valuations for accounting purposes may be a useful starting point, but the IRS is hesitant to depend on valuations prepared for financial reporting purposes since the accounting treatment of an intangible asset is not always in agreement with its economic value. TD 9568 published in the March 19, 2012 Internal Revenue Bulletin provides a wealth of information on this topic.
The Organization for Economic Cooperation and Development (“OECD”) has also taken great interest in the valuation of intangibles as it relates to transfer pricing. The 35 member countries of the OECD coordinated to develop a Base Erosion and Profit Shifting (BEPS) action plan. On May 23, 2017, the OECD released draft guidance regarding pricing hard-to-value intangibles (“HTVI”). HTVI are defined as intangibles or rights in intangibles for which, at the time of the transfer between related parties, no reliable comparables existed, and projections of future benefits expected to be derived from the transferred intangible or assumptions used in valuing the intangibles were extremely uncertain.
The draft guidance contains three sections that present (i) the principles that should trigger the application of the HTVI approach in various situations; (ii) examples to explain the application of the HTVI approach in various situations; and (iii) the interaction between the HTVI approach and the access to the mutual agreement procedure (“MAP”) under the applicable treaty.
Companies that have transferred, or are in the process of transferring HTVIs amongst related parties should be aware that HTVI guidelines for tax authorities have moved further along. Tax authorities will likely apply audit practices to identify and act upon HTVI transactions as early as possible.
At BlumShapiro, we have a firm grasp of the complexities involved with transfer pricing and necessary valuation methodologies. Working proactively with one of our experts can assist your company in developing a strategy to avoid costly non-compliance penalties, transfer pricing audits and double taxation.
 Treas. Reg. 1.482-1(b).
 Treas. Reg. § 20.2031-1(b) and § 25.2512-1.