Transfer Pricing Webinar
on Intellectual Property and Financing Transactions
A. Current Legislation
B. Upcoming Legislation
C. Case study on Intellectual Property
D. Case study on Intercompany Loans
A. Current Legislation
Article 33 - related party transactions should be at arm’s length
Obligations - No obligation to submit documentation except when the Cyprus company is involved in back to back financing
(a) A company in the Republic is directly or indirectly involved in the management or control or capital of another Company; or
(b) the same persons are directly or indirectly involved in the management, control or capital of two or more companies;
General Provisions of the upcoming Legislation
The definition of related parties will be amended with the inclusion of the minimum percentage of 25% of control
The pricing of related party transactions will be based on OECD transfer pricing guidance;
Introduction of the meaning of Advance Pricing Arrangements (APA’s);
The guidance provide:
Obligation for maintaining Master, Local file and summary table of related party transactions;
Obligation starts for related party transactions of over EUR 750,000 (cumulative per category);
Introduction of penalties for failing to comply with the above.
Cost of getting it wrong
C. Case Study :
Owner of the intellectual property
Makes key strategic decisions
Sales and Marketing activities
Provides license to US Co to sell CY Co software
Provides software development for the CY Co intellectual property
Sales and marketing activities
Framework for Analyzing Transactions OECD
Intellectual property is a work or invention that is the result of creativity and is subsequently protected by patents, copyrights, trademarks etc. It is therefore a type of intangible asset, which for transfer pricing purposes are those which meet the following criteria:
Is not a physical or financial asset
Is capable of being owned or controlled for commercial activities
Is an asset whose use or transfer would be compensated had it occurred in a transaction between independent parties in comparable circumstances
There are different categories of intangibles e.g., patents, know-how and trade secrets, trademarks, trade names and brands etc.
The software intellectual property owned by CY Co meets the above criteria and will therefore be classified as an intangible asset for transfer pricing purposes.
In transfer pricing for intangibles, the determination of the entity/entities within an MNE group which are ultimately entitled to a share in returns from exploiting the intangible is crucial. In some cases the legal owner will need to share the returns.
Although the legal owner may receive the proceeds from exploitation of the intangible, other members of the MNE group may have performed functions, used assets or assumed risks that are expected to contribute to the value of the intangible.
DEMPE analysis highlights the companies that have assumed risks relating to the Development, Enhancement, Maintenance, Protection and Exploitation of the asset.
Transfer Pricing Considerations
Software development process
• UA Branch performs software development activities.
• Employs >50 developers;
• Does it have the entrepreneurial / strategic functions or is fully managed and supervised by CY Co
• The branch operates to develop, enhance and maintain the IP, however, the risks of these processes are born by CY Co
• Branch should be remunerated on a cost-plus basis for software development services assuming CY Co can be attributed all the non-routine profits related to the Software IP.
Software development process
• CY Co bears core IP-related risk (DEMPE), executes legal risk mitigation and other routine activities. CY Co should consequently earn a significant share of the returns from exploitation of the intangibles in the MNE group.
• This can be earnt either through direct sales to clients or from licensing to US Co. The licensing fee can be determined via several models.
• This could be different for different members of the MNE group and will depend on the extent and nature of the services they provide and on the revenue they generate.
• For example, if US Co is unable to generate much revenue in the preliminary periods, then a cost plus may be more suitable.
IP Box regime
• Financing activities
• Makes Key strategic decisions
• Policies and procedures for the provision of loans in place
• Has personnel to manage the loans
• Issued bond to an unrelated company (SP co) to raise finance
• Mother company of the group
• Provided guarantees to (SP Co) by pledging the shares of IR Co to the bond holder
• Trading activities in Europe
Framework for Analyzing Transaction
Identify the commercial or financial relations
• Consider whether a prima facie loan should be regarded as a loan or should be regarded as some other kind of payment, in particular a contribution to equity.
• Accurate delineation of financial transactions. There are five economically relevant characteristics that form the analysis of the terms and conditions of financial transactions. These economically relevant characteristics are:
Ø Contractual Terms
Ø Functional Analysis
Ø Characteristics of Financial Instruments
Ø Economic Circumstances
Ø Business Strategies
The easiest to apply method is the Comparable Uncontrolled Price method (CUP) due to the high volume of financing transaction between unrelated parties which are available through databases (external comparable transactions). Also Group’s financing transactions with unrelated parties can be used as an internal comparable transactions for benchmarking purposes.
In the absence of CUP, other methods such as cost of funds, spread of credit default swaps, economic modelling etc can be used to arrive at an arm’s length price.
Credit scoring of a company or the group
Creditworthiness of a company is an essential factor that can affect the terms and conditions (amount to be provided, interest rate, period of loan to mature) of a loan that is conducted between unrelated parties. In order to achieve comparability when dealing with intragroup financing transactions, a credit rating assessment should be performed to the related party receiving the funds to support that based on the rating attributed, the terms of loan are comparable to unrelated entities.
Provision of Loans
• The purported loans should be regarded as loans
• The functions of the Cyco demonstrates a company that exercises control ,uses its own assets and assumes risks for the financing transactions
• Credit score of IR co
• Use CUP to establish the arm’s length price
• Search in databases to find comparables and set up the arm’s length rate.
Is it implicit guarantee or explicit ? Possible explicit
• Guarantee fees should be paid to DE co
Issue of Bond
• Unrelated party no TP issue the interest is at arm's length