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Intellectual Property and International Structuring

August 6, 2016

P V SRINIVASANCorporate Advisor

Email: [email protected]: +919845057597

1

International Fiscal AssociationSouthern Regional Chapter – India Branch

10th International Taxation Conference 2016

International Taxation – Dawn of a New EraTheme

When

On What

By Whom

Organized By

Taxation Strategies

Need not be parallel

Transfer Pricing & WHT

Tax on Interest, Dividend & Capital Gains

Driven by Driven by

Shareholders Wealth Maximization

Business Flow Investment Flow

Supply chain Holding structure

2

“Intangibles” form part of supply chain

Intangible

1. Not a physical asset;2. Not a financial asset;3. Capable of being owned or controlled for use in

commercial activities.4. Not merely “intangible assets” recognized in

accounting.5. Not merely “legally” recognized intangibles.6. Transfer would be compensated in arm’s length

conditions.

What is not intangible?: That which cannot be “owned” or “controlled’.

– Group synergies;– Market specific characteristics.

3

Categories of intangibles1. Patents: A legal instrument that grants an exclusive right to its owner to

use a given invention for a limited period of time within a specifiedgeography.

2. Know-how and trade secrets: Proprietary information or knowledge thatassist or improve business activity, but are not registered for protection.

3. Trademarks: A unique name, symbol, logo or picture that the owner mayuse to distinguish its products and services from those of other entities.Proprietary rights in trademarks are usually registered. May continueperpetually, if continuously used and the registration is renewed.

4. Trade name: Usually name of an enterprise, having the same force ofmarket penetration as a trademark and may be registered in a specificform as trademark.

5. Brand: Represents a combination of intangibles – trademarks,tradenames, customer relationships, reputational attributes, andgoodwill.

6. Government licenses: Rights to exploit natural resources – license ofbandwidth spectrum.

7. Rights under contracts: Contracts with key customers, suppliers,employee retainerships etc.

8. Licenses / limited rights in intangibles: May be limited to field of use,term of use, geography or other ways.

9. Goodwill and going concern value.4

Intangible assets relating to:1. Marketing: Trademarks, tradenames, brand names, logos.2. Technology: Process, patents / patent applications, technical know-how,

technical documentation.3. Artistic : Literary works and copyrights, musical compositions, copyrights,

maps, engravings.4. Data processing: Proprietary computer software, software copyrights,

automated databases, integral circuit masks and masters.5. Engineering: Industrial design, product designs, trade secrets,

engineering drawing and schematics, blueprints, proprietarydocumentation.

6. Customer: Customer lists, customer contracts, customer relationships,open purchase orders.

7. Contract: Favourable supplier, contacts, licence agreements, franchiseagreements, non-compete agreements;

8. Human capital : Trained and organized work force, employmentagreements, union contracts;

9. Location: Leasehold interest, mineral exploitation rights, easements, airrights, water rights.

10. Goodwill: Institutional goodwill, professional practice goodwill, personalgoodwill of professional, celebrity goodwill, general business goingconcern value.

Intangible Property – Explanation (ii) u/s 92B

5

General scope:• Methods, programmes, systems, procedures, campaigns, surveys, studies,

forecasts, estimates, customer lists, or technical data;• Any other similar item that derives its value from its intellectual content

rather that physical attributes.

Intangible Property – Explanation (ii) u/s 92B

6

Uber Largest Taxi Enterprise

Owns no Vehicle

Facebook Most popular social media

Creates no Content

Alibaba Most Valuable Retailer

Owns no Inventory

AirbnbWorld’s largest

Accommodation Provider

Owns no real estate

7

IP – Driving Value

Commercial Exploitation of IP

Licensing

Cross Licensing

Franchising

Merchandising

Sale

Own Use

8

Parent

Company

Holding Company

Manufacturer / Developer

Principal Entrepreneur

Sales Agent

Suppliers Customers

Toll manufacturing agreement

Cost plus or commission agreement

9

Traditional Structure

India

EU Holding Company

IP Co. EU Mfg entities

Low Taxed Principal



Finance Co.

Sales Agent

Royalty

Interest

10

Traditional Structure - Modified

A Inc.US Parent

Ireland / Bermuda

EU SALES COIreland Co.

Netherland, BV

Royalty 1

Royalty 2

COST

SHARING

Gross Sales 1000

Royalties 850

Net Sales 150

Royalty (+) 850

Royalty (-) 845

Netincome

5

Royalty (+) 845

Royalty (-) 842

Netincome

3

Royalty - 842

Technology Company

11

G Inc.US Parent

Ireland HC (IHC)

COST SHARING

Netherlands

GIL IrelandEMEA

SubsidiariesRoyalty 1

Royalty 2

Royalty 3

12

Technology Company

License for IPR

Sub-License for IPR

Bermuda

AM Inc. (US 1) AM Inc. (US 1)

Luxembourg LLC

Luxembourg OP Co, EU

AM UK LTD(Support)

AM Germany, GmBH(Support)

AM France, Sarl (Holding)

AM Germany, GmBH(Logistics)

AM France, Sarl (Support)

AM France, Sarl (Logistics)

Royalty

AM Service, Sarl100% 100% 100%

100% 100% 100%

100%

E-commerce Company

13

The “cashbox” issue

Parent

Bermuda “cashbox

” CoOffshoresubsidiary

Distributor

Infusion of funds • Legal owner of IP

• Funds R&D• Assumes risk of

funding

• Performs and controls allactivities related toDEMPE of IP

IP license

“Residual” license fee payment

Home country

Offshore

CFC rules

14

IP owner and parent company relationshipa) IP owner has an exclusive right

over the IP rights outside of parentcompany’s jurisdiction.

b) The entrepreneurial profitassociated with the IP rightsaccrues to the IP owner.

c) While there is some substance inthe IP owner, strategic decisionmaking with regards to theworldwide rights remains in theparent company.

IP owner and local / off-shore distributor relationship• IP owner licenses IP to a local

distributor who makes sales tothird parties in the localjurisdiction.

IP owner and affiliates relationship• IP owner enters into agreements

with affiliates to provide R&D and other services applicable to the IP.

Affiliate

15

Action 1: Address the tax challenges of the digital economy

COHRENCE SUBSTANCE TRANSPARENCYi. Establishing international

coherence of corporateincome taxation

ii. Restoring the full effects andbenefits of internationalstandards

iii. Ensuring transparency whilepromoting increased certainty andpredictability

Action 2:Neutralize the effects of hybrid mismatch arrangements

Action 6:Prevent treaty abuse

Action 11:Establish methodologies to collect and analyze data on BEPS and the actions to address it

Action 3:Strengthen Controlled Foreign

Company (CFC) rules

Action 7:Prevent the artificial avoidance of PE status

Action 12:Require taxpayers to disclose their aggressive tax planning arrangements

Action 4: Limit base erosion via interest deductions and other financial payments

Assure that transfer pricing outcomes are in line with value creation

Action 8:Intangibles

Action 13: Re-examine transfer pricing documentation

Action 9:Risk and capitalAction 5:Counter harmful tax

practices more effectively, taking into account transparency and substance

Action 14: Make dispute resolution mechanisms more effective Action 10:

Other high-risk transactions

Action 15: Develop a multilateral instrument

BEPS ACTION PLAN

Proposed framework• Identify the legal owner: Based on the

terms and conditions of legalarrangements, relevant registrations,license agreements, other relevantcontracts.

• Identify the parties performing functions:Assets used, and Risks Assumed relating toDEMPE Functions of the intangibles

• Confirm consistency between conduct ofthe parties and terms of the relevant legalarrangements through a functional analysis.

• Identify the controlled transactions relatedto the DEMPE of intangibles in light of thelegal ownership of the intangibles and theconduct of the parties and verifyingcreation of value.

• Re-characterize transactions as necessaryto reflect arm’s length conditions

• Determine arm’s length prices for thesetransactions consistent with each party’scontributions of functions performed,assets used, and risks assumed.

1. Identify legal owner

2. Identify parties regarding Functions,

Risks, Assets

3. Confirm consistency

4. Identify controlled transaction

5. Determine arm‘s length pricing

6. Or characterize transaction

Steps in determining returns Key functions

Development

Enhancement

Maintenance

Protection

Exploitation

16

BEPS Actions on IP Structures

1. MNEs need to confirm that IP owner carries out notonly the funding for development but also theDEMPE functions: Decision-making and control overDevelopment, Enhancement, Maintenance,Protection, and Exploitation of the IP.

2. Which enterprise or enterprises:a) Perform control functions and risk mitigation

functions;b) Encounter upside or downside consequences of

risk outcomes;c) Have the financial capacity to assume risk.

3. IP owner will also need to execute substantialproportion of the R&D activity.

17

Ideas

• Confidentiality Agreements• Non Disclosure Agreements• Trade Secrets Clauses

Research

• Collaboration Agreement• Cost Sharing Agreement

Technologies• Patents

Products• Technology Licensing Agreement

Valu

ead

ding

PROTECTION

18

Company B –Legal Owner of

Trademark

Company C –Licensed Owner of

Trademark

Exclusive license

19

Company A –Loan to acquire

Trademark

Legal owner solely acts asa holding entity:• Performs no relevant

functions,• uses no relevant

assets; and• Assumes no relevant

risks.

The legal owner will not beentitled to any portion ofthe return from theexploitation of theintangible. Only ALP forholding title.

AE providing funding andassuming related financialrisks, but not performingany functions relating tothe intangibles, couldexpect a risk adjustedreturn on its funding.

AE providing funding butnot exercising control overthe financial risksassociated with funding –entitled to no more thanrisk-free return.

Distinct owners

India

EU Holding Company

IP Co. EU Mfg entities

Low Taxed Principal



Finance Co.

Sales Agent

Royalty

Interest

20

• R&D arrangement• TP aligned to value

creation fromexploitation ofintangibles

• Level of substance,particularly wherepreferential rulingobtained

• Increased risk of place of management PE

• Increased reporting / disclosure requirement

• Increased TP documentation Increased risk of intra-group management charge

• Increased use of CFC rule in more jurisdictions

• Base erosion limitations• Hybrid mismatch• TP for treasury

arrangements• Preferential regimes –

increased substance anddisclosure requirements

• Treaty abuse

Potential BEPS impact• Align return to substance• Treaty abuse• TP arrangement – Interest, Royalty,

Manufacturing• Online sale taxation – E-Com

• PE focus – commissionaire, place of management

• TP Disclosure requirements • Increased re – characterisation threat

“P” - Parent Company

- MNE Group

“S” – WOS Company

1. Funds R & D2. Performs ongoing R&D functions

required for the business.3. R&D functions result in patentable

interventions.

Assi

gnm

ent o

f Pat

ents

1. Employs lawyers to perform patentadministration work.

2. No employees.3. No R&D activity of its own.4. No control on R & D activities of P.5. No technical personnel.6. No R & expenses of “P”

Nom

inal

Con

side

ratio

n

Exclusive, royalty free,patent license, with fullright of sub-licence, forfull life of the patent tobe registered.

Based on FAR analysis ALP for S – Only for Patent Administration Service. 21

1/ 5


- MNE Group


1. Funds R & D2. Performs ongoing R&D required for

the business.3. R&D functions result in patentable

interventions.

Assi

gnm

ent o

f Pat

ents


2. No employees.3. No R&D activity of its own.4. No control on R&D activities of P.5. No technical personnel.6. No R & D expenses of “P”

Nom

inal

Con

side

ratio

n

Based on FAR analysis ALP for S – Only for Patent Administration Service.

AE or Independent Parties

22

2/ 5


- MNE Group




interventions.

Assi

gnm

ent o

f Pat

ents


2. No employees.3. No R&D activity of its own.4. No control on R&D activities of P.5. No technical personnel.6. No R & D expenses of “P”

Nom

inal

Con

side

ratio

n

Based on FAR analysis ALP for S – Only for Patent Administration Service.

AE or Independent Parties

23

3/ 5


- MNE Group




interventions.

Assi

gnm

ent o

f Pat

ents

ALP

Con

side

ratio

n

Based on FAR analysis ALP for S – the entire Royalty.

Independent Parties

24

1. Has qualified employees capable ofmaking, and who actually make, thedecisions to take on patent portfolio.

2. Licensing is undertakenindependently.

3. Employees monitor compliance ofindependent licenses with the termsof the license.

4/ 5


- MNE Group




interventions.

Assi

gnm

ent o

f Pat

ents

ALP

Con

side

ratio

n

Based on FAR analysis ALP for S – the entire consideration including the Gain / Loss.

Independent Parties

25

1. Has qualified employees capable ofmaking, and who actually make, thedecisions to take on patent portfolio.

2. Employees make all decisionsregarding the sale of the patents,negotiate the terms of the sale, and inall respects manage and control thedisposition of the patents.

5/ 5

Parent - Pharma CompanyDevelops patents and other

intangibles relating to Product X

Sub AE – Distributor for EMEA

Limited risk distributor

1. No product liability risk.2. No recall risk.

Retains normal distribution

profits for three years

Patients experience side

effects

Incurs substantial expenses for the

recall. Not reimbursed by

Parent12

3

Conduct validation

26

Company A Company B Company CFunctionsa) Software Development - Partial Fullb) Brand Development / Core Marketing - Partial Fullc) Sales Activities Partial Full - d) Negotiation with suppliers - Full FullAssetsa) Design and Know-how - Partial Fullb) Methods and Procedures - Partial Fullc) Technology Solutions and Software - - Fulld) Trademark and Trade name - - Fulle) Clients lists and related information - Partial FullRisksa) Capacity risk - Full Partialb) Market Risk Partial Full Partialc) Operational Risk Full Full - d) IP Development Risk - - Fulle) IP Infringement Risk - - Fullf) IP liability / reputational risk - Partial Full

Intangibles in Software Products

27

28

Implementation Support

Testing

Coding

Low Level Design

High Level Design

Requirement

Analysis Parent

Captive

1. CRD gets into picture afterthe project is conceived /approved by head office.

2. CRD usually involves “D”more than “R” i.e. theactivities pertaining todesigning the system, coding,testing and ongoing support.

3. Usually not affected byoutcomes i.e. thecommercial success or failureof the product.

4. Carries on part of the sumtotal of the entire process asdepicted.

5. Is always monitored andcontrolled by the headoffice.

Contract R & D (“CRD”) Information Technology

FEATURES OF CONTRACT R&D

Activity Parent/ Head Office

Contract R&D/ Product developer

Concept Idea and production plan Completely

High level product definition Completely

Feasibility study Predominantly Partially supporting HO

Project Management Completely

Requirement Analysis and High Level Design Completely

Low Level Design Review Predominantly

Coding testing and software implementation Review Predominantly

Quality Assurance Predominantly Implement policies of HO

Marketing & sales responsibility of final product

Completely

Information Technology

29

Activity Parent/ Head Office

Contract R&D/ Product developer

Ownership of intangibles Completely

Place of providing services Globally India

Product Liability Risk Completely

FEATURES OF CONTRACT R&D

30

Preliminary Specifications

Business Opportunities

Cost BenefitAnalysis

RequirementAnalysis

Project Estimation

(High Level Design and Functionality)

1. Involved in complete life cycle from identifyingbusiness till the product/ software developmentis complete.

2. The primary business developer with marketinterface.

3. Entrepreneur who evaluates and decides onaccepting or rejecting a project.

4. Driven by cost and profit considerations.

5. Greatly influenced by commercial success orfailure of a product/ service.

Full Fledged Service Provider (FFS) Information Technology

31

Transfer Pricing – Intangibles under BEPS

Economic Owner

Functional Owner

Legal Owner

32

1. TP Approach: EnterpriseApproach instead of SeparateEntity Approach. Companiesunder the control of the samecompany should be treated asSingle Enterprise.

2. Economic Substance overForm: ContractingArrangement is not thedominant consideration.

3. Transparency: CbC reportingby Parent. EnterpriseApproach.

4. ALP based on: Specifity; Value Creation

Going forward1. Engage qualified employees in AEs where intangibles for

commercial exploitation are to be located.– Capable and actually making decisions with regard to the

DEMPE functions.2. Ensure that AEs assuming risks have financial capacity to

assume the risks.3. Contractual assumption of risks: Ex ante agreement to bear

some or all of the potential costs associated with:– Ex-post materialisation of downside outcomes of risk;– In return for some or all of the potential benefit associated

with ex-post materialisation of positive outcome.

33

Questions and Answers

34

Thank you !

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