A proposed treatment for HTVI

Volume No. 15-04

If you or your clients suffer from HTVI, or ‘hard to value intangibles’, news of a promising treatment has been announced by the OECD Centre for Tax Policy and Administration.[1] 

Back in the heady days of the emergence of Web 2.0, many young companies and partnerships inadvertently contracted HTVI in transactions involving the sale or cost sharing of new technologies and other intangible assets whose future revenues and cash flows were necessarily difficult to forecast.  More recently, HTVI has been singled out as being one of the leading causes of BEPS, the current affliction of the international tax system.

Many previously untreatable cases of HTVI have been hotly debated in transfer pricing audits, between Competent Authorities, and in the Courts, and involve asset valuations and assumptions that (to some, at least) now resemble home remedies.  Since Web 2.0 has established itself in the business world, hindsight has become very clear to many tax authorities.  As a practical matter, tax authorities often do not have the same information as a company owing simply to the lack of experience with the business, and hindsight is used to diminish this information asymmetry during audits or exams to some extent.

The discussion draft recommends that multinational companies look for evidence in independent transactions [for example in agreements that may have been entered into previously by the Company, or in agreements between similarly situated independent parties that are available in the public domain] of the treatment of uncertain future events.  In the event that independent parties to an agreement view the future as highly uncertain, related parties are encouraged to follow these examples and adopt similar terms used to manage the effects of uncertainty, for example: agreements with a shorter term or that include price adjustment clauses, milestone or contingency payments, or stepped royalty rate schedules.  Some evidence from arm’s-length agreements of events that trigger contract renegotiation when it is clear that the initial agreement was entered into at a time characterized by uncertainty is also suggested as a way to inform the structure of a related party agreement, the terms of that agreement, and the future obligations of the contracting parties to revisit terms.

Evidence of the form of independent agreements, as well as the ability to discern a foreseeable event from a truly unforeseeable event are two things that become critically important in view of the discussion draft.  It follows that the difference between expected profit from the exploitation of an intangible asset and actual profit can differ at arm’s length, provided there have been demonstrably unforeseeable events in the period following the intangible asset transaction.

To become immunized against the future adverse effects of HTVI, the discussion draft proposes that taxpayers provide a full explanation of all forecast inputs and assumptions used at the time of the intangible asset transfer, and explain how the risks expected to be incurred by the contracting parties are incorporated into the forecast.  This explanation should include a comprehensive “consideration of reasonably foreseeable events”.  The second and final step recommended is to document differences between forecasted and actual outcomes in subsequent years, and to show that these differences are the result of developments unforeseeable at the time of the intangible asset transaction.

Though more burdensome, these recommendations do reflect a good measure of common sense, especially if some reliable evidence of contractual terms agreed between independent parties can be found.  Of some concern however are the examples of a natural disaster and a bankruptcy as unforeseeable events in the discussion draft.  The list of surprises or unforeseeable events in business is considered by many to be longer than the various types of acts of G-d or business failures.  One only need look at the long lists of risk factors listed in SEC filings to appreciate the diversity of events that a business might consider unforeseeable.

A recurring theme of the BEPS Project as it relates to transfer pricing matters is the availability of relevant and reliable data upon which to base comparability analysis and adjustments.  The HTVI discussion draft reprises this theme, as the proposed procedures and tests depend critically on the presence and quality of contractual and other information.  As is noted in the discussion draft, this type of information is difficult to find.  Though information exists, it must be recognized that much of the building of the digital economy has been funded privately, making the terms of agreements that are relevant to modern businesses significantly harder to come by.  While this constraint operates on both companies and tax authorities, the approach proposed by the discussion draft places the initial burden of proof on the taxpayer.  Availability of examples of intangible asset transactions and contractual terms at the time of the transaction, as well as examples found after the conclusion of the transaction will become increasingly important to supporting valuation assumptions and documenting the entirety of the valuation process.  Unresolved by the discussion draft is the relevance of the timing of the transfer pricing documentation due date compared with the transaction date when determining which data were available to the taxpayer under relevant country law.

Clearly the discussion draft views opportunistic asset valuations as abusive.  In view of this position, the consistency of the forecasting methods and assumptions employed by companies and their advisors across time and between transactions will become the subject of transfer pricing scrutiny.  A company may be at risk of a transfer pricing adjustment if, for example, a tax authority obtains records of both (1) a valuation calculation prepared in respect of a Year 1 transaction of Intangible Asset Type A that assumes the intangible asset’s economic life is X years in duration, and (2) a buy-in payment valuation in respect of a Year 3 transaction of Intangible Asset Type A that assumes the intangible asset’s economic life is Y years in duration.  It will be ever more important to document the analytical process that is followed to determine the accuracy of assumptions[2] and the standard employed to identify and model uncertain events.

For some, the promise of a cure[3] will present an opportunity to vaccinate against certain strains of future transfer pricing uncertainty (once clinical trials are complete and legislative approvals have been granted, of course).  Unfortunately for others, a tax authority may well administer the treatment involuntarily, at great expense, and without regard for possible side effects.

[1] Discussion draft on arm’s length pricing of intangibles when valuation is highly uncertain at the time of the transaction and special considerations for hard-to-value intangibles, [OECD, June 4 2015]

[2] Assumptions that consist of statements that reference the analyst’s or valuator’s experience would no arguably longer be acceptable.

[3] The OECD Committee for Fiscal Affairs has not agreed a consensus definition of the cure for HTVI


THE NON-ARM’S LENGTH NEWS is provided as a free service to clients and friends of Cadesky Tax. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing a tax planning arrangement or taking an uncertain tax filing position. Cadesky Tax cannot accept any liability for the tax consequences that may result from acting based on the contents hereof.