Transfer pricing and intangibles : US and OECD arm's length distribution of operating profits from IP value chains.

The transfer pricing of intangibles (patents, trademarks, etc.) is an important issue in international tax law, because it determines how superprofits generated by multinationals through the exploitation of valuable intellectual property (IP) in their worldwide value chains are allocated among the jurisdictions in which they do business. For decades, multinationals have used IP transfer pricing to shift taxable profits out of high-tax jurisdictions, causing serious base erosion. Both the United States and the OECD seek to combat these practices through mandatory transfer pricing rules aimed at ensuring that IP superprofits are taxed where the intangible value was created. The profit allocation process prescribed by these rules is analysed in this text. The first part of the process determines the amount of superprofits allocable to a unique and valuable IP (royalty amount). The US and OECD transfer pricing methods that govern this determination are analysed, applying a distinction between unique and non-unique value chain contributions, and it is observed that the methodology has evolved significantly over the years, from primarily relying on imprecise third-party benchmarking to more substance-based approaches that seek to ensure results that adhere to the realistic alternatives of the controlled parties. The second part of the profit allocation process determines to which group entity, and thus indirectly also to which jurisdiction, the amount of IP superprofits will be allocated. The US and OECD intangible ownership provisions that govern this determination are analysed, applying an original analytical distinction between manufacturing and marketing IP. The analysis shows that, while both the US and OECD rules go a long way towards aligning the allocation of superprofits from R&D-based manufacturing IP with value creation, the allocation of superprofits from marketing IP still largely hinges on formal legal ownership and thus opens the opportunity for tax planning from multinationals and should be ripe for future reform. This book is suited for those that have an interest in transfer pricing analysis, e.g. students, lawyers, accountants and economists. The historical background of the current transfer pricing rules is explained, allowing for an “all-in-one” solution for catching up with the US and OECD transfer pricing development over the last decades. Cover IBFD Doctoral Series Title Copyright Table of Contents Preface Abbreviations Part 1 Chapter 1: Research Questions, Methodology and Sources of Law 1.1. Introductory comments 1.2. Key terminology and contextualization 1.3. Research questions and structure 1.4. Methodology 1.5. The relevant OECD sources of law 1.5.1. Introduction 1.5.2. Article 9 of the OECD MTC 1.5.3. The OECD Commentaries on Article 9 and the OECD Transfer Pricing Guidelines 1.5.4. Article 7 of the OECD MTC 1.5.5. The OECD Commentaries on Article 7 and the 2010 OECD Report 1.5.6. Case law in connection with articles 9 and 7 1.6. The relevant US sources of law 1.6.1. Introduction 1.6.2. IRC section 482 1.6.3. The IRC section 482 US Treasury Regulations 1.6.4. Case law 1.6.5. The OECD TPG 1.7. A few words on the 2017 US tax reform 1.8. The relationship between the book and other transfer pricing literature 1.9. Reference register and source abbreviations Chapter 2: Business and Tax Motivations for Intangible Value Chain Structures 2.1. Introduction 2.2. Horizontal and vertical FDI 2.3. To stay home (outsource) or to go out (FDI)? 2.4. The centralized principal model for profit allocation 2.5. IP regimes and the 2015 OECD nexus approach Chapter 3: Controlled Intangibles Transfers 3.1. Introduction 3.2. The US intangibles definition 3.2.1. Introduction 3.2.2. The pre-2018 version of the US IP definition 3.2.2.1. Introductory comments 3.2.2.2. The relationship between the 936 definition and profit allocation 3.2.2.3. Are goodwill, going concern value and workforce in place encompassed by the pre-2018 version of the 936 definition? 3.2.2.4. Is goodwill distinguishable from synergy value attributable to a group of identifiable 936-definition intangibles valued in the aggregate? 3.2.2.5. Concluding comments on the pre-2018 version of the US IP definition 3.2.3. The 2018 version of the US IP definition (the 2017 tax reform amendment) 3.3. The OECD intangibles concept 3.4. Useful distinctions on the intangibles concept 3.4.1. Introduction 3.4.2. Manufacturing and marketing intangibles 3.4.3. Unique and non-unique value chain contributions 3.5. Controlled intangibles transfers subject to transfer pricing under US law 3.5.1. The taxation of US inbound and outbound intangibles transfers 3.5.2. The context in which IRC section 367 applies: Non-recognition transactions 3.5.3. The historical background of IRC section 367 3.5.4. Current gain recognition under IRC section 367(a) 3.5.5. Deemed royalty inclusions under IRC section 367(d) 3.5.5.1. Historical background 3.5.5.2. The material content of IRC section 367(d): Sale of contingent payments 3.5.6. Income recognition under section 367(a) or (d) for intangible transfers? 3.5.7. The further relationship between profit allocation under sections 482 and 367 3.5.8. The relationship between profit allocation under the section 482 cost-sharing regulations and section 367(d) 3.6. Controlled intangibles transfers subject to transfer pricing under the OECD TPG 3.7. Concluding comments Chapter 4: Introduction to Part 2 Part 2 Chapter 5: The Historical Development of ­Profit-Based Trans 5.1. Introduction 5.2. Development of the US PSM and the contract manufacturer theory through case law 5.2.1. Introduction 5.2.2. The 1968 regulations and their background 5.2.3. Three inbound cases: Nestlé, French and Ciba 5.2.3.1. Introduction 5.2.3.2. Nestlé (1963) 5.2.3.3. French (1963) 5.2.3.4. Ciba (1985) 5.2.4. Three outbound cases: Eli Lilly, Searle and Merck 5.2.4.1. Introduction 5.2.4.2. The historical tax treatment of investments in US ­p 5.2.4.3. Eli Lilly (1985) 5.2.4.4. Searle (1987) 5.2.4.5. Merck (1991) 5.2.5. Four roundtrip cases: Bausch, Sundstrand, Perkin and Seagate 5.2.5.1. Introduction 5.2.5.2. Bausch (1989) 5.2.5.3. Sundstrand (1991) 5.2.5.4. Perkin-Elmer (1993) 5.2.5.5. Seagate (1994) 5.2.6. Two cases on controlled services and sales contracts: DuPont (1979) and Hospital Corporation of America (1983) 5.3. US legislative and regulatory implementation of “profit-based” methods 5.3.1. Introduction 5.3.2. The 1986 tax reform 5.3.3. The 1988 White Paper 5.3.4. The 1994 US regulations 5.4. OECD implementation of “profit-based” transfer pricing methodology Chapter 6: Metaconcepts Underlying the US and OECD Profit Allocation Rules 6.1. Introduction 6.2. The relationship between operating profits and the transfer pricing methods 6.2.1. Introduction 6.2.2. The concept of operating profits 6.2.3. Delineating the components of operating profits 6.2.3.1. Sales 6.2.3.2. Costs of goods sold 6.2.3.3. Gross profit 6.2.3.4. Operating expenses 6.2.3.5. Net profit 6.2.4. Information on gross profits may be unavailable 6.2.5. Information on transaction-level profits may be unavailable 6.3. The relationship between gross and net profit methods 6.3.1. Introduction 6.3.2. Common methodological traits among the gross and net profit methods 6.3.3. Relevant parameters under the gross and net profit methods and their impact on reliability 6.3.4. Are operating expenses relevant under the transactional pricing methods (CUT, resale and cost-plus)? 6.3.5. Are comparability adjustments under the gross profit methods more reliable than under the net profit methods? 6.4. Which transfer pricing method should govern the profit allocation among value chain inputs? 6.5. The arm’s length range 6.5.1. Introduction 6.5.2. The level of comparability required to include an uncontrolled transaction in the arm’s length range 6.5.3. On which point within the arm’s length range may a reassessment be based? 6.6. Comparability 6.6.1. Introductory comments 6.6.2. The standard of comparability 6.6.3. Does the degree to which comparability is required vary among the pricing methods? 6.6.4. The relationship between comparability and the rules for determining ownership of intra-group-developed intangibles 6.6.5. Comparability factors 6.6.5.1. Introduction 6.6.5.2. Contractual terms 6.6.5.2.1. Introduction 6.6.5.2.2. Comparability of contractual terms 6.6.5.2.3. Economic substance and non-recognition 6.6.5.3. Functions 6.6.5.4. Economic conditions 6.6.5.4.1. Introduction 6.6.5.4.2. Use of comparables from other markets 6.6.5.4.3. Location savings 6.6.5.4.4. Temporary pricing strategies 6.6.5.5. Risks 6.6.5.5.1. Introductory comments on risk 6.6.5.5.2. Contractual risk allocation among group entities 6.6.5.5.3. Risks affect pricing, not the other way around 6.7. The aggregation of controlled transactions 6.7.1. Introduction 6.7.2. The US regulations 6.7.3. The OECD TPG 6.7.4. GlaxoSmithKline (Canada) 6.7.4.1. Introduction 6.7.4.2. The factual pattern 6.7.4.3. The 2008 Tax Court ruling 6.7.4.4. The 2012 Supreme Court ruling 6.7.4.5. Observations on the Supreme Court ruling Chapter 7: Direct Transaction-Based Allocation of Residual Profits to Unique and Valuable IP: The CUT Method 7.1. Introduction 7.2. The US CUT method 7.2.1. Introduction 7.2.2. The purported CUT pertains to a transfer of the same intangible as transferred in the controlled transaction 7.2.3. The purported CUT pertains to a transfer of a different intangible than that transferred in the controlled transaction 7.2.3.1. Introduction 7.2.3.2. Direct assessment of profit potential 7.2.3.3. Indirect assessment of profit potential 7.2.3.4. Assessment of profit potential in other cases 7.2.4. There are no CUTs available 7.3. The OECD CUT method 7.3.1. Introduction 7.3.2. Comparability requirements for unique IP under the CUT method 7.3.3. Comparability adjustments for unique IP under the CUT method 7.3.4. Commercial databases 7.3.5. Concluding comments Chapter 8: Indirect Profit-Based Allocation of Residual Profits for Unique and Valuable IP: The CPM (US) and TNMM (OECD) 8.1. Introduction 8.2. A lead-in to the methodology 8.3. The scope of application of the methodology 8.4. How operating profits may be allocated to the tested party under the methodology 8.4.1. Introduction 8.4.2. Selecting an appropriate profit level indicator 8.4.3. Extracting the profit level indicator data from comparable independent enterprises 8.4.4. Applying the extracted profit level indicator data to the tested party 8.5. Comparability under the CPM 8.6. Comparability under the TNMM 8.6.1. Introduction 8.6.2. The concept of blended profits illustrated by an example 8.6.3. The 1995 consensus text on the TNMM with respect to aggregation of transactions 8.6.4. The 2006 comparability report 8.6.5. The 2008 discussion draft 8.6.6. The final 2010 OECD TPG on the use of aggregated third-party profits as comparables 8.6.6.1. Introduction 8.6.6.2. The first norm: Aggregated third-party profits may be used as comparables as long as they are the result of “similar” third-party transactions 8.6.6.3. The second norm: Aggregated third-party profits may be used as comparables as long as they are not the result of “materially different” third-party transactions 8.6.6.4. The third norm: Aggregated third-party profits may be used as comparables if the total functions performed by the third party are closely aligned with the functions performed by the tested party with respect to the controlled transaction 8.6.6.5. Harmonizing the three norms through interpretation 8.6.6.6. Conclusion 8.6.7. Applying the 2010 OECD TPG rule to the golf ball example 8.7. Has the TNMM converged towards the 1988 White Paper BALRM? 8.8. Is reduced transactional comparability under the TNMM a significant problem? 8.9. Closing comments on comparability under the one-sided, profit-based methodology Chapter 9: Direct Profit-Based Allocation of Residual Profits to Unique and Valuable IP: The Profit Split Method 9.1. Introduction 9.2. The scope of application of the methodology 9.2.1. Introduction 9.2.2. The US PSM 9.2.3. The OECD PSM 9.3. How operating profits may be split under the methodology 9.3.1. Introduction 9.3.2. Profit split allocation patterns allowed under the US regulations 9.3.3. Profit split allocation patterns allowed under the OECD TPG 9.4. The PSM in valuation scenarios 9.5. The OECD PSM is limited to information known or reasonably foreseeable at the outset Chapter 10: Location Savings, Local Market Characteristics and Synergies 10.1. Introduction 10.2. A lead-in to the topic: The incremental operating profits at stake 10.3. Which jurisdiction should be entitled to tax incremental operating profits: The basic arguments 10.4. What are location savings? 10.5. The allocation of cost savings 10.5.1. Introduction 10.5.2. Local comparables are available 10.5.3. Local comparables are unavailable 10.6. What are other LSAs? 10.7. The allocation of location rents 10.7.1. Introduction 10.7.2. Local comparables are available 10.7.3. Local comparables are unavailable 10.8. Synergies Chapter 11: Transfer Pricing of Intangibles in the Post-BEPS Era under the OECD TPG 11.1. Introduction 11.2. A transfer pricing paradigm under pressure 11.3. Shall something more now be allocated to source jurisdictions? 11.4. The relative roles of the CUT method, TNMM and PSM for the transfer pricing of intangibles Chapter 12: Allocation of Residual Profits for Unique and Valuable IP Based on Unspecified Pricing Methods 12.1. Introductory comments 12.2. Unspecified methods under the US regulations 12.3. Unspecified methods under the OECD TPG Chapter 13: Allocation of Residual Profits to Unique and Valuable IP through Valuation 13.1. Introduction 13.2. The valuation techniques accepted under the OECD TPG 13.3. The valuation parameters in DCF-based valuation 13.3.1. Introduction 13.3.2. The estimation of future operating profits 13.3.3. The estimation of useful life, growth rates and terminal value 13.3.4. The estimation of discount rates 13.3.5. What are the consequences of using unreliable valuation parameters? 13.4. Allocation of the valuation amount among the controlled value chain contributions 13.5. The options realistically available as a restriction on the possible allocation outcomes 13.6. Is there a legal basis for applying a discount to the transfer price? Chapter 14: Allocation of Residual Profits to Unique and Valuable IP through Cost-Sharing Structures 14.1. Introduction 14.2. Buy-in pricing under the US regulations 14.2.1. Introduction 14.2.2. The development of the US cost-sharing regulations 14.2.3. The 2007 Coordinated Issue Paper 14.2.4. Case law: Veritas (2009) 14.2.5. Case law: Amazon.com (2017) 14.2.6. Concluding comments on Veritas and Amazon.com 14.2.7. Key concepts under the current cost-sharing regulations 14.2.7.1. Introduction 14.2.7.2. Cost-sharing transactions 14.2.7.3. RAB share 14.2.7.4. Non-overlapping (ownership) interests in intangibles developed under the CSA 14.2.7.5. Platform contributions 14.2.8. The buy-in pricing methods 14.2.8.1. Introduction 14.2.8.2. The CUT method 14.2.8.3. The income method 14.2.8.4. The acquisition price method 14.2.8.5. The market capitalization method 14.2.8.6. The RPSM 14.2.8.7. Unspecified methods 14.3. Buy-in pricing under the OECD TPG 14.4. The relationship between US and OECD buy-in pricing Chapter 15: Taxpayer-Initiated Compensating Adjustments to Indirect IP Pricing 15.1. Introduction 15.2. A lead-in to compensating adjustments 15.3. Taxpayer-initiated adjustments under US law 15.4. Year-end adjustments under the OECD TPG 15.5. Year-end adjustments in the European Union 15.6. Case law: Vingcard (Norway, 2012) 15.6.1. Introduction 15.6.2. The factual pattern of the case 15.6.3. The comparables supporting the taxpayer profit allocation 15.6.4. The contractual risk allocation 15.6.5. Concluding comments 15.7. Case law: ITCO (Italy, 2010) 15.8. Case law: H1 A/S (Denmark, 2010) 15.9. Case law: H1.1.1 A/S (Denmark, 2012) 15.10. The US GlaxoSmithKline settlement (2006) Chapter 16: Periodic Adjustments of Controlled IP Transfer Pricing 16.1. Introduction 16.2. The development of the US periodic adjustment concept 16.2.1. Introduction 16.2.2. The 1985 House Report and the 1988 White Paper 16.2.3. The relationship between the transfer pricing methods and the periodic adjustment provisionin the White Paper 16.2.4. Exceptions from the White Paper’s periodic adjustment provision 16.3. The US periodic adjustment provision 16.3.1. Introduction 16.3.2. The main rule: The profit allocation must be commensurate with income 16.3.3. Exceptions to the periodic adjustment rule 16.3.3.1. Introduction 16.3.3.2. First exception: Initial fixed pricing based on CUTs involving the same intangible (“genuine” CUT exception) 16.3.3.3. Second exception: Initial fixed pricing based on CUTs involving a comparable intangible (inexact CUT exception) 16.3.3.4. Third exception: Initial fixed pricing based on methods other than the CUT method 16.3.3.5. Fourth exception: Extraordinary events 16.3.4. Five-year cut-off rule 16.3.5. Concluding remarks on the exceptions 16.4. Periodic adjustments to lump-sum IP transfers under US law 16.5. The OECD periodic adjustment provision 16.6. Periodic adjustments of buy-in pricing under the US regulations 16.6.1. Introductory remarks 16.6.2. A periodic adjustment is triggered if the AERR is greater than the PRRR 16.6.3. Making a periodic adjustment: Applying the adjusted RPSM 16.6.4. The procedure for making a periodic adjustment to a buy-in payment illustrated 16.6.5. Exceptions to the periodic adjustment provision 16.6.5.1. Introduction 16.6.5.2. Exception: The initial buy-in pricing is based on a CUT involving the same platform contribution 16.6.5.3. Exception: Extraordinary events 16.6.5.4. Exception: Reduced AERR does not cause a periodic trigger 16.6.5.5. Exception: Increased AERR does not cause a periodic trigger 16.6.5.6. Exception: Cut-off rule 16.7. Periodic adjustments of buy-in pricing under the OECD TPG Chapter 17: The Allocation of Residual Profits to a Permanent Establishment 17.1. Introduction 17.2. Historical background 17.3. The relationship between articles 7 and 9 17.4. The article 7 profit allocation system 17.4.1. Introduction 17.4.2. Assignment of assets, capital and risk to the PE 17.4.3. Assignment of transactions and dealings to the PE 17.5. Transfer pricing of the IP transactions and the dealings of a PE 17.6. Allocation of operating profits to a dependent agent PE 17.6.1. Introduction 17.6.2. A lead-in to the discussion 17.6.3. The OECD approach for allocating operating profits to a dependent agent PE 17.6.4. Is the dependent agent PE relevant? 17.7. The UN approach for allocating profits to a PE 17.7.1. Introduction 17.7.2. The allocation norm under article 7 of the 2011 UN MTC 17.7.3. The relationship between articles 7 and 9 of the UN MTC Chapter 18: Introduction to Part 3 Part 3 Chapter 19: The Evolution of the US and OECD Approaches to Intangible Ownership 19.1. Introduction 19.2. Determination of IP ownership under the 1968 US regulations 19.2.1. Introduction 19.2.2. The DA rule 19.2.3. The DA rule was geared towards, but not limited to, manufacturing IP 19.2.4. Was the DA rule limited to the development of entirely new IP? 19.2.5. Case law on the DA rule 19.2.5.1. Introduction 19.2.5.2. GlaxoSmithKline Holdings v. CIR (2006) 19.2.5.2.1. Introductory comments 19.2.5.2.2. A lead-in to the case 19.2.5.2.3. The principal IRS argument that the US subsidiary was the developer 19.2.5.2.4. The secondary IRS argument that the US subsidiary was the assister 19.2.5.2.5. How would the case have been assessed under the DA rule? 19.2.5.3. DHL Corporation v. CIR (1998) 19.3. Determination of IP ownership under the 1992 proposed and 1993 temporary US regulations 19.4. Determination of IP ownership under the 1994 final US regulations 19.4.1. Introduction 19.4.2. Reason 1 for replacing the DA rule: Criticism against its treatment of the legal owner 19.4.3. Reason 2 for replacing the DA rule: OECD conformity 19.4.4. The point of departure under the 1994 IP ownership rules: The legal owner (of IP subject to legal protection) and the developer (of IP not subject to legal protection) are entitled to residual profits 19.4.5. The first exception to the legal ownership rule: Economic substance 19.4.6. The second exception to the legal ownership rule: The multiple owners rule (1994 cheese examples) 19.4.7. Concluding remarks on the 1994 US approach to intangible ownership 19.5. Determination of IP ownership under the historical OECD TPG Chapter 20: A Lead-In to the Determination of IP Ownership under the US Regulations and OECD TPG: A Story about Legal Ownership, Control and Economic Substance 20.1. Introduction 20.2. The US regulations 20.2.1. Introduction 20.2.2. Legal ownership 20.2.3. The treatment of licensees 20.3. The OECD TPG 20.4. The determination of ownership of intangibles not subject to legal protection 20.5. Ownership and economic substance Chapter 21: The Distribution among Group Entities of Residual Profits Generated through Exploitation of Internally Developed Manufacturing IP under the US Regulations 21.1. Introduction 21.2. The value drivers in manufacturing IP development 21.3. The economic substance exception applied to manufacturing IP 21.3.1. Introduction 21.3.2. The economic substance exception should not replace the transfer pricing methods 21.3.3. Imputation of contingent payment terms: A lead-in 21.3.4. Imputation of contingent payment terms base example: Successful contract R&D arrangement with contingent profit split payment structure 21.3.5. Imputation of contingent payment terms example: Unsuccessful contract R&D arrangement with contingent profit split payment structure 21.3.6. Imputation of contingent payment terms example: Successful contract R&D arrangement with cost-plus-based contingent payment structure 21.3.7. Concluding remarks on the application of the economic substance exception to impute contingent payment terms 21.4. The US stance on contract R&D arrangements in light of the 2015 provisions on the arm’s length standard and best-method rule Chapter 22: The Distribution among Group Entities of Residual Profits Generated through Exploitation of Internally Developed Manufacturing IP under the OECD TPG 22.1. Introduction 22.2. A lead-in to the profit allocation problem for internally developed manufacturing IP 22.3. Profit allocation for IP development contributions: Functions 22.3.1. Introduction 22.3.2. The “important functions” doctrine 22.3.3. Outsourcing: Contract R&D arrangements 22.3.3.1. Introduction 22.3.3.2. The relationship between the 2015 OECD important-functions doctrine and the historical 2009 business ­restructuring and intra-group services guidance 22.3.3.3. The important-functions doctrine and contract R&D arrangements 22.3.3.4. Performance of important R&D functions through geographically dispersed employees 22.4. Profit allocation to IP development contributions: Funding 22.4.1. Introduction 22.4.2. A lead-in to the issue 22.4.3. Control over financial risk 22.4.4. The point of departure for determining the risk-adjusted rate of return 22.4.5. Uncontrolled transaction analogy for determining the risk-adjusted rate of return: Venture capital financing 22.4.6. Do the OECD TPG examples contribute to the determination of the risk-adjusted rate of return allocable to the funding entity? 22.4.7. Do the US CSA regulations contribute to the determination of the risk-adjusted rate of return allocable to the funding entity? 22.4.8. Does the cost of capital contribute to the determination of the risk-adjusted rate of return allocable to the funding entity? 22.4.9. Do the financing alternatives realistically available contribute to the determination of the risk-adjusted rate of return allocable to the funding entity? 22.4.10. Does the financial risk assumed contribute to the determination of the risk-adjusted rate of return allocable to the funding entity? 22.4.11. Concluding comments on IP development funding 22.5. Profit allocation for IP development contributions: Pre-existing unique IP 22.5.1. Introduction 22.5.2. The point of departure for pricing the contribution of the pre-existing IP 22.5.3. The pre-existing IP is contributed by the same group entity that carries out the ongoing R&D functions 22.5.4. The pre-existing IP is contributed by a group entity different from that which carries out the ongoing R&D functions 22.5.5. Concluding remarks on the contribution of pre-existing IP to intangible development processes Chapter 23: The Distribution among Group Entities of Residual Profits Generated through Exploitation of Internally Developed Marketing IP under the US Regulations 23.1. Introduction 23.2. A lead-in to the profit allocation problem for internally developed marketing IP 23.3. When are the US regulations unwilling to give pricing effect to foreign legal ownership of marketing IP due to a lack of economic substance? 23.3.1. Introduction 23.3.2. The wristwatch example: US distributor incurs incremental marketing expenditures to build local value of foreign-owned trademark 23.3.3. The athletic gear base example: US subsidiary incurs incremental marketing expenditures to build local value of foreign-owned trademark 23.3.4. The athletic gear example: The 2006 extension 23.3.5. Concurrent remuneration during the IP development phase as a safe harbour from the economic substance exception 23.3.6. A premise for triggering the economic substance exception: “Incremental” marketing expenditures 23.3.7. The economic substance exception should be relevant only for incoherent pricing structures 23.3.8. The economic substance exception is balanced relative to its 1994 predecessor 23.4. Remuneration of a US distribution entity when the economic substance exception is not triggered 23.4.1. Introduction 23.4.2. Arm’s length marketing expenditures are incurred 23.4.3. Above-arm’s length marketing expenditures are incurred 23.4.3.1. Introduction 23.4.3.2. Scenario 1: The US subsidiary is deemed owner of a licence 23.4.3.3. Scenario 2: The US subsidiary is compensated under a separate service agreement 23.4.3.4. Scenario 3: The foreign legal owner is compensated under a separate service agreement 23.4.4. What is the appropriate transfer pricing methodology to remunerate an assister? 23.5. Concluding remarks Chapter 24: Distribution among Group Entities of Residual Profits Generated through Exploitation of Internally Developed Marketing IP under the OECD TPG 24.1. Introduction 24.2. The 2017 OECD TPG require differentiation of market-based super profits 24.3. Scenario 1: The local group distribution entity is reimbursed on a cost-plus basis 24.4. Scenario 2: The local group distribution entity bears an arm’s length level of marketing costs 24.4.1. The subsidiary must earn a normal market return throughout the IP development phase 24.4.2. The first twist: The duration of the distribution agreement is shortened; can residual profits then be allocated to the subsidiary? 24.4.3. The second twist: A royalty payment is introduced; can residual profits then be allocated to the subsidiary? 24.5. Scenario 3: The local group distribution entity bears an above-arm’s length level of marketing costs 24.5.1. Introduction 24.5.2. The OECD TPG threshold for additional profit allocation to the source-state distribution subsidiary 24.5.3. The material content of the profit allocation 24.5.4. The profit allocation reservation 24.6. Concluding comments Chapter 25: The Allocation of Residual Profits from Unique and Valuable IP to Permanent Establishments 25.1. Introduction 25.2. Assigning economic ownership to internally developed manufacturing IP 25.3. Assigning economic ownership to internally developed marketing IP 25.4. Assigning economic ownership of acquired manufacturing IP 25.5. Assigning economic ownership of acquired marketing IP 25.6. The cliff effect under article 7 of the OECD MTC and the important-functions doctrine 25.6.1. Introduction 25.6.2. Philip Morris (Italy, 2001) 25.6.3. Rolls Royce (India, 2007) 25.6.4. Zimmer (France, 2010) 25.6.5. Dell (Norway, 2011) 25.6.6. Boston Scientific (Italy, 2012) 25.6.7. Concluding comments Chapter 26: Concluding Remarks 26.1. Introduction 26.2. The methodology for the transfer pricing of IP 26.3. Remuneration of IP development funding 26.4. Allocation of profits for foreign-owned marketing IP 26.5. The identification of local marketing IP 26.6. Is the OECD arm’s length standard heading towards formulary apportionment? References Other Titles in the IBFD Doctoral Series The transfer pricing of intangibles (patents, trademarks, etc.) is an important issue in international tax law, because it determines how superprofits generated by multinationals through the exploitation of valuable intellectual property (IP) in their worldwide value chains are allocated among the jurisdictions in which they do business. For decades, multinationals have used IP transfer pricing to shift taxable profits out of high-tax jurisdictions, causing serious base erosion. Both the United States and the OECD seek to combat these practices through mandatory transfer pricing rules aimed at ensuring that IP superprofits are taxed where the intangible value was created. The profit allocation process prescribed by these rules is analysed in this text. The first part of the process determines the amount of superprofits allocable to a unique and valuable IP (royalty amount). The US and OECD transfer pricing methods that govern this determination are analysed, applying a distinction between unique and non-unique value chain contributions, and it is observed that the methodology has evolved significantly over the years, from primarily relying on imprecise third-party benchmarking to more substance-based approaches that seek to ensure results that adhere to the realistic alternatives of the controlled parties. The second part of the profit allocation process determines to which group entity, and thus indirectly also to which jurisdiction, the amount of IP superprofits will be allocated. The US and OECD intangible ownership provisions that govern this determination are analysed, applying an original analytical distinction between manufacturing and marketing IP. The analysis shows that, while both the US and OECD rules go a long way towards aligning the allocation of superprofits from R & D-based manufacturing IP with value creation, the allocation of superprofits from marketing IP still largely hinges on formal legal ownership and thus opens the opportunity for tax planning from multinationals and should be ripe for future reform Roy Rohatgi on International Taxation'is an introductory text for practitioners and students of international tax law. For many years, this two-volume title has enjoyed a reputation as one of the leading handbooks in this complex area of taxation. With the latest rewrite of this seminal work, the authors provide in-depth treatment of the key topics in international tax, building up from detailed explanation of the basic concepts, all the way to solid analysis of the complex transactional issues. Volume 1, Principles, lays the foundation for this two-volume set. It examines international taxation through the prism of domestic law, explaining the conflicts of laws that give rise to issues seeking resolution in the international arena. This volume also introduces the reader to the world of tax treaties, crucially focusing on income and capital tax treaties, as well as on the main treaties that concern the administration and collection of taxes in the international sphere. In its analysis of income and capital tax treaties, this book takes the OECD Model Convention as the starting point and enriches the discussion with examples from real-life treaties, as well as by contrasting provisions from other Model treaties. The book is rounded out by a generous analysis of jurisprudence from all over the world. What the reader gets is a thoroughly researched handbook, explaining the key principles of international taxation, buttressed with real-world practice and written with practical application in mind. This volume is one of the first authoritative works to include analysis of the provisions of the updated OECD Model Convention (2017) and UN Model Convention (2017).