What’s So Hard About Hard-to-Value Intangibles?

Shifting intangibles is one of the most scrutinized transfer pricing transactions by tax authorities—and for good reason. It’s often seen as an easy target for base erosion and profit shifting—naturally, it’s one of the most complicated types of transactions for transfer pricing practitioners to navigate.

Recent court cases involving Medtronic, Veritas, and Amazon are proof, although the taxpayers in these cases ultimately prevailed.

Valuing intangibles is tricky: Comparables can be hard to find because often company-specific intangibles like trademarks, patents, and brand goodwill are unique.

But Ednaldo Silva, Ph.D., a seasoned economist who has worked as an adviser to the IRS and founder of RoyaltyStat, a renowned royalty-rate database, says that hard-to-value intangibles (HTVIs) aren’t actually hard to value at all. Why? We caught up with him to find out. 

What Makes Intangibles Hard to Value?

Does Starbucks’ logo hold the same value as say, Dunkin’ Donuts’? Tough to say, right? Welcome to the world of hard-to-value intangibles. Many experts think HTVIs are unique because they lead to high profits, but according to the OECD, hard-to-value intangibles are set apart by two distinguishing characteristics:

1. Comparables for them cannot be found.
2. You cannot predict future net revenue or benefits with certainty.

Straightforward, right? Maybe not. Dr. Silva takes issue with all these distinctions, asserting that very little separates HTVIs from other intangibles. His arguments:

• High profits are not a distinguishing result of HTVIs, but rather a result of market concentration.
• If HTVIs do not have comparables, then that fact should be supported by evidence. If it’s empirical, it’s subject to test.
• The second OECD distinction is unfounded as you cannot predict anything with certainty.

What’s in a Name?

From the very name “hard-to-value intangibles,” it seems we’re told to think of certain intangibles as complicated or difficult even before we begin an analysis. Dr. Silva suggests changing the mindset around hard-to-value intangibles, which may, in fact, be a misnomer. Consider the possibility that they’re not so difficult to value, after all. 

To value any asset there are three tried-and-true approaches to pricing: Look at past events, present values, or future projections. These approaches are rooted in economic theory and date back to the influential work of British political economist David Ricardo. 

• Past: This often-overlooked approach would price HTVIs based on the accumulated expense of producing that intangible.
• Present: This approach is not promising for HTVIs as there are very few asset-transfer agreements produced by the SEC that deal exclusively with intangibles.
• Future: This approach is favored by the U.S. and the OECD but is problematic because of the difficulty in projecting future benefits, lifespan, and discount value. Further, the sensitivity to small changes in the discount factor is dramatic.

“While projections are the favorite method of the U.S. and OECD, it is also the most perilous,” explains Dr. Silva. “It can lead to many controversies as assumptions must be made and applied about the company’s present value based on projected income. In a terrible omission, the OECD completely disregards pricing based on past expenses. You will find the values are not as hard to value as everyone thinks.”

Tangible Advice 

Having worked for tax authorities, Dr. Silva knows firsthand that they can be suspicious of missing information. In fact, you might say, they’re inclined to assume the worst. His strategy?

Be forthcoming and consider the tax authority’s position. Here, he offers a few helpful reminders when documenting transfer pricing transactions involving intangibles—hard to value, or not.  

• Track down the facts: Transfer pricing practitioners don’t always have access to a group’s financials. Figure out what facts you need to back-up your value chain and get them. Need to show which expenses were attributed to the intangible? Those numbers exist somewhere, so find them and include them in your analysis. 
• Make sure disclosures are relevant: Even tax authorities can have limited resources. Avoid overwhelming them with truckloads of unnecessary information that they don’t have the manpower to analyze. Instead, strategically guide tax authorities to the critical information they need.
• Team up: Relationships are based on trust—even when it’s between an MNE and an auditor.  Assist tax authorities by answering questions, providing details, and disclosing records. If you are transparent and cooperative, you can help tax authorities follow the facts to understand the rationale underpinning your transfer pricing approach to intangibles, which if you recall, was the goal in the first place.