RoyaltyStat Blog

Danish Tax Court: Valuation of Intangibles and the DCF Model

Posted by Harold McClure

In a previous blog post we reviewed a suggestion published in TaxNotes International to downplay the role of the Comparable Uncontrolled Transaction (CUT or CUP) approach. We also noted that in one of the litigation examples brought to illustrate pervasive issues with the CUT approach, the application of the method was not the primary point of controversy:

The CAPM is Misapplied in Transfer Pricing

Posted by Ednaldo Silva

Again the restless orb (orphan, blind) his toil renews, and sweat descends in dews. Homer, Odyssey, Book 11, 740-741.

The capital asset pricing model (CAPM) is widely used to calculate the expected return of equity shares, considering their risk relative to a stock market portfolio. The CAPM is ill-suited to valuing assets that lack stock’s spot market price volatility. Thus, I argue that the CAPM should not be used to determine the arm’s length remuneration for the intra-group transfer of intangibles.

Present Value of Intangibles in Transfer Pricing

Posted by Ednaldo Silva

The OECD is enamored with the present value of intangibles. To check this paramour, suppose that we don’t have historical (past) data and must rely on projections of sales attributed to certain identifiable intangibles that need to be valued. The present value of projected taxable profits expected from identifiable intangibles can be determined using two formulae, depending on available information. For intangible assets, the stream of taxable profits is called royalties.

Intangible Assets in Transfer Pricing Are Not Hard-to-Value

Posted by Ednaldo Silva

We can determine the value of certain identifiable assets (including the value of intangible assets) from knowledge about the associated (a) initial investment, (b) comparable growth rate of investments (g), and (c) estimated longevity of annual investment flows. Intangible producing investments include research & development, software development expenses, marketing and advertising expenses.

For this purpose, CAPM (capital asset pricing model) is inapplicable to determine comparable operating rates of return for intangible assets because CAPM is designed to estimate rates of return of traded equity shares, which reflect a stream of prospective dividends plus share price variation (capital gains or loss) during a certain period, and not a prospective stream of operating profits attributed to specific intangibles.

For a given enterprise, streams of dividends and capital gains and their calculated risks (measured during a specified useful period) are unlikely to be discounted or capitalized by an operating rate of return attributed to intangible assets. Inter alia, intangible assets are not frequently traded in ask-bid exchange markets and subject to speculative capital gains (loss).

Hard-to-Value Intangibles Sans Mystere in Transfer Pricing

Posted by Ednaldo Silva

Unlike the debutant affection of the OECD, we discourage using projected profits or cash flows to measure hard-to-value-intangibles (HTVI) for transfer pricing purposes because this method is speculative and based on several impeachable assumptions.

Forecasting Profit Margin Under CWI in Transfer Pricing

Posted by Ednaldo Silva

We can consider a first-order autoregressive (AR(1)) model to determine an arm’s length profit margin of a “tested party” subject to transfer pricing audit compliance:

Valuation of Intangibles: Pfizer Example

Posted by Ednaldo Silva

Estimates of unidentifiable intangibles based on Tobin’s Q tend to be exaggerated because (in addition to dividend yield) they include a speculative element represented by stock price appreciation. In many cases, capital appreciation can swarm dividend yield. Let’s consider Pfizer Inc. (NYSE: PFE), as an example. Pfizer is a global biopharmaceutical company engaged in discovering, developing and manufacturing healthcare products. Pfizer’s technology and marketing intangible-based products include Prevnar, Lyrica, Enbrel, Lipitor, Viagra, Sutent, BeneFIX, Genotropin, ReFacto, and Xyntha. Several products in Pfizer’s current portfolio were acquired from Wyeth Pharmaceuticals, including Prevnar and Enbrel.

Valuation of Intangibles: Measuring Excess Returns

Posted by Ednaldo Silva

To measure excess returns attributed to intangibles, we divide the “return on assets” into two components, including a return to tangible assets that is “separate and distinct” from a return to intangible assets. We think of tangible assets consisting primarily of property, plant and equipment, net of accumulated depreciation, and intangible assets consisting of a weighted sum of past investments in R&D, software, and advertising. As such, we define total assets composed of these two components, tangibles (index = 1) and intangibles (index = 2):

Valuation of Intangibles Based on Lagged Investments

Posted by Ednaldo Silva

The valuation of intangibles does not create any special problem as long as we keep track in a company’s general ledger the amounts of separate and distinct expenditures that for the purpose of valuation are treated as investments. Thus,

Valuation of Intangibles: Present Value Method

Posted by Ednaldo Silva

In transfer pricing intangibles are an enigma, regarded as hard-to-value assets. Let’s decipher: If we let Yt represent income (profits, royalties, dividends, interest), Greek gamma γ be the discount rate, and D = 1 + γ be the discount factor, then the present value (PV) of any asset, including intangibles, can be determined by a well-known formula:

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