What about transactions involving intangibles, where there is an intrinsic know-how component? Typically, there is a contract, as in practice the parties are involved in transfers of intellectual property items (IP) which must be backed by complex contractual arrangements.
For transfer pricing it is essential not to forget that when a company or an individual enters into a transaction with a related party, it has to prove that there is a business need behind this activity. Thus, when transactions involving intangibles occur between related parties, the transfer pricing (“TP”) documentation should generally include some documentation which is similar to that used for the benefit test, which is commonly used for services. It is acknowledged that this part of TP documentation is unlikely to contain quantifications, an option being to support the rationale of entering in the transaction by using descriptive paragraphs. Inspired by standard audit procedures, statements of the local management might be used to properly substantiate the local management’s decision to enter into that transaction.
Even for transactions involving IPs, questions arise with respect to the outcome of the transaction. In practice, sometimes there is no clear boundary between royalty payments and commissions or other service fees paid for various rights or benefits. As an example, payments made as a percentage of net sales, as remuneration for receiving the right to distribute certain products in a certain country or region challenged in practice by the tax authorities, when seeking to match the substance with other contractual clauses.
The difficulties in establishing transfer pricing rules for transactions involving intangibles illustrate the general point that transfer pricing documentation involves providing far more than a simple benchmarking study.