Transfer Pricing and Intangibles

Preface xxvii
Abbreviations xxxi
Part 1
Chapter 1: Research Questions, Methodology and Sources of Law 3
1.1. Introductory comments 3
1.2. Key terminology and contextualization 6
1.3. Research questions and structure 12
1.4. Methodology 16
1.5. The relevant OECD sources of law 22
1.5.1. Introduction 22
1.5.2. Article 9 of the OECD MTC 23
1.5.3. The OECD Commentaries on Article 9 and the OECD Transfer Pricing Guidelines 24
1.5.4. Article 7 of the OECD MTC 28
1.5.5. The OECD Commentaries on Article 7 and the 2010 OECD Report 29
1.5.6. Case law in connection with articles 9 and 7 30
1.6. The relevant US sources of law 30
1.6.1. Introduction 30
1.6.2. IRC section 482 31
1.6.3. The IRC section 482 US Treasury Regulations 33
1.6.4. Case law 35
1.6.5. The OECD TPG 36
1.7. A few words on the 2017 US tax reform 37
1.8. The relationship between the book and other
transfer pricing literature 41
1.9. Reference register and source abbreviations 45

Chapter 2: Business and Tax Motivations for Intangible Value Chain Structures 47
2.1. Introduction 47
2.2. Horizontal and vertical FDI 48
2.3. To stay home (outsource) or to go out (FDI)? 50
2.4. The centralized principal model for profit allocation 52
2.5. IP regimes and the 2015 OECD nexus approach 54

Chapter 3: Controlled Intangibles Transfers 63
3.1. Introduction 63
3.2. The US intangibles definition 64
3.2.1. Introduction 64
3.2.2. The pre-2018 version of the US IP definition 65
3.2.2.1. Introductory comments 65
3.2.2.2. The relationship between the 936 definition and profit allocation 68
3.2.2.3. Are goodwill, going concern value and workforce in place encompassed by the pre-2018 version of the 936 definition? 71
3.2.2.4. Is goodwill distinguishable from synergy value attributable to a group of identifiable 936-definition intangibles valued in the aggregate? 79
3.2.2.5. Concluding comments on the pre-2018 version of the US IP definition 82
3.2.3. The 2018 version of the US IP definition (the 2017 tax reform amendment) 84
3.3. The OECD intangibles concept 85
3.4. Useful distinctions on the intangibles concept 88
3.4.1. Introduction 88
3.4.2. Manufacturing and marketing intangibles 88
3.4.3. Unique and non-unique value chain contributions 90
3.5. Controlled intangibles transfers subject to transfer pricing under US law 95
3.5.1. The taxation of US inbound and outbound intangibles transfers 95
3.5.2. The context in which IRC section 367 applies: Non-recognition transactions 97
3.5.3. The historical background of IRC section 367 98
3.5.4. Current gain recognition under IRC section 367(a) 99
3.5.5. Deemed royalty inclusions under IRC section 367(d) 104
3.5.5.1. Historical background 104
3.5.5.2. The material content of IRC section 367(d): Sale of contingent payments 105
3.5.6. Income recognition under section 367(a) or (d) for intangible transfers? 108
3.5.7. The further relationship between profit allocation under sections 482 and 367 109
3.5.8. The relationship between profit allocation under the section 482 cost-sharing regulations and section 367(d) 112
3.6. Controlled intangibles transfers subject to transfer pricing under the OECD TPG 116
3.7. Concluding comments 117

Chapter 4: Introduction to Part 2 119
Part 2
Chapter 5: The Historical Development of Profit-Based Transfer Pricing Methodology 125
5.1. Introduction 125
5.2. Development of the US PSM and the contract manufacturer theory through case law 126
5.2.1. Introduction 126
5.2.2. The 1968 regulations and their background 127
5.2.3. Three inbound cases: Nestlé, French and Ciba 129
5.2.3.1. Introduction 129
5.2.3.2. Nestlé (1963) 130
5.2.3.3. French (1963) 131
5.2.3.4. Ciba (1985) 135
5.2.4. Three outbound cases: Eli Lilly, Searle and Merck 136
5.2.4.1. Introduction 136
5.2.4.2. The historical tax treatment of investments in US possessions 137
5.2.4.3. Eli Lilly (1985) 137
5.2.4.4. Searle (1987) 142
5.2.4.5. Merck (1991) 143
5.2.5. Four roundtrip cases: Bausch, Sundstrand, Perkin and Seagate 145
5.2.5.1. Introduction 145
5.2.5.2. Bausch (1989) 146
5.2.5.3. Sundstrand (1991) 148
5.2.5.4. Perkin-Elmer (1993) 149
5.2.5.5. Seagate (1994) 150
5.2.6. Two cases on controlled services and sales contracts: DuPont (1979) and Hospital Corporation of America (1983) 152
5.3. US legislative and regulatory implementation of “profit-based” methods 153
5.3.1. Introduction 153
5.3.2. The 1986 tax reform 153
5.3.3. The 1988 White Paper 155
5.3.4. The 1994 US regulations 159
5.4. OECD implementation of “profit-based” transfer
pricing methodology 161
Chapter 6: Metaconcepts Underlying the US and OECD Profit Allocation Rules 165
6.1. Introduction 165
6.2. The relationship between operating profits and the transfer pricing methods 167
6.2.1. Introduction 167
6.2.2. The concept of operating profits 167
6.2.3. Delineating the components of operating profits 169
6.2.3.1. Sales 169
6.2.3.2. Costs of goods sold 170
6.2.3.3. Gross profit 170
6.2.3.4. Operating expenses 170
6.2.3.5. Net profit 171
6.2.4. Information on gross profits may be unavailable 172
6.2.5. Information on transaction-level profits may be unavailable 173
6.3. The relationship between gross and net profit methods 174
6.3.1. Introduction 174
6.3.2. Common methodological traits among the gross and net profit methods 175
6.3.3. Relevant parameters under the gross and net profit methods and their impact on reliability 178
6.3.4. Are operating expenses relevant under the transactional pricing methods (CUT, resale and cost-plus)? 181
6.3.5. Are comparability adjustments under the gross profit methods more reliable than under the net profit methods? 184
6.4. Which transfer pricing method should govern the profit allocation among value chain inputs? 187
6.5. The arm’s length range 190
6.5.1. Introduction 190
6.5.2. The level of comparability required to include an uncontrolled transaction in the arm’s length range 191
6.5.3. On which point within the arm’s length range may a reassessment be based? 194
6.6. Comparability 194
6.6.1. Introductory comments 194
6.6.2. The standard of comparability 197
6.6.3. Does the degree to which comparability is required vary among the pricing methods? 198
6.6.4. The relationship between comparability and the rules for determining ownership of intra-group-developed intangibles 199
6.6.5. Comparability factors 200
6.6.5.1. Introduction 200
6.6.5.2. Contractual terms 201
6.6.5.2.1. Introduction 201
6.6.5.2.2. Comparability of contractual terms 201
6.6.5.2.3. Economic substance and non-recognition 202
6.6.5.3. Functions 207
6.6.5.4. Economic conditions 208
6.6.5.4.1. Introduction 208
6.6.5.4.2. Use of comparables from other markets 209
6.6.5.4.3. Location savings 209
6.6.5.4.4. Temporary pricing strategies 210
6.6.5.5. Risks 211
6.6.5.5.1. Introductory comments on risk 211
6.6.5.5.2. Contractual risk allocation among group entities 213
6.6.5.5.3. Risks affect pricing, not the other way around 217
6.7. The aggregation of controlled transactions 217
6.7.1. Introduction 217
6.7.2. The US regulations 218
6.7.3. The OECD TPG 220
6.7.4. GlaxoSmithKline (Canada) 221
6.7.4.1. Introduction 221
6.7.4.2. The factual pattern 222
6.7.4.3. The 2008 Tax Court ruling 225
6.7.4.4. The 2012 Supreme Court ruling 230
6.7.4.5. Observations on the Supreme Court ruling 232

Chapter 7: Direct Transaction-Based Allocation of Residual Profits to Unique and Valuable IP: The CUT Method 237
7.1. Introduction 237
7.2. The US CUT method 238
7.2.1. Introduction 238
7.2.2. The purported CUT pertains to a transfer of the same intangible as transferred in the controlled transaction 238
7.2.3. The purported CUT pertains to a transfer of a different intangible than that transferred in the controlled transaction 239
7.2.3.1. Introduction 239
7.2.3.2. Direct assessment of profit potential 241
7.2.3.3. Indirect assessment of profit potential 241
7.2.3.4. Assessment of profit potential in other cases 242
7.2.4. There are no CUTs available 246
7.3. The OECD CUT method 247
7.3.1. Introduction 247
7.3.2. Comparability requirements for unique IP under the CUT method 248
7.3.3. Comparability adjustments for unique IP under the CUT method 249
7.3.4. Commercial databases 250
7.3.5. Concluding comments 251

Chapter 8: Indirect Profit-Based Allocation of Residual Profits for Unique and Valuable IP:
The CPM (US) and TNMM (OECD) 253
8.1. Introduction 253
8.2. A lead-in to the methodology 254
8.3. The scope of application of the methodology 257
8.4. How operating profits may be allocated to the tested party under the methodology 259
8.4.1. Introduction 259
8.4.2. Selecting an appropriate profit level indicator 259
8.4.3. Extracting the profit level indicator data from comparable independent enterprises 262
8.4.4. Applying the extracted profit level indicator data
to the tested party 264
8.5. Comparability under the CPM 265
8.6. Comparability under the TNMM 267
8.6.1. Introduction 267
8.6.2. The concept of blended profits illustrated by an example 268
8.6.3. The 1995 consensus text on the TNMM with respect to aggregation of transactions 273
8.6.4. The 2006 comparability report 277
8.6.5. The 2008 discussion draft 282
8.6.6. The final 2010 OECD TPG on the use of aggregated third-party profits as comparables 284
8.6.6.1. Introduction 284
8.6.6.2. The first norm: Aggregated third-party profits may be used as comparables as long as they are the result of “similar” third-party transactions 284
8.6.6.3. The second norm: Aggregated third-party profits may be used as comparables as long as they are not the result of “materially different” third-party transactions 285
8.6.6.4. The third norm: Aggregated third-party profits may be used as comparables if the total functions performed by the third party are closely aligned with the functions performed by the tested party with respect to the controlled transaction 287
8.6.6.5. Harmonizing the three norms through interpretation 289
8.6.6.6. Conclusion 292
8.6.7. Applying the 2010 OECD TPG rule to the golf ball example 294
8.7. Has the TNMM converged towards the 1988 White Paper BALRM? 295
8.8. Is reduced transactional comparability under the TNMM a significant problem? 297
8.9. Closing comments on comparability under the one-sided, profit-based methodology 299

Chapter 9: Direct Profit-Based Allocation of Residual Profits to Unique and Valuable IP: The Profit Split Method 301
9.1. Introduction 301
9.2. The scope of application of the methodology 302
9.2.1. Introduction 302
9.2.2. The US PSM 302
9.2.3. The OECD PSM 304
9.3. How operating profits may be split underthe methodology 311
9.3.1. Introduction 311
9.3.2. Profit split allocation patterns allowed under the US regulations 311
9.3.3. Profit split allocation patterns allowed under the OECD TPG 317
9.4. The PSM in valuation scenarios 320
9.5. The OECD PSM is limited to information known or reasonably foreseeable at the outset 323

Chapter 10: Location Savings, Local Market Characteristics and Synergies 327
10.1. Introduction 327
10.2. A lead-in to the topic: The incremental operating profits at stake 328
10.3. Which jurisdiction should be entitled to tax incremental operating profits: The basic arguments 330
10.4. What are location savings? 331
10.5. The allocation of cost savings 333
10.5.1. Introduction 333
10.5.2. Local comparables are available 333
10.5.3. Local comparables are unavailable 339
10.6. What are other LSAs? 341
10.7. The allocation of location rents 343
10.7.1. Introduction 343
10.7.2. Local comparables are available 343
10.7.3. Local comparables are unavailable 343
10.8. Synergies 344

Chapter 11: Transfer Pricing of Intangibles in the Post-BEPS Era under the OECD TPG 347
11.1. Introduction 347
11.2. A transfer pricing paradigm under pressure 347
11.3. Shall something more now be allocated to source jurisdictions? 350
11.4. The relative roles of the CUT method, TNMM and PSM for the transfer pricing of intangibles 355

Chapter 12: Allocation of Residual Profits for Unique and Valuable IP Based on Unspecified Pricing Methods 359
12.1. Introductory comments 359
12.2. Unspecified methods under the US regulations 361
12.3. Unspecified methods under the OECD TPG 363

Chapter 13: Allocation of Residual Profits to Unique and Valuable IP through Valuation 367
13.1. Introduction 367
13.2. The valuation techniques accepted under the OECD TPG 369
13.3. The valuation parameters in DCF-based valuation 371
13.3.1. Introduction 371
13.3.2. The estimation of future operating profits 371
13.3.3. The estimation of useful life, growth rates and terminal value 372
13.3.4. The estimation of discount rates 375
13.3.5. What are the consequences of using unreliable valuation parameters? 376
13.4. Allocation of the valuation amount among the controlled value chain contributions 376
13.5. The options realistically available as a restriction on the possible allocation outcomes 379
13.6. Is there a legal basis for applying a discount to the transfer price? 382

Chapter 14: Allocation of Residual Profits to Unique and Valuable IP through Cost-Sharing Structures 383
14.1. Introduction 383
14.2. Buy-in pricing under the US regulations 385
14.2.1. Introduction 385
14.2.2. The development of the US cost-sharing regulations 385
14.2.3. The 2007 Coordinated Issue Paper 389
14.2.4. Case law: Veritas (2009) 394
14.2.5. Case law: Amazon.com (2017) 401
14.2.6. Concluding comments on Veritas and Amazon.com 409
14.2.7. Key concepts under the current cost-sharing regulations 412
14.2.7.1. Introduction 412
14.2.7.2. Cost-sharing transactions 412
14.2.7.3. RAB share 412
14.2.7.4. Non-overlapping (ownership) interests in intangibles developed under the CSA 413
14.2.7.5. Platform contributions 414
14.2.8. The buy-in pricing methods 416
14.2.8.1. Introduction 416
14.2.8.2. The CUT method 417
14.2.8.3. The income method 418
14.2.8.4. The acquisition price method 425
14.2.8.5. The market capitalization method 426
14.2.8.6. The RPSM 427
14.2.8.7. Unspecified methods 430
14.3. Buy-in pricing under the OECD TPG 430
14.4. The relationship between US and OECD buy-in pricing 435

Chapter 15: Taxpayer-Initiated Compensating Adjustments to Indirect IP Pricing 437
15.1. Introduction 437
15.2. A lead-in to compensating adjustments 438
15.3. Taxpayer-initiated adjustments under US law 443
15.4. Year-end adjustments under the OECD TPG 447
15.5. Year-end adjustments in the European Union 451
15.6. Case law: Vingcard (Norway, 2012) 452
15.6.1. Introduction 452
15.6.2. The factual pattern of the case 453
15.6.3. The comparables supporting the taxpayer profit allocation 454
15.6.4. The contractual risk allocation 457
15.6.5. Concluding comments 459
15.7. Case law: ITCO (Italy, 2010) 460
15.8. Case law: H1 A/S (Denmark, 2010) 460
15.9. Case law: H1.1.1 A/S (Denmark, 2012) 461
15.10. The US GlaxoSmithKline settlement (2006) 462

Chapter 16: Periodic Adjustments of Controlled IP Transfer Pricing 465
16.1. Introduction 465
16.2. The development of the US periodic adjustment concept 465
16.2.1. Introduction 465
16.2.2. The 1985 House Report and the 1988 White Paper 466
16.2.3. The relationship between the transfer pricing methods and the periodic adjustment provision in the White Paper 470
16.2.4. Exceptions from the White Paper’s periodic adjustment provision 471
16.3. The US periodic adjustment provision 472
16.3.1. Introduction 472
16.3.2. The main rule: The profit allocation must be commensurate with income 472
16.3.3. Exceptions to the periodic adjustment rule 479
16.3.3.1. Introduction 479
16.3.3.2. First exception: Initial fixed pricing based on CUTs involving the same intangible (“genuine” CUT exception) 480
16.3.3.3. Second exception: Initial fixed pricing based on CUTs involving a comparable intangible (inexact CUT exception) 481
16.3.3.4. Third exception: Initial fixed pricing based on methods other than the CUT method 487
16.3.3.5. Fourth exception: Extraordinary events 488
16.3.4. Five-year cut-off rule 490
16.3.5. Concluding remarks on the exceptions 490
16.4. Periodic adjustments to lump-sum IP transfers under US law 491
16.5. The OECD periodic adjustment provision 493
16.6. Periodic adjustments of buy-in pricing under the US regulations 503
16.6.1. Introductory remarks 503
16.6.2. A periodic adjustment is triggered if the AERR is greater than the PRRR 504
16.6.3. Making a periodic adjustment: Applying the adjusted RPSM 507
16.6.4. The procedure for making a periodic adjustment to a buy-in payment illustrated 508
16.6.5. Exceptions to the periodic adjustment provision 514
16.6.5.1. Introduction 514
16.6.5.2. Exception: The initial buy-in pricing is based on a CUT involving the same platform contribution 514
16.6.5.3. Exception: Extraordinary events 514
16.6.5.4. Exception: Reduced AERR does not cause a periodic trigger 515
16.6.5.5. Exception: Increased AERR does not cause a periodic trigger 516
16.6.5.6. Exception: Cut-off rule 517
16.7. Periodic adjustments of buy-in pricing under the OECD TPG 517

Chapter 17: The Allocation of Residual Profits to a Permanent Establishment 519
17.1. Introduction 519
17.2. Historical background 520
17.3. The relationship between articles 7 and 9 522
17.4. The article 7 profit allocation system 523
17.4.1. Introduction 523
17.4.2. Assignment of assets, capital and risk to the PE 524
17.4.3. Assignment of transactions and dealings to the PE 528
17.5. Transfer pricing of the IP transactions and the dealings of a PE 529
17.6. Allocation of operating profits to a dependent agent PE 532
17.6.1. Introduction 532
17.6.2. A lead-in to the discussion 533
17.6.3. The OECD approach for allocating operating profits to a dependent agent PE 535
17.6.4. Is the dependent agent PE relevant? 537
17.7. The UN approach for allocating profits to a PE 543
17.7.1. Introduction 543
17.7.2. The allocation norm under article 7 of the 2011 UN MTC 544
17.7.3. The relationship between articles 7 and 9 of the UN MTC 547

Chapter 18: Introduction to Part 3 549
Part 3
Chapter 19: The Evolution of the US and OECD Approaches to Intangible Ownership 555
19.1. Introduction 555
19.2. Determination of IP ownership under the 1968 US regulations 556
19.2.1. Introduction 556
19.2.2. The DA rule 557
19.2.3. The DA rule was geared towards, but not limited to, manufacturing IP 559
19.2.4. Was the DA rule limited to the development of entirely new IP? 560
19.2.5. Case law on the DA rule 561
19.2.5.1. Introduction 561
19.2.5.2. GlaxoSmithKline Holdings v. CIR (2006) 561
19.2.5.2.1. Introductory comments 561
19.2.5.2.2. A lead-in to the case 562
19.2.5.2.3. The principal IRS argument that the US subsidiary was the developer 563
19.2.5.2.4. The secondary IRS argument that the US subsidiary was the assister 564
19.2.5.2.5. How would the case have been assessed under the DA rule? 566
19.2.5.3. DHL Corporation v. CIR (1998) 567
19.3. Determination of IP ownership under the 1992 proposed and 1993 temporary US regulations 571
19.4. Determination of IP ownership under the 1994 final US regulations 572
19.4.1. Introduction 572
19.4.2. Reason 1 for replacing the DA rule: Criticism against its treatment of the legal owner 573
19.4.3. Reason 2 for replacing the DA rule: OECD conformity 575
19.4.4. The point of departure under the 1994 IP ownership rules: The legal owner (of IP subject to legal protection) and the developer (of IP not subject to legal protection) are entitled to residual profits 577
19.4.5. The first exception to the legal ownership rule: Economic substance 580
19.4.6. The second exception to the legal ownership rule: The multiple owners rule (1994 cheese examples) 581
19.4.7. Concluding remarks on the 1994 US approach to intangible ownership 584
19.5. Determination of IP ownership under the historical OECD TPG 585

Chapter 20: A Lead-In to the Determination of IP Ownership under the US Regulations and OECD TPG: A Story about Legal Ownership, Control and Economic Substance 589
20.1. Introduction 589
20.2. The US regulations 590
20.2.1. Introduction 590
20.2.2. Legal ownership 590
20.2.3. The treatment of licensees 591
20.3. The OECD TPG 596
20.4. The determination of ownership of intangibles not subject to legal protection 597
20.5. Ownership and economic substance 597

Chapter 21: The Distribution among Group Entities of Residual Profits Generated through Exploitation of Internally Developed Manufacturing IP under the US Regulations 607
21.1. Introduction 607
21.2. The value drivers in manufacturing IP development 608
21.3. The economic substance exception applied to manufacturing IP 610
21.3.1. Introduction 610
21.3.2. The economic substance exception should not replace the transfer pricing methods 610
21.3.3. Imputation of contingent payment terms: A lead-in 612
21.3.4. Imputation of contingent payment terms base example: Successful contract R&D arrangement with contingent profit split payment structure 614
21.3.5. Imputation of contingent payment terms example: Unsuccessful contract R&D arrangement with contingent profit split payment structure 615
21.3.6. Imputation of contingent payment terms example: Successful contract R&D arrangement with cost-plus-based contingent payment structure 616
21.3.7. Concluding remarks on the application of the economic substance exception to impute contingent payment terms 617
21.4. The US stance on contract R&D arrangements in light of the 2015 provisions on the arm’s length standard and best-method rule 619

Chapter 22: The Distribution among Group Entities of Residual Profits Generated through Exploitation of Internally Developed Manufacturing IP under the OECD TPG 625
22.1. Introduction 625
22.2. A lead-in to the profit allocation problem for internally developed manufacturing IP 626
22.3. Profit allocation for IP development contributions: Functions 628
22.3.1. Introduction 628
22.3.2. The “important functions” doctrine 629
22.3.3. Outsourcing: Contract R&D arrangements 630
22.3.3.1. Introduction 630
22.3.3.2. The relationship between the 2015 OECD important-functions doctrine and the historical 2009 business restructuring and intra-group services guidance 631
22.3.3.3. The important-functions doctrine and contract R&D arrangements 634
22.3.3.4. Performance of important R&D functions through geographically dispersed employees 639
22.4. Profit allocation to IP development contributions:Funding 640
22.4.1. Introduction 640
22.4.2. A lead-in to the issue 640
22.4.3. Control over financial risk 643
22.4.4. The point of departure for determining the riskadjusted rate of return 646
22.4.5. Uncontrolled transaction analogy for determining the risk-adjusted rate of return: Venture capital financing 647
22.4.6. Do the OECD TPG examples contribute to the determination of the risk-adjusted rate of return allocable to the funding entity? 652
22.4.7. Do the US CSA regulations contribute to the determination of the risk-adjusted rate of return allocable to the funding entity? 655
22.4.8. Does the cost of capital contribute to the determination of the risk-adjusted rate of return allocable to the funding entity? 658
22.4.9. Do the financing alternatives realistically available contribute to the determination of the risk-adjusted rate of return allocable to the funding entity? 659
22.4.10. Does the financial risk assumed contribute to the determination of the risk-adjusted rate of return allocable to the funding entity? 663
22.4.11. Concluding comments on IP development funding 667
22.5. Profit allocation for IP development contributions: Pre-existing unique IP 672
22.5.1. Introduction 672
22.5.2. The point of departure for pricing the contribution of the pre-existing IP 673
22.5.3. The pre-existing IP is contributed by the same group entity that carries out the ongoing R&D functions 675
22.5.4. The pre-existing IP is contributed by a group entity different from that which carries out the ongoing R&D functions 677
22.5.5. Concluding remarks on the contribution of pre-existing IP to intangible development processes 679

Chapter 23: The Distribution among Group Entities of Residual Profits Generated through Exploitation of Internally Developed Marketing IP under the US Regulations 681
23.1. Introduction 681
23.2. A lead-in to the profit allocation problem for internally developed marketing IP 682
23.3. When are the US regulations unwilling to give pricing effect to foreign legal ownership on marketing IP due to a lack of economic substance? 684
23.3.1. Introduction 684
23.3.2. The wristwatch example: US distributor incurs incremental marketing expenditures to build local value of foreign-owned trademark 684
23.3.3. The athletic gear base example: US subsidiary incurs incremental marketing expenditures to build local value of foreign-owned trademark 685
23.3.4. The athletic gear example: The 2006 extension 686
23.3.5. Concurrent remuneration during the IP development phase as a safe harbour from the economic substance exception 687
23.3.6. A premise for triggering the economic substance exception: “Incremental” marketing expenditures 688
23.3.7. The economic substance exception should be relevant only for incoherent pricing structures 691
23.3.8. The economic substance exception is balanced relative to its 1994 predecessor 694
23.4. Remuneration of a US distribution entity when the economic substance exception is not triggered 696
23.4.1. Introduction 696
23.4.2. Arm’s length marketing expenditures are incurred 697
23.4.3. Above-arm’s length marketing expenditures are incurred 699
23.4.3.1. Introduction 699
23.4.3.2. Scenario 1: The US subsidiary is deemed owner of a licence 699
23.4.3.3. Scenario 2: The US subsidiary is compensated under a separate service agreement 702
23.4.3.4. Scenario 3: The foreign legal owner is compensated under a separate service agreement 703
23.4.4. What is the appropriate transfer pricing methodology to remunerate an assister? 705
23.5. Concluding remarks 707

Chapter 24: Distribution among Group Entities of Residual Profits Generated through Exploitation of Internally Developed Marketing IP under the OECD TPG 711
24.1. Introduction 711
24.2. The 2017 OECD TPG require differentiation of market-based super profits 712
24.3. Scenario 1: The local group distribution entity is reimbursed on a cost-plus basis 714
24.4. Scenario 2: The local group distribution entity bears an arm’s length level of marketing costs 719
24.4.1. The subsidiary must earn a normal market return throughout the IP development phase 719
24.4.2. The first twist: The duration of the distribution agreement is shortened; can residual profits then be allocated to the subsidiary? 724
24.4.3. The second twist: A royalty payment is introduced; can residual profits then be allocated to
the subsidiary? 726
24.5. Scenario 3: The local group distribution entity bears an above-arm’s length level of marketing costs 729
24.5.1. Introduction 729
24.5.2. The OECD TPG threshold for additional profit allocation to the source-state distribution subsidiary 729
24.5.3. The material content of the profit allocation 734
24.5.4. The profit allocation reservation 741
24.6. Concluding comments 742

Chapter 25: The Allocation of Residual Profits from Unique and Valuable IP to Permanent Establishments 745
25.1. Introduction 745
25.2. Assigning economic ownership to internally developed manufacturing IP 745
25.3. Assigning economic ownership to internally developed marketing IP 747
25.4. Assigning economic ownership of acquired manufacturing IP 749
25.5. Assigning economic ownership of acquired marketing IP 750
25.6. The cliff effect under article 7 of the OECD MTC and the important-functions doctrine 751
25.6.1. Introduction 751
25.6.2. Philip Morris (Italy, 2001) 753
25.6.3. Rolls Royce (India, 2007) 755
25.6.4. Zimmer (France, 2010) 756
25.6.5. Dell (Norway, 2011) 758
25.6.6. Boston Scientific (Italy, 2012) 761
25.6.7. Concluding comments 762

Chapter 26: Concluding Remarks 767
26.1. Introduction 767
26.2. The methodology for the transfer pricing of IP 767
26.3. Remuneration of IP development funding 768
26.4. Allocation of profits for foreign-owned marketing IP 771
26.5. The identification of local marketing IP 773
26.6. Is the OECD arm’s length standard heading towards formulary apportionment? 773

References 777