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What is intellectual property? Intellectual property definition: ‘Intellectual property’ refers to intangible assets that are products of the mind. E.g., inventions, brand names, and artistic or technological designs. Intellectual property assets themselves are not physical in nature. Rather, they are the ideas, knowledge and creativity that go into making a product, service, process or business. ‘Intellectual property’ also refers to the legal protection given to these intangible assets to stop others using and damaging them. Intellectual property is incredibly valuable for businesses as it gives them a competitive edge. That’s why organizations protect intellectual property assets with legal safeguards. Types of intellectual property There are five main types of intellectual property: • Patents A patent is a legal instrument that grants an exclusive right to its owner to use a given invention for a limited period of time within a specific geography. A patent may relate to a physical object or to a process. • Trademarks A trademark is a unique name, symbol, logo or picture that the owner may use to distinguish its products and services from those of other entities. Proprietary rights in trademarks are often confirmed through a registration system. The registered owner of a trademark may exclude others from using the trademark in a manner that would create confusion in the marketplace. Trademarks may be established for goods or services, and may apply to a single product or service, or to a line of products or services. • Copyright The exclusive and assignable legal right, given to the originator for a fixed number of years, to print, publish, perform, film, or record literary, artistic, or musical material. • Trade secrets and know-how Know-how and trade secrets are proprietary information or knowledge that assist or improve a commercial activity, but that are not registered for protection in the manner of a patent or trademark. Know-how and trade secrets generally consist of undisclosed information of an industrial, commercial or scientific nature arising from previous experience, which has practical application in the operation of an enterprise. Know-how and trade secrets may relate to manufacturing, marketing, research and development, or any other commercial activity. • Goodwill or going concern value Goodwill reflects the difference between the aggregate value of an operating business and the sum of the values of all separately identifiable tangible and intangible assets. These are the intellectual property types that can be legally protected. Having legal protections in place means that the assets can only be used by the party that owns the intellectual property rights – or by parties that have intellectual property rights assigned to them (e.g. in a licensing deal). Intellectual property rights definition The term ‘intellectual property rights’ refers to the right to use an intellectual property asset. If an asset is protected by intellectual property rights, it can only be used by those parties who hold the rights to the intellectual property. This could be the individual or organization that created the intellectual property, or it could be a different party that has been assigned the rights to it. Intellectual property rights are often sold or transferred to other parties in licensing agreements. The purpose of intellectual property rights is to stop intellectual property being taken and used by other parties. They offer legal protection to the assets and the party that holds the rights to them. DEMPE Another factor that MNEs must consider when assigning transfer prices for intellectual property is DEMPE. The term ‘DEMPE’ means the development, enhancement, maintenance, protection and exploitation of intangibles. DEMPE was introduced by the OECD in the final Actions 8–10 report of the Transfer Pricing Aspects of Intangibles, which was released on October 5th 2015. Under DEMPE, organizations must consider how returns are allocated when revenue is generated by an intangible – e.g., an intellectual property asset like a patent. It cannot be assumed that the legal owner of the intellectual property is entitled to the returns in full. Rather, the returns must be allocated according to which parties contributed to the value of the intellectual property. That is, which parties performed functions, used assets and assumed risks in the development, enhancement, maintenance, protection and exploitation of the intangibles or intellectual property. The introduction of the concept of DEMPE has resulted in significant changes in how multinational enterprises implement the arm’s length principle for transfer pricing. DEMPE is designed to ensure that allocation of the returns from the exploitation of intangibles, and also allocation of costs related to intangibles, is performed by compensating MNE group entities for functions performed, assets used, and risks assumed in the development, enhancement, maintenance, protection and exploitation of intangibles. Multiple entities within an MNE – not just the intangible’s legal owner – may have been involved in the creation of an intangible’s value. They may have “performed functions, used assets, or assumed risks that are expected to contribute to the value of the intangible”. As such, those various entities within an MNE should receive a portion of the profits that were gained from the exploitation of the intangible in question. DEMPE is designed to help both taxpayers and tax authorities achieve an accurate assessment of transactions to help with the determination of appropriate transfer pricing. By identifying the entities that perform DEMPE functions in a transaction, MNEs and taxpayers in general can ensure that they are complying with the OECD’s BEPS guidelines. Before the DEMPE concept was introduced, the legal owner of an intangible was entitled to essentially all the returns generated by that particular intangible (such as a brand name or logo). This meant that, in practice, the owner of a brand could set up their company – for example, in the UK – but also register their trademark in a low-tax environment – such as Cyprus or similar – so that they could charge royalties to the UK business for any income related to the IP registered in the low-tax environment. With the old model, the IP owner would be entitled to the income effectively generated by the UK entity. Now, however, any income that is generated as a result of that IP is owned by all the parties that perform the DEMPE functions. So, rather than the IP owner receiving the full amount of the returns generated by the intangible, these instead have to be divided between the relevant parties, in line with each entity’s contribution to the value of the IP. To return to the Cyprus example: if there were entities in Cyprus that carried out DEMPE functions, then they would be entitled to a proportional share of the income generated by the intangible in question. If no DEMPE functions resulted from the Cyprus activities, then under the new approach the UK tax authorities would likely disallow the Cyprus IP royalty deductions from the taxable UK profits, especially if these functions were performed by the UK entity. For transfer pricing purposes, legal ownership of intangibles, by itself, does not confer the right to retain returns derived by the MNE group from exploiting the intangible. As a result of the contractual arrangement between the MNE entities, these returns may initially accrue to the legal owner. However, if the legal owner performs no DEMPE functions, but acts only as a holding entity, the legal owner will not be entitled to any portion of the returns, other than compensation for the holding activities, if any. It is important to look at each of the DEMPE functions individually. Development The development of intangibles refers to everything that is associated with coming up with ideas for the brand and products and putting plans and strategies in place for their creation. Enhancement ‘Enhancement’ involves continuing to work on aspects of intangibles to make sure they can perform well at all times and be constantly improved. Maintenance Maintaining intangibles involves doing everything that is possible to ensure they continue to perform well and generate revenue for a business. Protection Brand protection is important for ensuring that the value of a brand’s assets remains strong. It involves securing IP legal rights, making sure nobody can copy the ideas and monitoring competitor’s activities. Exploitation The term ‘exploitation’ refers to the way in which intangibles are used to generate profits. Analysing transactions involving intangibles The OECD’s six steps for analysing transactions involving intangibles are as follows: 1. Identify the intangibles and risks within a particular transaction 2. Identify the contractual agreements relating to the transaction in question 3. Identify which parties performed DEMPE functions, by means of a functional analysis 4. Determine whether the conduct of the parties was consistent with the contractual assumption of risk 5. Delineate the actual controlled transactions relating to DEMPE 6. Determine arm’s length prices for the transactions The OECD TPG outlines how MNEs can identify the information needed for a comparability analysis between the conditions of a controlled transaction and those of a comparable transaction between independent parties. The economically relevant characteristics or comparability factors that need to be identified in the commercial relations between the associated enterprises in order to accurately delineate the actual transaction can be broadly categorized as follows: 1. The contractual terms 2. The functions performed 3. The characteristics of property transferred or services provided 4. The economic circumstances of the parties and of the market 5. The business strategies