OECD BEPS Action #8 - Thoughts on the Guidance on Transfer Pricing Aspect of Intangibles (2)

In my latest post on BEPS Action #8, I mentioned that the OECD Guidance on Transfer Pricing Aspect of Intangibles ("GTPAI") is an interesting development because:

• it is a jail-breaking attempt to free "intangibles" from the traditional boundaries of legal and/or accounting convention; and 
• it is also a bond-severing attempt to change the context in which traditional "intangibles" were recognized and dealt with under the implicit legal/accounting notions and to enable introducing an entirely new cadre of "somethings" into the conception of "intangibles"

So what would be the implications of this new definition of "intangibles"?

Figure 1.

Figure 1. shows a series of tests that were typically applied for determining whether a non-physical or non-financial  asset or property constitutes an intangible asset/property as per the previous, ordinary meaning of intangibles. All that was required was a sequence of two simple tests:

1. Is there a legal protection?: if the non-physical or non-financial asset was patented,  registered or otherwise protected by the applicable laws, then it was automatically presumed to constitute an "intangible". 
2. Is it recognizable as an asset from an accounting standpoint? : even if the assets above fails the first test, most of the intangible assets/properties fell to be recognized as intangible assets as long as the accounting principle required their recognition.

As such, the taxpayers had some clarity in terms of how to establish and defend their position with respect to their intangible asset transactions with related parties. The uncertainty therefore relating to the tax implications of such transactions was more or less manageable. 

Now, however, severing all the accounting and legal "lineages" from the notion of intangibles, the GTPAI seems to shift the focus of a transfer pricing analysis from mere recognition of intangibles to characterization of abstract "somethings" as intangibles that would not have been recognized as intangibles before. 

                                

Figure 2.

The new definition requires the following four tests: 

1. Is it a physical or financial asset?: this serves as a safeguard that none of the financial instruments falls to be "intangibles."
2. Is it capable of being owned?: the question is directed not at verifying whether the legal ownership may be exercised, but rather at determining whether "something" can be merely owned. This opens up a possibility that even if there is no legal ownership present, a mere discovery that certain "something" is an object of an effective or economic ownership by virtue of its use or exercise of certain interests can still trigger an intangible characterization. 
3. Is it capable of being controlled?:  This is actually an extension of the second question above. In contesting whether "something" could be an object of effective or economic ownership, a mere hint of control (whatever the definition may be) by virtue of certain activities or functions (e.g., exploitation, development, derivative works, etc.) performed by some of the transacting parties concerned may also trigger an intangible characterization. 
4. Is the use or transfer of "something" compensable?: what baffles me most about this new definition is that the badge of "intangible" now presupposes, ultimately, the compensability of "something" had it been used or transferred under the arm's length conditions. Why should this abstract and fictitious "compensability" be a necessary component? 

Personally, I think that any definition of intangible should only serve as a minimum standard for 'recognition' of an intangible actually traded or otherwise utilized in a related party transaction, and not for 'identification' of some abstract "intangibles" for transfer pricing purposes.  At least in accordance with the present version of the OECD Transfer Pricing Guidelines ("OECD TPG"), the arm's length testing of intercompany compensation for an intangible or even its compensability should be the one and the only concern for a transfer pricing review after it has been established that there was a related party transaction involving the intangible. The identification of intangibles was not part of a transfer pricing review; it was a task always delegated to the applicable laws, accounting practices or even court decisions.