In outsourcing cases, it may happen that a party voluntarily decides to undergo a restructuring and to bear the associated restructuring costs in exchange for anticipated savings. For instance, assume a taxpayer that is manufacturing and selling products in a high-cost jurisdiction decides to outsource the manufacturing activity to an associated enterprise situated in a low-cost jurisdiction. Further to the restructuring, the taxpayer will purchase from its associated enterprise the products manufactured and will continue to sell them to third party customers. The restructuring may entail restructuring costs for the taxpayer while at the same time making it possible for it to benefit from cost savings on future procurements compared to its own manufacturing costs. Independent parties implementing this type of outsourcing arrangement may not necessarily require explicit compensation from the transferee, for example, where the anticipated benefits for the transferor are greater than its restructuring costs ...

The situation might however be different where the loss-making activity provided other benefits such as synergies with other activities performed by the same taxpayer. There can also be circumstances where a loss-making activity is maintained because it produces some benefits to the group as a whole. In such a case, the question arises whether at arm’s length the entity that maintains the loss-making activity should be compensated by those who benefit from it being maintained. See Section D.3 of Chapter I ...

The question may arise of whether the transferee should in fact be compensated by the transferor for taking over a loss-making activity. The response depends on whether an independent party in comparable circumstances would have been willing to pay for getting rid of the loss-making activity, or whether it would have considered other options such as closing down the activity; and on whether a third party would have been willing to acquire the loss-making activity (e.g. because of possible synergies with its own activities) and if so under what conditions, e.g. subject to compensation. There can be circumstances where an independent party would be willing to pay, e.g. if the financial costs and social risks of closing down the activity would be such that the transferor finds it more advantageous to pay a transferee who will attempt to reconvert the activity and will be responsible for any redundancy plan that may be needed ...

Not every case where a restructured entity experiences a reduction of its functions, assets and risks involves an actual loss of expected future profits. In some restructuring situations, the circumstances may be such that, rather than losing a “profit-making opportunity”, the restructured entity is actually being saved from the likelihood of a “loss-making opportunity”. An entity may agree to a restructuring as a better option than going out of business altogether. If the restructured entity is forecasting future losses absent the restructuring (e.g. it operates a manufacturing plant that is uneconomic due to increasing competition from low-cost imports), then there may be in fact no loss of any profit-making opportunity from restructuring rather than continuing to operate its existing business. In such circumstances, the restructuring might deliver a benefit to the restructured entity from reducing or eliminating future losses if such losses exceed the restructuring costs ...

An example is the case where a manufacturing activity that used to be performed by M1, one entity of the MNE group, is re-located to another entity, M2 (e.g. to benefit from location savings). Assume M1 transfers to M2 its machinery and equipment, inventories, patents, manufacturing processes and know-how, and key contracts with suppliers and clients. Assume that several employees of M1 are relocated to M2 in order to assist M2 in the start of the manufacturing activity so relocated. Assume such a transfer would be regarded as a transfer of an ongoing concern, should it take place between independent parties. In order to determine the arm’s length remuneration, if any, of such a transfer between associated enterprises, it should be compared with a transfer of an ongoing concern between independent parties rather than with a transfer of isolated assets ...

The determination of the arm’s length compensation for a transfer of an ongoing concern does not necessarily amount to the sum of the separate valuations of each separate element that comprises the aggregate transfer. In particular, if the transfer of an ongoing concern comprises multiple contemporaneous transfers of interrelated assets, risks, or functions, valuation of those transfers on an aggregate basis may be necessary to achieve the most reliable measure of the arm’s length price for the ongoing concern. Valuation techniques that are used, in acquisition deals, between independent parties may prove useful to valuing the transfer of an ongoing concern between associated enterprises. The guidance on the use of valuation techniques for transactions involving the transfer of intangibles or rights in intangibles contained in Section D.2.6.3 of Chapter VI should be considered ...

Business restructurings sometimes involve the transfer of an ongoing concern, i.e. a functioning, economically integrated business unit. The transfer of an ongoing concern in this context means the transfer of assets, bundled with the ability to perform certain functions and assume certain risks. Such functions, assets and risks may include, among other things: tangible property and intangibles; liabilities associated with holding certain assets and performing certain functions, such as R&D and manufacturing; the capacity to carry on the activities that the transferor carried on before the transfer; and any resource, capabilities, and rights. The valuation of a transfer of an ongoing concern should reflect all the valuable elements that would be remunerated between independent parties in comparable circumstances. See Section A.4.6 of Chapter VI. For example, in the case of a business restructuring that involves the transfer of a business unit that includes, among other things, research facilities staffed with an experienced research team, the valuation of such ongoing concern should reflect, among other things, the value of the facility and the impact (e.g. time and expense savings) of the assembled workforce on the arm’s length price. For a discussion on the transfer pricing treatment of assembled workforce, see Section D.7 of Chapter I ...

Tax administrations have expressed concerns about cases they have observed in practice where an entity voluntarily terminates a contract that provided benefits to it, in order to allow a foreign associated enterprise to enter into a similar contract and benefit from the profit potential attached to it. For instance, assume that company A has valuable long-term contracts with independent customers that carry significant profit potential for A. Assume that at a certain point in time, A voluntarily terminates its contracts with its customers under circumstances where the latter are legally or commercially obligated to enter into similar arrangements with company B, a foreign entity that belongs to the same MNE group as A. As a consequence, the contractual rights and attached profit potential that used to lie with A now lie with B. If the factual situation is that B could only enter into the contracts with the customers subject to A’s surrendering its own contractual rights to its benefit, and that A only terminated its contracts with its customers knowing that the latter were legally or commercially obligated to conclude similar arrangements with B, this in substance would consist in a tri-partite transaction and it may amount to a transfer of valuable contractual rights from A to B that may have to be remunerated at arm’s length, depending on the value of the rights surrendered by A from the perspectives of both A and B ...

Contractual rights can be valuable intangibles. Where valuable contractual rights are transferred (or surrendered) between associated enterprises, they should be remunerated at arm’s length, taking account of the value of the rights transferred from the perspectives of both the transferor and the transferee ...

In particular, in the case of the conversion of a full-fledged distributor into, for example, a limited risk distributor or commissionnaire, it may be important to examine whether the distributor has developed local marketing intangibles over the years prior to its being restructured and if so, what the nature and the value of these intangibles are, and whether they were transferred to an associated enterprise. Where such local intangibles are found to be in existence and to be transferred to a foreign associated enterprise, the arm’s length principle should apply to determine whether and if so how to compensate such a transfer, based on what would be agreed between independent parties in comparable circumstances. In this regard it is relevant to note that the transferor should receive arm’s length compensation (in addition to the arm’s length compensation for the transferred intangibles) when after the restructuring it continues to perform functions related to the development, enhancement, maintenance, protection or exploitation of the local intangible transferred (see Section B.2. 1 of Chapter VI). On the other hand, where such local intangibles are found to be in existence and to remain in the restructured entity, they should be taken into account in the functional analysis of the post-restructuring activities. They may accordingly influence the selection and application of the most appropriate transfer pricing method for the post-restructuring controlled transactions, in order that appropriate compensation can be determined ...

Where a local full-fledged operation is converted into an operation assuming limited risk, using limited intangibles and receiving low remuneration, the questions arise of whether this conversion entails the transfer by the restructured local entity to a foreign associated enterprise of valuable intangibles or rights in intangibles and whether there are local intangibles that remain with the local operation ...

In addition, where the intangible being transferred as a result of the restructuring meets the criteria for being considered a hard-to value-intangible in paragraph 6.189, then the guidance in Section D.4 of Chapter VI is applicable ...

Difficulties can arise in the context of business restructuring where the valuation of an intangible or rights in an intangible at the time of the transaction is highly uncertain. In these cases, the question arises as to how arm’s length pricing should be determined. The question should be resolved, both by taxpayers and tax administrations, by reference to what independent enterprises would have done in comparable circumstances to take account of the valuation uncertainty in the pricing of the transaction. To this aim, the guidance in Section D.3 of Chapter VI is relevant ...

Where the business restructuring provides for a transfer of an intangible followed by a new arrangement whereby the transferor will continue to use the intangible transferred, the entirety of the commercial arrangement between the parties should be examined in order to accurately delineate the transaction. If an independent party were to transfer an asset that it intends to continue exploiting, it would be prudent for it to negotiate the conditions of such a future use (e.g. in a license agreement) concomitantly with the conditions of the transfer. In effect, there will generally be a relationship between the determination of an arm’s length compensation for the transfer, the determination of an arm’s length compensation for the post-restructuring transactions in relation to the transferred intangible, such as future licence fees that may be payable by the transferor to be able to continue using the asset, and the expected future profitability of the transferor from its future use of the asset. For instance, in an arrangement whereby a patent is transferred for a price of 100 in Year N and a licence agreement is concomitantly concluded according to which the transferor will continue to use the patent transferred in exchange for a royalty of 100 per year over a 10-year period, it is likely that at least one of the two prices is not arm’s length or that the arrangement should be delineated as something other than a sale and concomitant license back. In some circumstances, the accurate delineation of the transaction might conclude that the arrangements reflect the provision of financing, as illustrated in Example 16 of Annex I to Chapter VI ...

Also in the case where a local operation disposes of the legal ownership of its intangibles to a foreign associated enterprise and continues to use the intangibles further to the disposal, but does so in a different legal capacity (e.g. as a licensee), the conditions of the transfer should be assessed from both the transferor’s and the transferee’s perspectives. The determination of an arm’s length remuneration for the subsequent ownership, control and exploitation of the transferred intangible should take account of the extent of the functions performed, assets used and risks assumed by the parties in relation to the intangible transferred, and in particular analysing control of risks and control of functions performed relating to the development, enhancement, maintenance, protection, or exploitation of the intangibles ...

The arm’s length principle requires an evaluation of the conditions made or imposed between associated enterprises, at the level of each of them. The fact that centralisation of legal ownership of intangibles may be motivated by sound commercial reasons at the level of the MNE group does not answer the question whether the conditions of the transfer are arm’s length from the perspectives of both the transferor and the transferee ...

MNE groups may have sound business reasons to centralise ownership of intangibles or rights in intangibles. An example in the context of business restructuring is a transfer of legal ownership of intangibles that accompanies the specialisation of manufacturing sites within an MNE group. In a pre-restructuring environment, each manufacturing entity may be the owner and manager of a series of patents – for instance if the manufacturing sites were historically acquired from third parties with their intangibles. In a global business model, each manufacturing site can be specialised by type of manufacturing process or by geographical area rather than by patent. As a consequence of such a restructuring the MNE group might proceed with the transfer of all the locally owned patents to a central location which will in turn give contractual rights (through licences or manufacturing agreements) to all the group’s manufacturing sites to manufacture the products falling in their new areas of competence, using patents that were initially owned either by the same or by another entity within the group. In such a scenario it will be important to delineate the actual transaction and to understand whether the transfer of legal ownership is for administrative simplicity (as in Example 1 of Annex I to Chapter VI), or whether the restructuring changes the identity of the parties performing or controlling functions related to the development, enhancement, maintenance, protection, and exploitation of intangibles ...

Business restructurings sometimes involve the transfer of the legal ownership of intangibles or rights in intangibles that were previously owned by one or more local operation(s) to a central location situated in another tax jurisdiction (e.g. a foreign associated enterprise that operates as a principal or as a so-called “IP company”). In some cases the transferor continues to use the intangible transferred, but does so in another legal capacity (e.g. as a licensee of the transferee, or through a contract that includes limited rights to the intangible such as a contract manufacturing arrangement using patents that were transferred; or a limited risk distribution arrangement using a trademark that was transferred). In accordance with the guidance in Chapter VI, it is important to remember that the legal ownership of an intangible by itself does not confer any right ultimately to retain returns derived by the MNE group from exploiting that intangible (see 6.42). Instead, the compensation required to be paid to associated enterprises performing or controlling functions related to the development, enhancement, maintenance, protection, or exploitation of intangibles may comprise any share of the total return anticipated to be derived from the intangibles (see 6.54). Therefore, the change in legal ownership of an intangible in a business restructuring may not affect which party is entitled to returns from that intangible ...

The determination of the arm’s length price for a transfer of intangibles or rights in intangibles should be conducted in accordance with the guidance in Section D. 1 of Chapter VI. It will be affected by a number of factors among which are the amount, duration and riskiness of the expected benefits from the exploitation of the intangible, the nature of the intangible right and the restrictions that may be attached to it (restrictions in the way it can be used or exploited, geographical restrictions, time limitations), the extent and remaining duration of its legal protection (if any), and any exclusivity clause that might be attached to the right. See Section D.2. 1 of Chapter VI. Valuation of intangibles can be complex and uncertain. The general guidance on intangibles and on cost contribution arrangements that is found in Chapters VI and VIII is applicable in the context of business restructurings ...

Transfers of intangibles or rights in intangibles raise difficult questions both as to the identification of the intangibles transferred and as to their valuation. Identification can be difficult because not all valuable intangibles are legally protected and registered and not all valuable intangibles are recognised or recorded for accounting purposes. Relevant intangibles might potentially include rights to use industrial assets such as patents, trademarks, trade names, designs or models, as well as copyrights of literary, artistic or scientific work (including software) and intellectual property such as know-how and trade secrets. They may also include customer lists, distribution channels, unique names, symbols or pictures. An essential part of the analysis of a business restructuring is to identify with specificity the relevant intangibles or rights in intangibles that were transferred (if any), whether independent parties would have remunerated their transfer, and what their arm’s length value is ...

In practice, what to do about inventory at the time of the restructuring would likely be taken into account by unrelated parties in agreeing the terms of the total deal, and inventory should be analysed as part of delineating the actual transactions comprising the business restructuring. A key consideration is how to deal with the risks inherent in the inventory, and how to avoid double counting—i.e. the party reducing its risks should not receive a price that takes into account risks it has given up, and cannot exploit. If raw materials costing 100 now have a market price of 80 or 120, then a transfer would crystallise a loss or gain which could be a significant impediment to one of the parties to the restructuring. The matter is likely to be resolved as part of the overall terms of the restructuring and should be analysed accordingly. In practice there may be a transition period where inventory is run down before starting the new arrangements, and thus avoiding transfer of inventory, particularly when there may be several complications beyond transfer pricing involved in transferring legal ownership of inventory cross-border ...

The choice of the appropriate transfer pricing method depends in part on which part of the transaction is the less complex and can be evaluated with the greater certainty (the functions performed, assets used and risks assumed by the manufacturer, or the marketing and sales functions that remain to be performed taking account of the assets to be used and risks to be assumed to perform these functions). See paragraphs 3.18-3.19 on the choice of the tested party ...

Assume that in order to migrate from the pre-existing arrangement to the restructured one, the raw materials and finished products that are on the balance sheet of the taxpayer at the time the new arrangement is put in place are transferred to the foreign associated enterprise. The question arises how to determine the arm’s length transfer price for the inventories upon the conversion. This is an issue that can typically be encountered where there is a transition from one business model to another. The arm’s length principle applies to transfers of inventory among associated enterprises situated in different tax jurisdictions. The choice of the appropriate transfer pricing method depends upon the comparability (including functional) analysis of the parties. The functional analysis may have to cover a transition period over which the transfer is being implemented. For instance, in the above example: One possibility could be to determine the arm’s length price for the raw material and finished products by reference to comparable uncontrolled prices, to the extent the comparability factors can be met by such comparable uncontrolled prices, i.e. that the conditions of the uncontrolled transaction are comparable to the conditions of the transfer that takes place in the context of the restructuring. Another possibility could be to determine the transfer price for the finished products as the resale price to customers minus an arm’s length remuneration for the marketing and distribution functions that still remain to be performed. A further possibility would be to start from the manufacturing costs and add an arm’s length mark-up to remunerate the manufacturer for the functions it performed, assets it used and risks it assumed with respect to these inventories. There are however cases where the market value of the inventories is too low for a profit element to be added on costs at arm’s length ...

Assume the arrangement is restructured and the taxpayer now operates as a so-called “toll-manufacturer” and “limited risk distributor”. As part of the restructuring, a foreign associated enterprise is established that acquires various intangibles from various affiliates including the taxpayer. Further to the restructuring, raw materials are to be acquired by the foreign associated enterprise, put in consignment in the premises of the taxpayer for manufacturing in exchange for a manufacturing fee. The stock of finished products will belong to the foreign associated enterprise and be acquired by the taxpayer for immediate re-sale to third party customers (i.e. the taxpayer will only purchase the finished products once it has concluded a sale with a customer). Under this new business model, the foreign associated enterprise contractually assumes the inventory risks that were previously borne by the taxpayer, and meets the requirements of control over the risk and financial capacity to assume the risk ...

Assume a taxpayer, which is a member of an MNE group, used to operate as a “full-fledged” manufacturer and distributor. According to the pre-restructuring business model, the taxpayer purchased raw materials, manufactured finished products using tangible property and intangibles that belonged to it or were rented/licensed to it, performed marketing and distribution functions and sold the finished products to third party customers. In doing so, the taxpayer assumed a series of risks such as inventory risks, bad debt risks and market risks ...

Business restructurings can involve the transfer of tangible assets (e.g. equipment) by a restructured entity to a foreign associated enterprise. One common issue relates to the valuation of inventories that are transferred upon the conversion by a restructured manufacturer or distributor to a foreign associated enterprise (e.g. a principal), where the latter takes title to the inventories as from the implementation of the new business model and supply chain arrangements ...

Sections E. 1 to E.3 below contain a discussion of some typical transfers that can arise in business restructurings: transfers of tangible assets, of intangibles and rights in intangibles, and of activities (ongoing concern) ...

In outsourcing cases, it may happen that a party voluntarily decides to undergo a restructuring and to bear the associated restructuring costs in exchange for anticipated savings. For instance, assume a taxpayer that is manufacturing and selling products in a high-cost jurisdiction decides to outsource the manufacturing activity to an associated enterprise situated in a low-cost jurisdiction. Further to the restructuring, the taxpayer will purchase from its associated enterprise the products manufactured and will continue to sell them to third party customers. The restructuring may entail restructuring costs for the taxpayer while at the same time making it possible for it to benefit from cost savings on future procurements compared to its own manufacturing costs. Independent parties implementing this type of outsourcing arrangement may not necessarily require explicit compensation from the transferee, for example, where the anticipated benefits for the transferor are greater than its restructuring costs ...

The situation might however be different where the loss-making activity provided other benefits such as synergies with other activities performed by the same taxpayer. There can also be circumstances where a loss-making activity is maintained because it produces some benefits to the group as a whole. In such a case, the question arises whether at arm’s length the entity that maintains the loss-making activity should be compensated by those who benefit from it being maintained. See Section D.3 of Chapter I ...

The question may arise of whether the transferee should in fact be compensated by the transferor for taking over a loss-making activity. The response depends on whether an independent party in comparable circumstances would have been willing to pay for getting rid of the loss-making activity, or whether it would have considered other options such as closing down the activity; and on whether a third party would have been willing to acquire the loss-making activity (e.g. because of possible synergies with its own activities) and if so under what conditions, e.g. subject to compensation. There can be circumstances where an independent party would be willing to pay, e.g. if the financial costs and social risks of closing down the activity would be such that the transferor finds it more advantageous to pay a transferee who will attempt to reconvert the activity and will be responsible for any redundancy plan that may be needed ...

Not every case where a restructured entity experiences a reduction of its functions, assets and risks involves an actual loss of expected future profits. In some restructuring situations, the circumstances may be such that, rather than losing a “profit-making opportunity”, the restructured entity is actually being saved from the likelihood of a “loss-making opportunity”. An entity may agree to a restructuring as a better option than going out of business altogether. If the restructured entity is forecasting future losses absent the restructuring (e.g. it operates a manufacturing plant that is uneconomic due to increasing competition from low-cost imports), then there may be in fact no loss of any profit-making opportunity from restructuring rather than continuing to operate its existing business. In such circumstances, the restructuring might deliver a benefit to the restructured entity from reducing or eliminating future losses if such losses exceed the restructuring costs ...

An example is the case where a manufacturing activity that used to be performed by M1, one entity of the MNE group, is re-located to another entity, M2 (e.g. to benefit from location savings). Assume M1 transfers to M2 its machinery and equipment, inventories, patents, manufacturing processes and know-how, and key contracts with suppliers and clients. Assume that several employees of M1 are relocated to M2 in order to assist M2 in the start of the manufacturing activity so relocated. Assume such a transfer would be regarded as a transfer of an ongoing concern, should it take place between independent parties. In order to determine the arm’s length remuneration, if any, of such a transfer between associated enterprises, it should be compared with a transfer of an ongoing concern between independent parties rather than with a transfer of isolated assets ...

The determination of the arm’s length compensation for a transfer of an ongoing concern does not necessarily amount to the sum of the separate valuations of each separate element that comprises the aggregate transfer. In particular, if the transfer of an ongoing concern comprises multiple contemporaneous transfers of interrelated assets, risks, or functions, valuation of those transfers on an aggregate basis may be necessary to achieve the most reliable measure of the arm’s length price for the ongoing concern. Valuation techniques that are used, in acquisition deals, between independent parties may prove useful to valuing the transfer of an ongoing concern between associated enterprises. The guidance on the use of valuation techniques for transactions involving the transfer of intangibles or rights in intangibles contained in Section D.2.6.3 of Chapter VI should be considered ...

Business restructurings sometimes involve the transfer of an ongoing concern, i.e. a functioning, economically integrated business unit. The transfer of an ongoing concern in this context means the transfer of assets, bundled with the ability to perform certain functions and assume certain risks. Such functions, assets and risks may include, among other things: tangible property and intangibles; liabilities associated with holding certain assets and performing certain functions, such as R&D and manufacturing; the capacity to carry on the activities that the transferor carried on before the transfer; and any resource, capabilities, and rights. The valuation of a transfer of an ongoing concern should reflect all the valuable elements that would be remunerated between independent parties in comparable circumstances. See Section A.4.6 of Chapter VI. For example, in the case of a business restructuring that involves the transfer of a business unit that includes, among other things, research facilities staffed with an experienced research team, the valuation of such ongoing concern should reflect, among other things, the value of the facility and the impact (e.g. time and expense savings) of the assembled workforce on the arm’s length price. For a discussion on the transfer pricing treatment of assembled workforce, see Section D.7 of Chapter I ...

Tax administrations have expressed concerns about cases they have observed in practice where an entity voluntarily terminates a contract that provided benefits to it, in order to allow a foreign associated enterprise to enter into a similar contract and benefit from the profit potential attached to it. For instance, assume that company A has valuable long-term contracts with independent customers that carry significant profit potential for A. Assume that at a certain point in time, A voluntarily terminates its contracts with its customers under circumstances where the latter are legally or commercially obligated to enter into similar arrangements with company B, a foreign entity that belongs to the same MNE group as A. As a consequence, the contractual rights and attached profit potential that used to lie with A now lie with B. If the factual situation is that B could only enter into the contracts with the customers subject to A’s surrendering its own contractual rights to its benefit, and that A only terminated its contracts with its customers knowing that the latter were legally or commercially obligated to conclude similar arrangements with B, this in substance would consist in a tri-partite transaction and it may amount to a transfer of valuable contractual rights from A to B that may have to be remunerated at arm’s length, depending on the value of the rights surrendered by A from the perspectives of both A and B ...

Contractual rights can be valuable intangibles. Where valuable contractual rights are transferred (or surrendered) between associated enterprises, they should be remunerated at arm’s length, taking account of the value of the rights transferred from the perspectives of both the transferor and the transferee ...

In particular, in the case of the conversion of a full-fledged distributor into, for example, a limited risk distributor or commissionnaire, it may be important to examine whether the distributor has developed local marketing intangibles over the years prior to its being restructured and if so, what the nature and the value of these intangibles are, and whether they were transferred to an associated enterprise. Where such local intangibles are found to be in existence and to be transferred to a foreign associated enterprise, the arm’s length principle should apply to determine whether and if so how to compensate such a transfer, based on what would be agreed between independent parties in comparable circumstances. In this regard it is relevant to note that the transferor should receive arm’s length compensation (in addition to the arm’s length compensation for the transferred intangibles) when after the restructuring it continues to perform functions related to the development, enhancement, maintenance, protection or exploitation of the local intangible transferred (see Section B.2. 1 of Chapter VI). On the other hand, where such local intangibles are found to be in existence and to remain in the restructured entity, they should be taken into account in the functional analysis of the post-restructuring activities. They may accordingly influence the selection and application of the most appropriate transfer pricing method for the post-restructuring controlled transactions, in order that appropriate compensation can be determined ...

Where a local full-fledged operation is converted into an operation assuming limited risk, using limited intangibles and receiving low remuneration, the questions arise of whether this conversion entails the transfer by the restructured local entity to a foreign associated enterprise of valuable intangibles or rights in intangibles and whether there are local intangibles that remain with the local operation ...

In addition, where the intangible being transferred as a result of the restructuring meets the criteria for being considered a hard-to value-intangible in paragraph 6.189, then the guidance in Section D.4 of Chapter VI is applicable ...

Difficulties can arise in the context of business restructuring where the valuation of an intangible or rights in an intangible at the time of the transaction is highly uncertain. In these cases, the question arises as to how arm’s length pricing should be determined. The question should be resolved, both by taxpayers and tax administrations, by reference to what independent enterprises would have done in comparable circumstances to take account of the valuation uncertainty in the pricing of the transaction. To this aim, the guidance in Section D.3 of Chapter VI is relevant ...

Where the business restructuring provides for a transfer of an intangible followed by a new arrangement whereby the transferor will continue to use the intangible transferred, the entirety of the commercial arrangement between the parties should be examined in order to accurately delineate the transaction. If an independent party were to transfer an asset that it intends to continue exploiting, it would be prudent for it to negotiate the conditions of such a future use (e.g. in a license agreement) concomitantly with the conditions of the transfer. In effect, there will generally be a relationship between the determination of an arm’s length compensation for the transfer, the determination of an arm’s length compensation for the post-restructuring transactions in relation to the transferred intangible, such as future licence fees that may be payable by the transferor to be able to continue using the asset, and the expected future profitability of the transferor from its future use of the asset. For instance, in an arrangement whereby a patent is transferred for a price of 100 in Year N and a licence agreement is concomitantly concluded according to which the transferor will continue to use the patent transferred in exchange for a royalty of 100 per year over a 10-year period, it is likely that at least one of the two prices is not arm’s length or that the arrangement should be delineated as something other than a sale and concomitant license back. In some circumstances, the accurate delineation of the transaction might conclude that the arrangements reflect the provision of financing, as illustrated in Example 16 of the Annex to Chapter VI ...

Also in the case where a local operation disposes of the legal ownership of its intangibles to a foreign associated enterprise and continues to use the intangibles further to the disposal, but does so in a different legal capacity (e.g. as a licensee), the conditions of the transfer should be assessed from both the transferor’s and the transferee’s perspectives. The determination of an arm’s length remuneration for the subsequent ownership, control and exploitation of the transferred intangible should take account of the extent of the functions performed, assets used and risks assumed by the parties in relation to the intangible transferred, and in particular analysing control of risks and control of functions performed relating to the development, enhancement, maintenance, protection, or exploitation of the intangibles ...

The arm’s length principle requires an evaluation of the conditions made or imposed between associated enterprises, at the level of each of them. The fact that centralisation of legal ownership of intangibles may be motivated by sound commercial reasons at the level of the MNE group does not answer the question whether the conditions of the transfer are arm’s length from the perspectives of both the transferor and the transferee ...

MNE groups may have sound business reasons to centralise ownership of intangibles or rights in intangibles. An example in the context of business restructuring is a transfer of legal ownership of intangibles that accompanies the specialisation of manufacturing sites within an MNE group. In a pre-restructuring environment, each manufacturing entity may be the owner and manager of a series of patents – for instance if the manufacturing sites were historically acquired from third parties with their intangibles. In a global business model, each manufacturing site can be specialised by type of manufacturing process or by geographical area rather than by patent. As a consequence of such a restructuring the MNE group might proceed with the transfer of all the locally owned patents to a central location which will in turn give contractual rights (through licences or manufacturing agreements) to all the group’s manufacturing sites to manufacture the products falling in their new areas of competence, using patents that were initially owned either by the same or by another entity within the group. In such a scenario it will be important to delineate the actual transaction and to understand whether the transfer of legal ownership is for administrative simplicity (as in Example 1 of the Annex to Chapter VI), or whether the restructuring changes the identity of the parties performing or controlling functions related to the development, enhancement, maintenance, protection, and exploitation of intangibles ...

Business restructurings sometimes involve the transfer of the legal ownership of intangibles or rights in intangibles that were previously owned by one or more local operation(s) to a central location situated in another tax jurisdiction (e.g. a foreign associated enterprise that operates as a principal or as a so-called “IP company”). In some cases the transferor continues to use the intangible transferred, but does so in another legal capacity (e.g. as a licensee of the transferee, or through a contract that includes limited rights to the intangible such as a contract manufacturing arrangement using patents that were transferred; or a limited risk distribution arrangement using a trademark that was transferred). In accordance with the guidance in Chapter VI, it is important to remember that the legal ownership of an intangible by itself does not confer any right ultimately to retain returns derived by the MNE group from exploiting that intangible (see 6.42). Instead, the compensation required to be paid to associated enterprises performing or controlling functions related to the development, enhancement, maintenance, protection, or exploitation of intangibles may comprise any share of the total return anticipated to be derived from the intangibles (see 6.54). Therefore, the change in legal ownership of an intangible in a business restructuring may not affect which party is entitled to returns from that intangible ...

The determination of the arm’s length price for a transfer of intangibles or rights in intangibles should be conducted in accordance with the guidance in Section D. 1 of Chapter VI. It will be affected by a number of factors among which are the amount, duration and riskiness of the expected benefits from the exploitation of the intangible, the nature of the intangible right and the restrictions that may be attached to it (restrictions in the way it can be used or exploited, geographical restrictions, time limitations), the extent and remaining duration of its legal protection (if any), and any exclusivity clause that might be attached to the right. See Section D.2. 1 of Chapter VI. Valuation of intangibles can be complex and uncertain. The general guidance on intangibles and on cost contribution arrangements that is found in Chapters VI and VIII is applicable in the context of business restructurings ...

Transfers of intangibles or rights in intangibles raise difficult questions both as to the identification of the intangibles transferred and as to their valuation. Identification can be difficult because not all valuable intangibles are legally protected and registered and not all valuable intangibles are recognised or recorded for accounting purposes. Relevant intangibles might potentially include rights to use industrial assets such as patents, trademarks, trade names, designs or models, as well as copyrights of literary, artistic or scientific work (including software) and intellectual property such as know-how and trade secrets. They may also include customer lists, distribution channels, unique names, symbols or pictures. An essential part of the analysis of a business restructuring is to identify with specificity the relevant intangibles or rights in intangibles that were transferred (if any), whether independent parties would have remunerated their transfer, and what their arm’s length value is ...

In practice, what to do about inventory at the time of the restructuring would likely be taken into account by unrelated parties in agreeing the terms of the total deal, and inventory should be analysed as part of delineating the actual transactions comprising the business restructuring. A key consideration is how to deal with the risks inherent in the inventory, and how to avoid double counting—i.e. the party reducing its risks should not receive a price that takes into account risks it has given up, and cannot exploit. If raw materials costing 100 now have a market price of 80 or 120, then a transfer would crystallise a loss or gain which could be a significant impediment to one of the parties to the restructuring. The matter is likely to be resolved as part of the overall terms of the restructuring and should be analysed accordingly. In practice there may be a transition period where inventory is run down before starting the new arrangements, and thus avoiding transfer of inventory, particularly when there may be several complications beyond transfer pricing involved in transferring legal ownership of inventory cross-border ...

The choice of the appropriate transfer pricing method depends in part on which part of the transaction is the less complex and can be evaluated with the greater certainty (the functions performed, assets used and risks assumed by the manufacturer, or the marketing and sales functions that remain to be performed taking account of the assets to be used and risks to be assumed to perform these functions). See paragraphs 3.18-3.19 on the choice of the tested party ...

Assume that in order to migrate from the pre-existing arrangement to the restructured one, the raw materials and finished products that are on the balance sheet of the taxpayer at the time the new arrangement is put in place are transferred to the foreign associated enterprise. The question arises how to determine the arm’s length transfer price for the inventories upon the conversion. This is an issue that can typically be encountered where there is a transition from one business model to another. The arm’s length principle applies to transfers of inventory among associated enterprises situated in different tax jurisdictions. The choice of the appropriate transfer pricing method depends upon the comparability (including functional) analysis of the parties. The functional analysis may have to cover a transition period over which the transfer is being implemented. For instance, in the above example: One possibility could be to determine the arm’s length price for the raw material and finished products by reference to comparable uncontrolled prices, to the extent the comparability factors can be met by such comparable uncontrolled prices, i.e. that the conditions of the uncontrolled transaction are comparable to the conditions of the transfer that takes place in the context of the restructuring. Another possibility could be to determine the transfer price for the finished products as the resale price to customers minus an arm’s length remuneration for the marketing and distribution functions that still remain to be performed. A further possibility would be to start from the manufacturing costs and add an arm’s length mark-up to remunerate the manufacturer for the functions it performed, assets it used and risks it assumed with respect to these inventories. There are however cases where the market value of the inventories is too low for a profit element to be added on costs at arm’s length ...

Assume the arrangement is restructured and the taxpayer now operates as a so-called “toll-manufacturer” and “limited risk distributor”. As part of the restructuring, a foreign associated enterprise is established that acquires various intangibles from various affiliates including the taxpayer. Further to the restructuring, raw materials are to be acquired by the foreign associated enterprise, put in consignment in the premises of the taxpayer for manufacturing in exchange for a manufacturing fee. The stock of finished products will belong to the foreign associated enterprise and be acquired by the taxpayer for immediate re-sale to third party customers (i.e. the taxpayer will only purchase the finished products once it has concluded a sale with a customer). Under this new business model, the foreign associated enterprise contractually assumes the inventory risks that were previously borne by the taxpayer, and meets the requirements of control over the risk and financial capacity to assume the risk ...

Assume a taxpayer, which is a member of an MNE group, used to operate as a “full-fledged” manufacturer and distributor. According to the pre-restructuring business model, the taxpayer purchased raw materials, manufactured finished products using tangible property and intangibles that belonged to it or were rented/licensed to it, performed marketing and distribution functions and sold the finished products to third party customers. In doing so, the taxpayer assumed a series of risks such as inventory risks, bad debt risks and market risks ...

Business restructurings can involve the transfer of tangible assets (e.g. equipment) by a restructured entity to a foreign associated enterprise. One common issue relates to the valuation of inventories that are transferred upon the conversion by a restructured manufacturer or distributor to a foreign associated enterprise (e.g. a principal), where the latter takes title to the inventories as from the implementation of the new business model and supply chain arrangements ...

Sections E. 1 to E.3 below contain a discussion of some typical transfers that can arise in business restructurings: transfers of tangible assets, of intangibles and rights in intangibles, and of activities (ongoing concern) ...