Meeting of the Minds

The Valuation of Intellectual Property for Transfer Pricing Purposes

Xiaoying Zhang, Danny Ko, and Adam Karp

©2015. Published in Landslide, Vol. 8, No. 1, September/October 2015, by the American Bar Association. Reproduced with permission. All rights reserved. This information or any portion thereof may not be copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association or the copyright holder.

Traditional intellectual property (IP) refers to copyrights, patents, and trademarks. Tax professionals reference IP interchangeably as intellectual property or intangible property, which is broader in scope. The Internal Revenue Code has several intangible property definition lists that include traditional IP and nontraditional IP such as customer lists and goodwill.1 IP migration refers to the outbound transfer of intangible assets from a company’s host country to its related foreign affiliates. The taxation of IP migration requires deriving an arm’s length price via a transfer pricing (TP) method—these methods are provided in the U.S. Treasury regulations2 and the Organisation for Economic Co-operation and Development (OECD) TP Guidelines.3

The OECD currently has 34 member countries4 but does not have legislative authority—each member has the option to adopt any portion of the OECD TP Guidelines. The United States is an OECD member but does not follow the OECD TP Guidelines. Instead, Congress delegates its legislative power to the U.S. Treasury,5 which promulgates TP regulations. This article will focus on the taxation of IP migration under the U.S. tax rules in comparison with the OECD guidelines, the challenges raised and proposals for solutions. Presently, the United States and the OECD treat all intangibles alike—we suggest patents, copyrights, and trademarks be considered separately from other intangibles and the use of a perfected security interest as a comparable to value IP with periodic value adjustments.

Multinational Enterprises Exploit Tax Loopholes

IP-intensive industries support over 40 million jobs and contribute more than $5 trillion to the U.S. gross domestic product (GDP).6 Pfizer, the world’s largest drug manufacturer, made 40 percent of its sales in the United States between 2010 and 2012, but reported no federal taxable income in the United States during the last five years. The U.S. branch of Pfizer sells drugs in the United States but pays its offshore subsidiary high licensing fees, thus shifting domestic profits to low-tax countries.7 Apple, Google, and other multinational enterprises (MNEs) take advantage of similar loopholes in domestic and international laws to avoid taxes. Many of the tax avoidance techniques rely on transferring profits to places like Ireland and Bermuda, or other low-tax jurisdictions. Few corporations pay the full 35 percent corporate income tax in the United States. Both Apple and Google had income tax rates below 10 percent in 2013.8 In the United Kingdom, Google paid a 1.1 percent tax rate in 2013.9 As a whole, the top 15 MNEs averaged a 12.6 percent effective tax rate in 2010,10 which is a lower rate than what the median middle-class family paid in the United States in that same year.

The OECD identifies base erosion and profit shifting (BEPS) as “tax planning strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations where there is little or no economic activity, resulting in little or no overall corporate tax being paid.”11 During the 2013 G20 Summit, the OECD unveiled its plan entitled “OECD/G20 BEPS Project” to give tax authorities broader access to an MNE’s global operation.12

Arm’s Length Standard and Transfer Pricing Rules in General

An MNE can strategically base a permanent establishment (PE) in a low–tax rate country while its U.S. affiliate makes payments to its related foreign party for interest, royalties, and services. Transferring profits out of the United States via related-party charges reduces the U.S. tax base, which may result in BEPS. The arm’s length pricing system is meant to act as a safeguard and conduit for fair taxation.13 The IRS can challenge a taxpayer’s TP method and choice of comparables and make an adjustment.14 Both the OECD and the United States adopt the arm’s length principle, which requires a taxpayer to employ an arm’s length price to related-party transactions, such as IP migration.

Complying with Current Transfer Pricing Rules for IP Migration Does Not Prevent BEPS

Uncertainty in IRS and OECD IP Definitions Creates Tax Avoidance Opportunities

A taxpayer can comply with TP documentation requirements but still manipulate pricing—documenting an unfair price—contributing to BEPS. The IRS and OECD differ on the definition of intangible property. Under U.S. tax rules, intangible property is open-ended, including inventions, formulas, contracts, customer lists, or any similar items, which have substantial value independent of the services of any individual.15 Chapter VI of the OECD TP Guidelines formerly limited intangibles to marketing intangibles (i.e., trademarks, trade names, customer lists, symbols, and pictures) and trade (commercial) intangibles (i.e., patents, know-how, and software)—at least there was a semblance of a list. But now under Action 8,16 chapter VI was completely replaced with language that is even further removed from a specific list, but provides a discussion on traditional IP (copyrights and patents) along with nontraditional intangibles, including goodwill, going concern, group synergies, location savings, and assembled workforce. In summary, the OECD TP Guidelines on intangibles are more broad and ambiguous than before, while the U.S. rules continue to provide an even broader scope but with more specificity.

The Paradox of Intangible Property Tax Regulation

If the IRS, OECD, and taxpayers restricted IP migration to its traditional definition, then many intangibles could be untaxed. But too broad of a definition allows the IRS to arbitrarily assess taxpayers for intangibles that are overlooked, such as an assembled workforce. Whether a workforce in place, or access to a group of employees, is an intangible is a disputed issue.17 The Obama administration’s 2015 plan seeks to expand the definition of intangibles to include (assembled) workforce, goodwill, and going concern.18

The OECD solicited comments which criticized the IRS’s open-ended list for intangible property because it creates new intangibles that do not currently exist in transactions between unrelated parties.19 An overly broad definition of the term “intangible” allows taxpayers and governments to propose compensation in circumstances where no such compensation would be provided between independent enterprises.

Unique Issues in IP Sales, Leasing, and Royalty Payments

Despite the broad definition of intangibles and the difference in same by the IRS and OECD, traditional IP suffers from complicated tax regulations that facilitate BEPS.

Applying the Arm’s Length Principle in Transfer Pricing for Intangibles

Application of Arm’s Length Standards for the Transfer of Intangibles

IP transactions vary in form—common methods include an outright sale, a transfer for payments contingent on the IP’s productivity or use, and a fixed payment over a period of time. The commensurate with income (CWI) standard enacted in 1986 has been applicable specifically to transfers of IP—it allows the IRS to impose periodic adjustments to the taxpayer’s proposed arm’s length price.20

Transfer Pricing Methods and the Best Method Rule for the Transfer of Intangibles

The United States employs the “best method rule” (any method can be used upon a showing it is the best method), while the OECD requires the taxpayer to consider transactional methods in priority over a profit-based method. The OECD prefers the comparable uncontrolled price (CUP) method as the primary transactional-based method.21 The U.S. also employs the CUP method (for tangibles) but calls it the comparable uncontrolled transaction (CUT) method when addressing intangibles.22 The United States has even more specific methods for intangible buy-ins or platform contribution transactions (PCTs).23

The CUP and CUT methods allow taxpayers to produce one or more comparables, or “comps,” similar to real estate brokers using same to value property—a prior sale of a similar intangible can be used by a taxpayer to support its intercompany price. Taxpayers have few restrictions on what comps to use, and this creates opportunities to manipulate intercompany pricing and shift income into lower-tax jurisdictions.

IP Transfer Pricing Loopholes under the Arm’s Length Standard

IP profit shifting is made possible via royalty payments or through a cost-sharing agreement.24 Effective regulation of IP transfer pricing is a double-edged sword. It is an opportunity for lawmakers to resolve BEPS but can curtail IP contributions to global economic growth.25

Recent Developments in Transfer Pricing of Intangibles

IRS Regulations

A cost-sharing arrangement involves a partnership whereby a U.S. company and foreign affiliate develop an intangible together and each party enjoys the revenues from its territory. The revenues from third parties cannot be manipulated, and the cost of development is split based on those revenues. For example if an intangible costs $200 million to make and generates $2 billion of U.S. revenues and $2 billion of foreign revenues, then the costs would be split 50/50 and they each make a profit of $1.9 billion. If the revenue share turns out to be 60/40, then the cost share would follow suit.

The above cost-sharing deal assumes that each party only contributes the intangible development costs (IDCs). The IRS usually scrutinizes such arrangements to see if there was a preexisting intangible owned in the United States—if so, the IRS can tax the U.S. entity on the value of such preexisting intangible and require recognition of royalty income each year for the life of the asset.26 Alternatively, the U.S. entity recognizes a gain on the intangible’s fair market value (FMV)—this is a gain on the PCT. A sophisticated taxpayer will use the CUT method to manipulate the intercompany price of the PCT by “cherry-picking” a low comparable the same way a real estate appraiser cherry-picks home sales. The U.S. regulations on comparables do not specifically exclude CUTs from, for example, 10 years earlier. The IRS prefers the income method for PCTs since the taxpayer cannot control the third-party revenues generated from an intangible. The income method applies a discount rate to derive a net present value (NPV) of the projected revenues.

U.S. Tax Court Disagrees with IRS’s Income Method over CUT Method

In VERITAS Software Corp. v. Commissioner, the U.S. Tax Court determined VERITAS Ireland made an arm’s length buy-in payment to VERITAS U.S. in a PCT for software in connection with a cost-sharing agreement.27 The taxpayer employed the CUT method and provided previous unrelated comparable software sales to support the outbound transfer price paid by its foreign subsidiary. Under the income method, the IRS used the ultimate revenues earned by the foreign related party and applied a discount rate for the NPV and further discounted same for risk but derived a buy-in payment of $2.5 billion—15 times higher than the software transfer price of $166 million VERITAS derived under the CUT method. The IRS revised its income method calculation to $1.675 billion (10 times higher), but no settlement was reached. The Tax Court decided with the CUT method and held the IRS was arbitrary, capricious, and unreasonable in its assessment.

The taxpayer used agreements between VERITAS U.S. and certain original equipment manufacturers (OEMs) (i.e., Sun, HP, Dell, NEC, etc.) as comparables (CUTs). The IRS argued the CUTs were not comparable because the taxpayer’s PCT (contribution) included broad “market-sell rights” with respect to VERITAS U.S.’s full range of products, while the OEM agreements did not.28 The court acknowledged the term PCT under the temporary regulations but noted that such were only effective for transactions entered into on or after January 5, 2009.29 Thus, the new methods for PCTs such as the income method did not apply to this taxpayer’s transactions that were entered into 10 years before the effective date of the regulations.30 In summary, the $166 million sales price was upheld over the IRS adjusted value of $1.675 billion. The IRS did not appeal but subsequently issued an action on decision (AOD) after VERITAS and announced that it would not follow the holding of the court on a nationwide basis.31

In, Inc. v. Commissioner, the IRS assessed a value of $3.6 billion versus the taxpayer’s value of $217 million for the value of “Amazon-branded websites”—the trade name and technology was contributed to a qualified cost-sharing arrangement with Amazon’s Luxembourg subsidiary. The dispute centers on only the 2005–2006 tax years, and the IRS argues the payments in those years should amount to $2.2 billion versus the taxpayer asserting $217 million. Both parties chose a method to discount projected income, aggregated multiple intangibles, and used the same income projections, and the IRS even chose a higher discount rate of 18 percent versus the taxpayer’s rate of 13 percent. The key difference is the IRS’s use of a perpetual life with a 3.8 percent terminal growth rate. Citing VERITAS, Amazon argues the IRS erred in assuming the intangibles had a perpetual useful life, whereas Amazon determined a useful life of seven years or less. A separate issue centers on what constitutes the IDCs—Amazon proposes to exclude from the IDC items in various “cost centers.”32 The Tax Court has yet to decide the case.

Amazon relied on Deloitte Tax LLP for the transfer pricing study and value the preexisting IP. Had Amazon used the CUT method, it could have relied on the VERITAS case since the income method was not applicable to the years at issue (2005 and 2006 are not governed by regulations effective in 2009). The IRS chose the discounted cash flow (DCF) method, which is similar in substance to the new income method.33

OECD Focuses on Transparency through Documentation of International Transactions

In July 2013, per request of the G20, the OECD released a 15-point action plan to address BEPS.34 Action 13 proposes new TP documentation requirements.35 The OECD laid out three annual reporting requirements: country-by-country (CBC) reports, master file reports, and local file reports. The CBC report requires MNEs to report activity on key data points in each jurisdiction in which they do business. The master file requires MNEs to disclose the taxpayer’s TP methods, related-party contracts, and high-level information in each country in which it does business. The master file will be available to all relevant countries’ tax administrations.

The commentaries expressed concerns about confidentiality and the potential for arbitrary adjustments by tax administrations leading to increased TP controversies. Confidentiality issues may be addressed by requiring that information be exchanged only pursuant to treaties. Some countries (including Brazil, China, and India) wish to add data points to the template regarding interest, royalties, and related-party service fees. The OECD will decide whether data points should be added or changed before 2020.

Proposals and Predictions

Separate Consideration for Traditional IP

Patents, copyrights, and trademarks are the three intangibles that generate huge economic growth. Based on their shared characteristics, we propose that the United States and the OECD set different considerations for them.

Security Interest on IP to Be Used as TP Comparable

We propose requiring a security interest on patents, copyrights, and trademarks for comparability. A security interest will restrict the owner’s ability to alienate some of its IP. The higher the security interest, the more restriction it imposes. This will motivate MNEs to take a reasonable position on the FMV.

As IP rights rise in value, more commercial lenders collateralize them. There are already federal and state laws in place for IP security interest perfection. Article 9 of the Uniform Commercial Code (UCC) governs the method for perfecting security interests in personal property, including IP. Under article 9, the lender generally must file a UCC-1 financing statement with the secretary of state of the state in which the borrower resides in order to perfect a security interest.36 This can be used for TP purposes.

Periodic Adjustments

A mandatory security interest should be adjusted periodically to reflect its value, for example, a patent losing its monopoly to new technology.


We expect more regulation and legislation targeted toward BEPS and IP transfer pricing. The arm’s length principle will continue to be the basis for TP rules. Countries will agree on a formula by which a new TP regime will be based. MNEs should expect closer scrutiny when engaging in international IP transactions.


1. See, e.g., I.R.C. § 482 (citing I.R.C. § 936(h)(3)(B), which defines “intangible property” as “any (i) patent, invention, formula, process, design, pattern, or know-how; (ii) copyright, literary, musical, or artistic composition; (iii) trademark, trade name, or brand name; (iv) franchise, license, or contract; (v) method, program, system, procedure, campaign, survey, study, forecast, estimate, customer list, or technical data; or (vi) any similar item, which has substantial value independent of the services of any individual”); Treas. Reg. § 1.482-4(b) (providing a similar definition).

2. Treas. Reg. § 1.482.

3. OECD, OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (2010) [hereinafter OECD TP Guidelines], available at

4. Members and Partners, OECD, (last visited July 16, 2015).

5. I.R.C. § 482; see also J.W. Hampton, Jr., & Co. v. United States, 276 U.S. 394 (1928) (holding that delegation of legislative authority to the executive branch is an implied power of Congress).

6. U.S. Dep’t of Commerce, Intellectual Property and the U.S. Economy: Industries in Focus (2012) [hereinafter IP and the U.S. Economy], available at

7. Dan Smith, U.S. Pub. Interest Research Grp. (PIRG), The Offshore Shell Games: The Use of Offshore Tax Havens by the Top 100 Publicly Traded Companies (2013), available at

8. Tim Worstall, Can We Please Get This Straight, Apple and Google Do Not Avoid US Corporate Tax, Forbes, Nov. 25, 2013,

9. Alan Pyke, Google Paid 1.1 Percent Tax Rate on Billions of Dollars in the U.K., Think Progress (Oct. 1, 2013),

10. Alan Pyke, Report: Corporations Pay Lower Tax Rates than the Middle Class, Think Progress (July 2, 2013),

11. About BEPS, OECD, (last visited July 16, 2015).

12. See, e.g., OECD, Addressing Base Erosion and Profit Sharing (2013), available at

13. See I.R.C. § 482 (requiring that any consideration paid by non-U.S. affiliates to U.S. companies for the transfer or license of IP be for an arm’s length amount that is “commensurate with the income attributable to the intangible” property).

14. Id. (“[T]he Secretary may distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among such organizations, trades, or businesses in order to prevent evasion of taxes or clearly to reflect [their] income.”); see also Treas. Reg. § 1.482-1(a)(1).

15. See supra note 1.

16. OECD, OECD/G20 Base Erosion and Profit Shifting Project Action 8: Guidance on Transfer Pricing Aspects of Intangibles (2014), available at

17. OECD, Revised Discussion Draft on Transfer Pricing Aspects of Intangibles 7–8 (2013), available at

18. Office of Mgmt. & Budget, Analytical Perspectives: Budget of the United States Government, Fiscal Year 2015, at 149 (2014), available at

19. OECD, The Comments Received with Respect to the Discussion Draft Revision of the Special Considerations for Intangibles in Chapter VI of the OECD Transfer Pricing Guidelines and Related Provisions 6–8, 71, 389, available at

20. Treas. Reg. § 1.482-4(f)(2). The IRS will not adjust if actual profits earned fall between 80–120 percent of expected profits.

21. OECD TP Guidelines, supra note 3, at ch. II.

22. See Treas. Reg. § 1.482-4(a) (providing four methods to value intangibles: (1) CUT method per § 1.482-4(c); (2) comparable profits method (CPM) per § 1.482-5; (3) profit split (PS) method per § 1.482-6; and (4) unspecified methods per § 1.482-4(d)).

23. See id. § 1.482-7(g)(1) (requiring PCTs to be valued using: (1) CUT method, (2) income method, (3) acquisition price method, (4) market capitalization method, (5) residual profit split (RPS) method, and (5) unspecified methods).

24. See Treas. Reg. § 1.482-7.

25. See IP and the U.S. Economy, supra note 6; OECD, OECD Science, Technology and Industry Scoreboard 2013 (2013), available at

26. I.R.C. § 367(d).

27. 133 T.C. 297 (2009).

28. Id. at 329–30. The IRS challenged the comparability under Treasury regulation section 1.482-4(c)(2)(iii)(A). Section 1.482-1(d) governs comparability in general, while section 1.482-4(c) covers comparability for intangibles.

29. See Temp. Treas. Reg. § 1.482-7T, 74 Fed. Reg. 340, 352 (Jan. 5, 2009).

30. VERITAS, 133 T.C. at 330–31.

31. AOD 2010-05, 2010-49 I.R.B. 803.

32. See, Inc. v. Comm’r, T.C.M. (RIA) 2014-149.

33. DCF is an unspecified method under Treasury regulation section 1.482-4(d) and is similar to the income method under section 1.482-7(g), which was promulgated after (i.e., does not apply to) the Amazon case.

34. See supra note 12 and accompanying text; see also OECD, OECD/G20 Base Erosion and Profit Shifting Project Action 1: Addressing the Tax Challenges of the Digital Economy 11 (2014), available at

35. OECD, OECD/G20 Base Erosion and Profit Shifting Project Action 13: Guidance on Transfer Pricing Documentation and Country-by-Country Reporting (2014), available at

36. U.C.C. §§ 9-307, 301(1).