When a multinational group transfers, licenses, or restructures ownership of an intangible asset among related parties, the figure that ultimately appears in the contract—the transfer price or the agreed-upon royalty rate—tends to receive all the attention. What supports that figure during a tax audit, however, is a different and less visible document: the valuation report, which explains how that figure was arrived at and why the assumptions used are reasonable.
An intangible asset that is correctly valued in the working papers but supported by a weak or incomplete valuation report may still be vulnerable to scrutiny by the tax authority.
Essential Elements of the Document
A defensible valuation report must precisely identify the intangible asset subject to the transaction—its nature, scope, and stage of development at the time of the transaction—and link that identification to the DEMPE analysis, considering who developed, improved, maintained, protected, and exploited the asset, as well as the functions performed, the assets used, and the risks assumed by the parties in relation to the intangible asset.
This functional analysis provides insight into how the activities and contributions of the various entities relate to the creation of value in the intangible asset and serves as a key element in justifying the compensation due to each party, without the legal ownership of the asset alone determining the allocation of the benefits derived from its exploitation.
Without this explicit connection between the functional analysis and the valuation, the numerical exercise may become disconnected from the analysis of the functions performed, the assets used, and the risks assumed by the parties, making it difficult to justify how the economic value associated with the intangible asset is attributed and what remuneration corresponds to each entity.
The document must also explain the selected valuation methodology or technique—for example, techniques based on discounted cash flows or other approaches appropriate to the characteristics of the intangible asset—and justify why it is appropriate given the nature of the asset, the available information, and the circumstances of the transaction.
It is not enough simply to apply a methodology; it is necessary to explain why that methodology constitutes a reasonable basis for estimating the value of the intangible asset.
The report should also consider the economic perspective of both parties to the transaction. In particular, it is important to evaluate the economically viable alternatives for the transferor and the acquirer and to determine whether the agreed-upon terms are consistent with the economic alternatives each party would have if the transaction did not take place.
This analysis allows the valuation of the intangible asset to be supplemented with each party’s perspective and assesses whether the price or terms of the transaction are economically reasonable for both parties, based on expected benefits and available alternatives.
Financial Projections: The Weakest Point in Valuation Reports
One of the most sensitive sections of any valuation report is the one containing the financial projections used to estimate future cash flows.
A robust valuation report must explicitly document the assumptions underpinning these projections—growth rates, expected margins, the intangible asset’s useful life, discount rate, and other relevant variables—and explain the basis used to construct them at the time of the transaction.
Tracing these assumptions back to business plans, financial information, market data, or other evidence available at that time is particularly important for demonstrating that the projections were not prepared solely to achieve a specific result.
This issue becomes even more important when the transaction involves hard-to-value intangibles (HTVI).
The OECD Guidelines classify certain intangibles or rights to intangibles as HTVI when, at the time of transfer, there are no reliable comparables and there is a high degree of uncertainty regarding projections of future cash flows or the assumptions used in their valuation.
In such cases, a significant deviation between ex ante projections and ex post results may be used by the tax authority as evidence to assess the reasonableness of the original valuation.
In light of this risk, a particularly important defense is to have contemporaneous documentation that demonstrates the reasonableness of the projections, assumptions, and probabilities considered at the time of the transaction, as well as to subsequently explain any significant deviation from the results actually obtained.
The Sensitivity of Variables, Not Just the Specific Result
A rigorously prepared valuation report should, as a best practice, include a sensitivity analysis showing how the result varies in response to reasonable changes in the key variables used.
These may include the discount rate, growth rates, projected useful life, or specific operating margins.
This analysis allows one to observe whether the value obtained depends excessively on a specific assumption or whether it remains within a reasonable range under different plausible scenarios.
Rather than presenting a single figure as an absolute result, the sensitivity analysis helps demonstrate the robustness of the premises used in the valuation exercise.
Why the Date of the Document Matters as Much as Its Content
As with other Transfer Pricing documents, a report prepared contemporaneously with the transaction provides a more solid documentary basis for demonstrating what information, projections, and assumptions were available at the time the valuation was performed.
This is particularly relevant in transactions involving intangibles, where future results may differ significantly from initial expectations.
When the documentation is prepared months or years after the transaction, it can be more difficult to demonstrate that the assumptions used truly reflected the information available on the transaction date and that they were not adjusted retroactively based on results that were already known.
Therefore, the report should include adequate documentary traceability, including the date of preparation, sources used, responsible parties, assumptions considered, and version control.
At TPC Group, we prepare intangible asset valuation reports designed to document, in a traceable manner, the assumptions, methodology, and analyses underpinning each result, with the aim of strengthening the technical consistency of the valuation in the event of a review by the tax authority.
Source:
OECD — Transfer Pricing Guidelines 2022, Chapter VI and Annex II on Hard-to-Value Intangibles (HTVI).