DEMPE Functional Analysis and Intangible Economic Asset Allocation Rules
Intangible returns belong to the entities controlling technical functions and bearing financial risks, overriding nominal title and passive capital financing.
Intellectual Property Licensing
Meaning
Commercial authorization occurs when an owner of proprietary technology grants another party the right to use it in exchange for a fee. Through intellectual property licensing, multinational corporations centralize their assets in one entity and grant usage rights to regional subsidiaries. This mechanism allows the parent company to recover research costs through royalty payments.
Tax authorities scrutinize these transactions to ensure that the royalties paid reflect the actual economic benefit received by the local operating units.
Payment Structure
Compensation in these agreements often takes the form of running royalties calculated as a percentage of the licensee’s net sales. Some contracts employ milestone payments or fixed annual fees instead. The chosen structure must align with typical industry agreements for comparable assets.
This pricing must remain consistent over time.
Regulatory Compliance
Transfer pricing documentation must demonstrate that the royalty rate complies with the arm’s length standard. If the rate is too high, the tax authority in the payer’s country will disallow the expense. Companies use database studies to find comparable third-party agreements to justify their rates.
This benchmarking defends the tax deductions.
Risk Allocation
License agreements define which party is responsible for defending the patents against infringement and maintaining their registration. In many group structures, the licensor retains the responsibility to defend the asset while the licensee assumes the market risks of exploitation. This division must match the real capabilities of the parties involved.
The written contract must reflect the actual conduct of both entities.