Intellectual property in the age of BEPSteidetroitchapter.camp7.org/resources/Documents/Michigan...Page 5 Intellectual property in the age of BEPS Introduction ‘New’ categories

Intellectual property in the ageof BEPSTax Executives Institute Michigan ChapterDetroit28 October 2015

Page 1 Intellectual property in the age of BEPS

Disclaimer

► EY refers to the global organization, and may refer to one or more, of the member firms ofErnst & Young Global Limited, each of which is a separate legal entity. Ernst & Young LLP is aclient-serving member firm of Ernst & Young Global Limited operating in the US.

► This presentation is © 2015 Ernst & Young LLP. All rights reserved. No part of this document maybe reproduced, transmitted or otherwise distributed in any form or by any means, electronic ormechanical, including by photocopying, facsimile transmission, recording, rekeying, or using anyinformation storage and retrieval system, without written permission from Ernst & Young LLP.Any reproduction, transmission or distribution of this form or any of the material herein isprohibited and is in violation of US and international law. Ernst & Young LLP expressly disclaimsany liability in connection with use of this presentation or its contents by any third party.

► Views expressed in this presentation are those of the speakers and do not necessarily representthe views of Ernst & Young LLP.

► This presentation is provided solely for the purpose of enhancing knowledge on tax matters. Itdoes not provide tax advice to any taxpayer because it does not take into account any specifictaxpayer’s facts and circumstances.

► These slides are for educational purposes only and are not intended, and should not be reliedupon, as accounting advice.


Your presenters► Terry McDowell, Moderator

► Canada Tax Desk, New York

► Ernst & Young LLP

► +1 212 773 6332, [email protected]

► Mark Mukhtar

► International Tax Services, Central Region► Ernst & Young LLP

► +1 313 628 7150, [email protected]

► Stephen Slazinski

► International Tax Services, Detroit

► Ernst & Young LLP

► +1 313 628 8909, [email protected]

► Erwin Sieders

► Dutch Tax Desk, Chicago► Ernst & Young LLP

► +1 312 879 2338, [email protected]


Today’s agenda

► Introduction► Intangibles landscape change► IP transfers► Developments impacting IP structures► What can you do now?


Introduction

What is intellectual property (IP)?► The identity, ownership and valuation of IP for tax purposes is rarely the same

as for accounting or legal purposes.

Traditional IP► Technology (patents, copyrights, know-how, formulas, processes, designs, etc.)► Marketing (brands, trademarks, trade names, etc.)► Customer-related (contracts, subscriptions, customer lists, etc.)


Introduction

‘New’ categories of IP► User base (and relative “stickiness” of that base)► IP that is integrated with high-value services (Software as a service (SaaS), as an example)► Cloud technology “infrastructure”► Digital rights► Adaptions of product designs for mobile or other unique channels of distribution► Centralized engineering centers► Location savingsOther types of IP► Goodwill► Workplace in force► Group synergies► Networks


The IP life cycle

Establishment phase► “Offshore” versus

“onshore” models► IP incentives

► Patent/Innovation box► Amortization regimes

► IP valuation► Funding of transfer

payments► Debt versus equity► Circular flow of cash

Development phase► Loss utilization and exit

planning► Cost-sharing arrangements

and substance► Treas. Reg. 1.482-1(d)► “DEMPE” functions► Impact of Altera case

► R&D expense funding► Intercompany financing

and §956► F/X and hedging

Commercialization phase► Deferral planning► Permanent establishment

considerations► Holding companies and

treasury centers► Use of branches

(check-the-box or actual)► Future acquisitions

► Ongoing transfer pricing► Exit strategies


Intangibles landscape change


Typical functionality and taxation► IP owner

► Minimal substance► High royalty income► No taxation

► Principal► No or minimal substance► Minimal taxable income (high income, high royalty

charge)► No or minimal taxation

► Manufacturer/Distributor► High royalty charge to Principal► Minimal taxation► No substance requirement at level of Principal to

benefit from low withholding tax rate under tax treaty

Offshore IP ownership concept

P owner

US Parent

Customer

Principal

Limited riskdistributor (LRD)

Contract/Tollmanufacturer

Transfer ofexisting IP

Sales/Distributionagreement

LicenseRoyalty

Contract manufacturingservices

Minimal substanceNot taxed

Sale


Intangibles landscape change

Owner

Developer

User

Economic owner

Legal owner

Developer

User

Legal owner

Controller/Functional contributor

Investor

Developer/Functional contributor

Routine developer

Value contributor

Pure user

2014

Non-routine (residual claimant)

Routine

1990s1980s


IP structures in the current environment

Onshoring considerations► Impact of base erosion and profit shifting (BEPS) action plan► Potential in-country pitfalls► Location of DEMPE functions► Reconciling existing activities with new profits► Future ability to obtain rulings► Availability of patent or innovation boxSustainability of structures► IP committees and branch planning► US cost-sharing and Altera► Cash management and capital markets considerations


Around the world

► Intangibles raise complex transfer pricing issues because► They account for a high proportion of the value/profits of MNEs in various industries► They are hard to price/value – a multiperiod perspective is usually necessary and there are rarely reliable comparable

Australia

China

India

Mexico

Mexico

Netherlands

Spain

Broader powers to recharacterize transactions

Audit directive to broadly investigate outbound license and services fees, especiallyif payment to no/low tax jurisdictions

Introduction of safe harbor rules (e.g., minimum expected operating profit margins);application of location savings and “location rent”

Increased transfer pricing audit focus on location savings, local marketing intangibles and IPtransactions

Tax reform bill with provisions that seek to increase taxable income from contract manufacturing

Decree with provisions on transfers of IP; valuation of hard-to-value IP and cost-sharing

Business restructuring cases. IP and services policies under examination

2014

2014

2013

20132014

2014

2013

20132014

Germany 2008 Hypothetical arm’s-length test and transfer of functions regulations


IP transfers


IP transfers: exit strategies and considerations

► §367(d) regulations► IP partnerships and Notice 2015-54


§367(d) regulations

► Proposed regulations released 14 September 2015► Effective for transactions occurring on or after this date► Major components

► Eliminate foreign goodwill exception under Reg. §1.367(d)-1T► Generally limit application of the active trade or business exception of

§367(a)(3) to certain tangible property and financial assets► Generally treat foreign goodwill and going-concern value as an asset

subject to §367(a) ineligible for the modified active trade or businessexception, but permit US transferor to elect to apply §367(d) instead

► Regulations under §482 released in conjunction


OpCo 2

IP partnerships

Facts► US and CFC are related► US contributes IP and CFC contributes

operating business to FP► US and CFC each receive a partnership interest

with no special allocation or preferred interest► Prior to partnership transaction

► US earns royalty income from license of IPto CFC

► Royalty income brings little to no foreigntax credit (FTC)

► After partnership transaction► US owns partnership interest► Receives distributive share of partnership

income with significant foreign taxes

CFCUS

FP

IP OpCo 1

royalty (after)


IP partnerships: Notice 2015-54

► Treasury and the IRS announced the intent to issue regulations under► §721(c) providing that §721(a) will not apply when a US Transferor contributes “§721(c)

Property” to a “§721(c) Partnership,” unless the “gain deferral method” described in theNotice is applied with respect to such “§721(c) Property” and

► §482 and 6662 applicable to controlled transactions involving partnerships to ensure theappropriate valuation of such transactions

► §721(c) Property► Built-in gain property, subject to certain exclusions

► §721(c) Partnership► Domestic or Foreign Partnership if : (1) one or more foreign persons related to the US

Transferor is a direct or indirect partner in the partnership and (2) the US Transferor andrelated persons own more than 50% of the interests in partnership capital, profits, deductionsor losses

► Regulations under §721(c) are effective immediately


IP partnerships: Notice 2015-54

Gain deferral method requirements► Remedial allocation method► Proportionate allocation► Reporting requirements► Acceleration events► Subsequent contributions


Developments impacting IP structures


Developments impacting operating models

Intangibleproperty

(IP)

Intangibleproperty

(IP)

Data privacy and protectionData privacy and protection

Action 5 – Harmful tax practices► Real economic activity versus “harmful tax practice”► “Modified nexus approach”► Deep focus on substance

Action 8 – Transfer pricing for intangibles► DEMPE functions► Revised transfer pricing standards for intangibles

European Union (EU) state aidEuropean Union (EU) state aid


BEPS considerations► Potential impact of Action item 2 on hybrids► Impact of Action item 7 should be reviewed

(permanent establishment (PE) scrutiny)► Is the royalty structured in an arm’s-length

manner in view of EU state aidinvestigations?

► Action items 8, 9 and 10 – DEMPE functions► Cost contribution/sharing arrangements and

US branch planning► Alignment of principal remuneration with its

functions and risk profile► Consider items to be disclosed under Action

item 13► Audit focus from continental EU

jurisdictions on distributor/commissionairereturns

► Future onshoring of IP

Potential BEPS implicationsOffshore IP ownership

P owner

US Parent

Customer

Principal

Limited riskdistributor (LRD)commissionaire

Contract/Tollmanufacturer

Cost-sharingagreement/buy-in ofexisting IP

Sales/Distributionagreement

Sale

Licenseroyalty

Contract manufacturingservices

Low substance –no DEMPE(develop, enhance,maintain, protectand exploit)functionsNot taxed

Regular tax paidafter deductionof expenses,including royalty

sale


Action 8 proposes a taxpayer review of:► Performance/control of key functions► Provision of assets and funding► Bearing and control of risks in the following key areas

DEMPE functions under Actions 8 and 10

Develop Enhance Maintain Protect Exploit

► Taxpayers are directed to review the allocation of profits, for eachDEMPE component, with respect to the level and nature of activityundertaken

“If the legal owner neither controls nor performs the functions related to the development, enhancement,maintenance, protection or exploitation of the intangible, the legal owner would not be entitled to anyongoing benefit attributable to the outsourced functions.”


► Action 10 proposes a RACI analysis of responsibilities and decision-making to measure relative contributions to value

RACI = Responsible, Accountable, Consulted, Informed► Identify key value drivers (technology innovation, marketing, customer

relationships, content development)► Identify processes (functions) in the value chain and identify their

relative contribution to the value drivers (engineering, process design,pricing, customer service, advertising, strategic planning, productionplanning, etc.)

► Assign RACI responsibility for each process by entity and itscontribution to overall value

DEMPE functions under Actions 8 and 10


Responding to BEPS developmentsFuture state global (onshore) structures

Organizational structure► Existing (non-US) IP transferred to Principal► Principal can finance IP acquisition with a mix

of debt and equityTax considerations► Amortization of IP based on fair market value

at time of transfer► Innovation/Patent box regimes plus existing

R&D credits or other incentives► Exit charges and/or significant change in

value can be mitigated (e.g., through priceadjustment)

Transfer pricing considerations► OECD Guidelines, including results of BEPS

Action Item 8► Compensation for DEMPE activities outside

Principal► Local distribution model

FinCo

US Parent

Principal

Contractmanufacturers

R&Dservices

Sharedservices

Interest

Localdistributors

Contract R&Dproviders

Customer

SharedServicesCenter

Loan

Sales

Sales/Distributionrights

Contractmanufacturing


What can you do now?


What can you do now?

20152015► IP ownership and rulings concluded► Location of people functions► Transfer pricing policy► Corporate structure and governance► Financial statement positions

► Perform a coordinated risk assessment

► Identify alternatives that you can consider to reduce risks► Consider controversy and reputational risks, as well as resource

considerations► Outline changes, estimated timing and implementation costs► Stakeholder engagement

► Develop design and implementation work plans

Understandyouroperatingmodel

Perform a“sustainabilitycheck”

Consider availableoptions andperform analyses

Take next steps

Questions?


Thank you for your participation.