OECD - WP 6 - Special Session on the Transfer Pricing Aspects of Intangibles. Paris, March 22, 2011

Transcription

1 OECD - WP 6 - Special Session on the Transfer Pricing Aspects of Intangibles Paris, March 22, 2011 Dr. Jutta Menninger Werner Stuffer Andrew Casley

2 Valuation Standards and Guidelines Internationally various valuation standards and guidelines for the valuation of intangibles are available Examples for such valuation standards and guidelines are: - ISO Brand Valuation - Requirements for Monetary Brand Valuation (ISO, August 2010) - IDW S 5 - Valuation of Intangibles Assets (IDW, latest version August 2010) - DIN Patent Valuation - General Principles for Monetary Patent Valuation (DIN, November 2010) 2

3 ISO Brand Valuation (1/2) The ISO (International Organization for Standardization) is a worldwide federation of national standards bodies ISO standards are developed by technical committees comprising experts from the industrial, technical and business sectors which have asked for the standards, and which subsequently put them to use The ISO was approved August 2010 and will be reviewed at the least three years after publication by all the ISO member bodies The ISO provides a consistent, reliable approach to brand valuation, including - Financial Aspects, - Behavioural Aspects, - Legal Aspects. 3

4 ISO Brand Valuation (2/2) Financial Aspects: Analytical review of the current and predicted market volumes, values, margins and channels Behavioural Aspects: Assessment of the brand situation in the market, including the brand value drivers; measuring brand strength such as awareness, perceptual attributes, knowledge, attitude and loyalty; incorporate an evaluation of the brand s relevance in its specific market and sector environment Legal Aspects: Assessment of the legal parameters such as distinctiveness, scope of use/scope of registration (territory, goods and services), extent of use, notoriety/extent to which brand is well-known, right of cancellation priority, dilution and the ability or willingness or both of the owner to enforce legal rights 4

5 IDW S 5 Valuation of Intangible Assets (1/2) The Institute of Public Auditors in Germany, Incorporated Association IDW) is a privately run organisation established to serve the interests of its members who comprise German Public Auditors and German Public Audit firms The IDW S 5 is an open standard, which was first published in 2007 giving guidance on the general framework as well as on the valuation of brands It was supplemented by the special principles for the valuation of customer-related intangible assets in 2009 and will be more or less accomplished this year by the valuation principles for technology-based intangibles The principles are primarily based on general business valuation procedures and not for the question of whether intangible assets can be accounted for and how they are valued for measurement purposes 5

6 IDW S 5 Valuation of Intangible Assets (2/2) The value of an intangible is determined by discounting the attributable future net cash flows to the valuation date. Under the widely used risk premium method, the expected cash flows are discounted using a riskadjusted capitalization rate. In practice, the company s weighted average cost of capital (WACC) is used as the basis. Based on the capital asset pricing model (CAPM), the cost of equity specific to the particular asset comprises a risk-free interest rate and a market risk premium adjusted to the specific features of the asset in question. For valuation purposes, assumptions must be made about the estimated useful life of the brand and thus the period during which the expected cash flows from the brand will be capitalized. It is not permissible to generally assume an unlimited useful life and thus to use a terminal value in the valuation. 6

7 DIN Patent Valuation (1/2) The DIN (German Institute for Standardization) develops norms and standards as a service to industry, state and society as a whole Ninety percent of the standards work now carried out by DIN are international in nature The DIN was approved November 2010 The norm specifies requirements for procedures and methods of monetary patent value measurement as well as their interdependent value drivers. Depending on the availability and the quality of the data for such a valuation the different valuation approaches are prioritized. The norm specifies a framework for patent valuation, including objectives, bases of valuation, approaches to valuation, methods of valuation, sourcing of quality data and assumptions including the reporting of results of such a valuation. 7

8 DIN Patent Valuation (2/2) Three main parameters, the legal, the technical and the economic parameters, determine the value of a patent and all of them have to be taken into account to assure an accurate valuation The standard contains an enumeration of typical parameters for each group: Legal parameters: the possibility to legally protect and defend an invention, the freedom-to-operate, the chance to circumvent the patent, the geographic cover of the protection and whether any patent infringements are known Technical parameters: technical feasibility, scalability, technological life cycle, technical field of application or technical substitution Economic parameters: market potential of the invention, availability of complementary goods, a business model of marketing and the interdependencies with other intangible assets 8

9 Some key elements in common Three main parameters, the legal, the technical/behavioural and the economic parameters, determine the value of an intangible Three basic methods market, income and cost are available The importance of selecting a method that fits the facts of the case subject to the reliability of the data available to apply it Standards support the notion that in most cases intangibles will have a limited duration, i.e. an indefinite life and a calculation of a perpetuity is not accurate Although some standards focus on specific intangibles as brands and patents they provide frameworks that can easily be applied to other intangibles or groups of intangibles 9

10 Available Valuation Standards and Guidelines Principally Distinguish Three Basic Approaches Approaches for the Valuation of Intangibles Market Approaches Income Approaches Cost Approaches Active Market Prices Incremental Cash Flow Method Reproduction Cost Method Market/Transaction Comparables Relief-from-Royalty Method Replacement Cost Method Residual Income Method 10

11 Key Elements of Market Approaches Application of market approaches call for existence of direct active market prices available particularly for the intangible in focus or for the availability market price comparables for intangibles that are sufficiently comparable to the intangible in focus In most cases active markets for intangibles that allow for a sufficient transparency of data and prices paid do not exist Comparability of intangibles among each other is inherently limited and, thus, is the application of data drawn from supposed comparable market transactions Hence, a one-to-one application of market approaches is often limited in reality, a circumstance hinted to by ISO 10668, IDW S 5 and DIN

12 Application of One of the Methods Strongly Depends on Valuation Object and Available Data Market approaches can best resemble arm s length transactions, yet due to the often inherent individuality of intangibles may not be applicable, hence, shifting the focus to income approaches with the assumptions being subject to a sound arm s length challenge Income approaches according to: ISO 10668: Price premium method, volume premium method, incomesplit method, multi-period excess earnings method, incremental cash flow method, royalty relief method IDW S 5: Direct cash flow method, relief-from-royalty method, residual income method, incremental cash flow method DIN 77100: Incremental cash flow method, relief-from-royalty method 12

13 Key Elements of Income Approaches Income approaches presume that an intangible s value is inherent in its ability to generate future cash flows to the benefit of its owner Across all income methods, ultimately, the value of an intangible is determined as the present value of the intangible s future cash flow generating potential Basis for the determination of future cash flows is a business plan, which ideally can be broken down to show such cash flows that can be directly associated to the intangible in focus otherwise assumptions how to perform such an intangible-specific breakdown have to be derived in close cooperation with experts The determination of the present value is technically performed by applying an intangible-specific risk adjusted discount rate over a remaining economic useful life considered appropriate 13

14 Incremental Cash Flow Method a Standards Favorite ISO 10668, IDW S 5 and DIN express a preference for the incremental cash flow method which is based on the notion that specific intangibles have the ability to realize price premiums, volume premiums as well as cause cost savings Intangible specific price premium Isolation module Intangible specific volume premium Intangible specific revenue Intangible specific cost savings Risk module Simulation module Intangible specific Revenue t = 1 Cost t = 1 Intangible specific cash flows t = 1 Forecast module Intangible specific Revenue t = Cost t = Intangible specific cash flows t = Budget period t = 1 to t = t Risk analysis and discounting Monetary value of intangible Value of intangible + scenario analyses = strategic value of intangible Intangible specific Revenue t = t Cost t = t Intangible specific cash flows t = t 14

15 Key Elements of Cost Approaches Cost approaches are built on the notion of capitalizing costs that would either be incurred when - reproducing an intangible with identical economic features - replacing the intangible by an intangible with identical economic features Cost approaches might look like to be easiest to perform, however have the conceptual weakness of not taking any future benefits that may originate from the intangible in question into account In practice it is intended to use cost approaches for plausibility checks only or if neither a market orientated nor an income approach appear to be reasonable, e. g. where alternatives can readily be built or bought such as software As with market approaches, the application of cost approaches may be limited due to the inherent individuality of intangibles 15

16 How Intangibles are Embedded in Business Functions A functional analysis is crucial for - the determination of key value drivers - a clear understanding of the business process(es), the (part of the) value chain the considered intangibles are associated to - the interdependencies individual assets (tangible and intangible) unfold within such business process(es) Extend functional analysis to closely identify the risk(s) involved with the individual intangible(s) that are being transferred - Define risk categories and attempt to allocate them to the parties - Explain risk(s) in the greater context of the function or value chain - Show how risk(s) may change due to the considered transfer 16

17 Draw Appropriate Conclusions From Functional and Risk Analysis Understand how risk and return correlate Link conclusions from functional and risk analyses to corresponding contractual terms documenting the transfer or from principles that govern business relationships between independent parties, e.g.: - product/market risk - R&D-risk - production risk - inventory and warranty risks - exchange rate risks - credit risk from distribution Challenge appropriateness of risk allocation in accordance with arm s length principle 17

18 Conclusions from a Valuation Professional s Point of View Having analyzed and drawn sound conclusions from the functional and risk analysis it needs to be determined how such conclusions drive the determination of a transfer price, i.e. the valuation parameters The value of an intangible is determined by several parameters, e.g.: - defined valuation object, - the availability of applicable uncontrolled transaction reference, - the method used to derive a value - amount and riskiness of the expected benefits from the exploitation of the intangible - exclusivities and restrictions attached to the intangible - extent and duration of economic useful life 18

19 The Value of an Intangible Lies in the Eye of the Beholder The economic, functional and risk-related elements of the intangible as economically observed at the level of each of them need to be considered and tested with sound economic judgment From an arm s length perspective the ultimate value set as a transfer price should reflect a sound compromise as if made between independent parties and should allow for the reconciliation of all valuable elements making the transferred intangible a monetary asset in the first place 19

20 The Valuation of Intangibles is a Complex Exercise (1/2) Existing valuation standards can provide guidance and give hints for the technical performance of the valuation The complexity of an individual valuation should also be determined by the economics of a particular transfer meaning that in some cases pragmatic feasible approaches may lead to a more realistic result than highly sophisticated approaches built on a multitude of assumptions The extensiveness of this process should be determined in accordance with the prudent business management principle (5.28 TPG), i.e. the amount of resource required to derive a reliable result should be proportionate to the materiality and significance of the asset. 20

21 The Valuation of Intangibles is a Complex Exercise (2/2) Is a profit margin or profit split view, drawn from data bases representing average or even just one-year samples, considered to be a good, comparable proxy? Instead a net present value approach derived from - the respective business plans... - set up under consideration of a functional and risk analysis...seems to be a solid arm s length proxy in many cases. Present value approaches not necessarily need to be more complex and technical than other approaches A most appropriate method test however is desirable, to achieve a consent between taxpayers and countries 21

22 Example 1 - Transfer of Product and Service Related IP - Incremental Cash Flows (1/2) Large MNC reorganized IP-ownership within a business unit IP-ownership had grown with various legal entities over time and due to past M&A activity Intention: centralization of IP-ownership and introduction of a corresponding licensing model for transfer pricing purposes Available data allowed for a sophisticated bottom-up incremental cash flow valuation (income approach) deriving precise individual valuation object specific values The valuation ultimately provided to the licensing model: - definition of transferred IP, - determination of individual IP-values and - derivation of implicit individual license rights 22

23 Example 1 - Transfer of Product and Service Related IP - Incremental Cash Flows (2/2) Illustrative derivation of incremental cash flows presuming the existence of price and volume premiums as well as implied cost savings taking an economic life cycle into account Simplistic example in m Budget period FY 1 FY 2 FY 3 FY 4 FY 5 Total revenue 1, , , Price premium through intangible Volume premium through intangible Intangible specific revenue Intangible specific COGS Intangible specific SGA Intangible specific cost savings Intangible specific earnings Corporate taxes 30.0% Intangible specifc amortization Intangible specifc capex Intangible specific cash flows Intangible specific cost of capital 8.0% 8.0% 8.0% 8.0% 8.0% Present value factor Discounted after-tax intangible specific cash flows Present value of intangible as at valuation date

24 Example 2 - Transfer of Sales Related Know-How - A Top Down Approach Large MNC transferred a bundle of sales related intangibles, defined as specific sales related know-how from various regional entities to a new headquarter Structure was meant to locally centralize value flows and revenue realization at the new headquarter Data was available on a high level aggregation level only which prevented a detailed bottom up valuation approach Based on a functional analysis the business plan translated into a top down approach and the value of the transferred sales related intangibles were derived following a pragmatic residual value income approach 24

25 Resume - The Valuation of Intangibles Demands Experienced Case-by-Case Judgment The answer to the question what is being transferred involves many levels that need to be considered closely due to their reciprocal implications The TPG methods for intangible valuation in combination with valuation standards can provide guidance... but appropriate interpretation and sound case-by-case judgement is irreplaceable Understanding the economic and business set-up that surrounds the intangible considered for transfer is a critical prerequisite for a profound valuation Thus, the importance of thorough functional and risk analysis cannot be overstated! 25

26 Resume - The Valuation Itself Stretches over Multiple Parameters The valuation object definition is the basis for all further technical elements of the valuation, with such elements covering among others, e.g.: - the choice of an appropriate method for the given case, - valuation object specific business plan parameters, - risks (e.g. definition of risk categories and consideration in derivation of a discount rate) and - timing issues (e.g. determination of the period of economic useful life and derivation of possible attrition factors) 26

27 Contacts WP/StB Dr. Jutta Menninger Phone: StB Werner Stuffer Phone: Andrew Casley Phone:

28 Thank you 2011 PricewaterhouseCoopers AG Wirtschaftsprüfungsgesellschaft. Alle Rechte vorbehalten. In diesem Dokument bezieht sich "" auf die PricewaterhouseCoopers Aktiengesellschaft Wirtschaftsprüfungsgesellschaft, Frankfurt am Main, die eine Mitgliedsgesellschaft der PricewaterhouseCoopers International Limited (IL) ist. Jede der Mitgliedsgesellschaften der IL ist eine rechtlich und wirtschaftlich selbständige Gesellschaft.