In this series of articles, we have highlighted a number of the tax and transfer pricing challenges faced by multinationals as a result of current economic conditions. In our most recent article, we focused on a number of key areas where multinationals should prepare, due to the uncertain environment in which they are operating and the high likelihood of an increase in tax authority activity to recoup the costs of the stimulus measures currently in place.
In this article, we explore some particular considerations in respect of managing intellectual property (IP). Specifically, we are hearing multinationals ask the following questions:
- Is now a good time to move IP?
- How do I value IP given current uncertainties?
- Should we expect new taxes on IP-based businesses?
We will now provide some general thoughts regarding each of these questions that may be of interest to those of you who are contemplating similar issues.
Is now a good time to move IP?
We are typically seeing this question asked by multinationals that have been keen to undertake some sort of business restructuring; however, the likelihood of significant tax consequences has potentially caused them to hold off from doing so. Currently, given the impact of COVID-19 on their business operations, IP valuations are in theory likely to be somewhat depressed (particularly when IP is valued using an income approach methodology which is driven by revenue projections). Therefore, given lower revenues in the current environment, it may be possible to transfer the ownership of IP with a lower tax cost. All taxes, however, including exit taxes, need to be considered and modelled before making such decisions.
While this may provide a good opportunity to a multinational business to execute a transaction at a lower tax cost, the broader question as to whether it makes good business sense to do so should be considered. For example, and as described in our previous article, it is highly likely that tax authorities will be on alert for multinationals perceived to be ‘taking advantage’ of the current economic situation to reduce their tax liabilities. Therefore, the preparation of appropriate documentation setting out the facts and circumstances of the transaction, and in particular any items or assumptions that have been impacted by the current economic environment, will need to be carefully documented.
Further, all of the usual questions that should be asked in a business restructuring should be fully considered, rather than discounted in the haste to secure a beneficial tax outcome. For example, accurately addressing substance and form related requirements is paramount, as is the need for such a transaction to be commercially driven, rather than tax driven.
Overall, moving IP in a time of uncertainty will require a certain level of confidence on the part of the multinational as to the anticipated benefit, as the costs of undertaking a business restructure of this nature are not insignificant if it is to be done correctly, particularly given the additional documentation requirements with respect to the impact of COVID-19 on the overall restructure.
So, as is normally the case in relation to transfer pricing matters, the answer to the question as to whether it is a good time to move IP is ‘it depends’. That said, there is clearly an opportunity to derive a less costly tax outcome for those multinationals who are both bold and well organised.
How should I value my IP given the current uncertainty?
While we are in a period of unprecedented uncertainty, certain factors may contribute to a lower IP valuation compared to pre-Covid times. In particular, as mentioned above, revenue forecasts may be depressed as a result of broader economic issues, which may give rise to a lower net present value in respect of those future income streams. Further, due to unprecedented uncertainty, discount rates may arguably be higher in the current environment, which may also give rise to lower valuations where an income approach is used.
That said, for most businesses we would not expect there to be material changes to pre COVID-19 valuations as a result of these issues at this stage. While there is much conjecture as to the overall impact of COVID-19 on the global economy, we would only expect certain types of heavily impacted businesses to derive material differentials in valuations in the short term, for example, those in the hospitality industry. As a true litmus test of whether the valuation is appropriate, multinationals should sense check any reduced valuations by asking themselves whether they would sell that IP to a third party for the price they have calculated.
Therefore, we recommend both a “top down” and a “bottom up” approach to valuation, with some of the incremental and detailed changes to a valuation model as a result of COVID-19 being sense checked on an overall basis. Further, as with any valuation, we recommend the adoption of multiple valuation methods where possible, with the ideal value being one in respect of which multiple valuation methods overlap.
Should we expect new taxes on intellectual property-based businesses?
Before COVID-19 swept all other considerations aside, a great deal of international discussion was taking place with respect to the OECD’s Pillar 1 and 2 proposals to address the taxation of the digital economy. In addition, many multinationals were keen to understand which countries were likely to take unilateral action (with France being one of the more recent to contemplate the unilateral introduction of a digital services tax or “DST”) if consensus could not be reached on a unified Pillar 1 solution. And although many thought that COVID-19 would indefinitely delay such a unified solution, the OECD continues developing both Pillar 1 and Pillar 2 plans, with the goal of presenting a complete blueprint in early October of this year.
What is hard to predict is whether the impact of COVID-19 will be the catalyst to drive some form of international consensus in this area. In favour of this argument will be the desire of many tax authorities to identify new income streams to repair their battered balance sheets. However, the bandwidth constraints faced by policy makers, and their own inward facing policy pressures, may be sufficient to make such an international consensus harder to come by in favour of more rapid, unilateral DST action.
On balance, we anticipate additional taxes on IP-related businesses to become more common, particularly in the digital space, with an increase in unilateral action by tax authorities a likely outcome. Therefore, it will be important for multinationals contemplating a business restructuring to consider how these factors are likely to impact their existing or proposed arrangements. Indeed, the likely imposition of some form of digital tax on a unilateral basis may be a clear impetus for multinationals to implement restructures at this time.
Clearly while we are living in a period of heightened uncertainty and therefore risk, there are opportunities to be had for those that assess them carefully and are willing to take them on. We therefore leave you with a quote from Cervantes that remains true to this day: “Diligence is the mother of good fortune.”