Intellectual property rights

Basic facts

An international, listed group with global headquarters in the canton of Zurich is active in the development and marketing of innovative software solutions. Various market analyses show that the Group's main value drivers are the Finexus ^software platform1 ("platform") and the underlying technology ^design2 ("technology").

The Finexus financial analysis software platform provides an infrastructure on which various applications and tools can be developed, integrated and operated. It enables companies to access a powerful, cloud-based solution that covers their specific needs in areas such as data analysis, financial management and corporate management.

The platform is the basis for providing software solutions to customers and offers a range of functions and services that are crucial for processing and visualizing large volumes of data. The main product is a platform that supports companies in monitoring and analyzing their finances in real time. The platform provides the infrastructure, security protocols and tools to process data. The technology includes the user interfaces (UI/UX) as well as the underlying algorithm that analyses and visualizes data.

The technology is constantly being developed to meet the changing requirements of customers and to improve the platform's functionalities.

The Group's operating business is structured legally and operationally as follows:

• XYZ AG, based in Zurich (the ultimate parent company and headquarters of the Group), is responsible for the legal protection of the Finexus platform and design in the various sales markets (including the renewal of local patents, defense against unauthorized use), the strategic development of the platform and the development and coordination of global marketing campaigns. While the marketing department ("global marketing") is located at XYZ AG based in Zurich, the legal department ("legal department") responsible for the global protection of the software platform and design was outsourced to the wholly owned subsidiary XYZ Management AG based in Zug, which is remunerated by XYZ AG on the basis of the transactional net margin method with a net cost mark-up of 5% (Transactional Net Margin Method with Net Cost Plus, or "NCP" for short, as a profit level indicator). The Group's research and development department at XYZ AG is also responsible for the further development of the software platform (R&D).
• The formal owner of the property rights to the Finexus software platform and the design in the various countries is XYZ IP Ltd. based in Luxembourg. This company owns the technology algorithms for providing the software, which is resold to independent licensees and end customers. XYZ IP Ltd. pays all fees for the registration and renewal of worldwide trademark and property rights, which are initiated by XYZ AG and carried out by XYZ Management AG on behalf of XYZ IP Ltd. XYZ IP Ltd. compensates XYZ AG for this on the basis of the NCP with a surcharge of 5%. It also remunerates XYZ AG for the development and coordination of global marketing campaigns and research and development activities, also on the basis of NCP, with a mark-up of 8% in accordance with a benchmarking study. In return, ABC IP Ltd. charges the Group's technology companies a license fee on the basis of short, written contracts. According to the wording of the contracts, the subject matter of the license is "various IP rights necessary for the business".
• XYZ Production BV in the Netherlands and other regional technology companies are responsible for the technical development and customization of specific software products based on the designs and algorithms of XYZ AG (production). They ensure that the software is available in the various markets and functions in accordance with global standards.
• The software products are sold by the respective technology companies to independent license partners. These license partners purchase the software and receive the exclusive right to distribute the software in their respective markets (distribution license). In Austria, the independent XYZ Lizenzpartner AG, which purchases the software from XYZ Production BV in the Netherlands, is responsible for this. The purchase price for the software covers the exclusive right of use, meaning that no separate license fees are charged for sales to end customers.
• The license partners sell the software products to end customers, such as companies or individual consumers, and may offer additional services such as training, implementation and technical support. These partners take on the task of distributing the software in the respective markets and making the solution available to their customers. The license partners are therefore distributors who resell the software products in various markets, but are not allowed to make their own changes or adaptations to the code. They are responsible for the distribution and sale of the software to end customers, while the technology companies manage the development, further development and global market launch of the software products.
• The Group has local national companies in the individual sales markets, including XYZ (Österreich) AG. These national companies are responsible for country-specific marketing, which is implemented within the framework of the global conditions defined by XYZ AG (e.g. global marketing campaigns that are adapted to the respective countries). In addition, the national companies act as contacts for the independent license partners who are responsible for the provision and distribution of the software solutions.
• The national companies are also compensated by XYZ IP Ltd. on the basis of a benchmarking study using NCP and a mark-up of 8%. This compensation covers the costs of local marketing and support in the implementation of global campaigns tailored to the needs of the local markets.

Case 1: Attribution of intangible assets

1. facts of the case

See basic facts.

Questions

1. How do the OECD Transfer Pricing Guidelines define the term "intangible assets" and which ones are involved in the present case?
2. Since the BEPS project, the OECD has distinguished - even if these terms are not explicitly mentioned in the OECD Transfer Pricing Guidelines - between "legal", "financial" and "functional" ownership of intangible assets. What is meant by this and what are the transfer pricing consequences?
3. To which group company or companies are the following intangible assets to be allocated for transfer pricing purposes?

• Brand;
• Finexus software platform;
• Technology (incl. algorithms and databases);
• Production know-how;
• Sales rights;
• Customer relationships?

4. what is the significance of intra-group contracts in the transfer pricing attribution of the software platform, technology design and brand?

5. can the group parent company XYZ AG charge the subsidiaries compensation "on the merits" for the use of the "Finexus" trademark in their business presentation (e.g. in the company name)?

6. how is the fact that the marketing activities are carried out by XYZ AG but the legal activities by XYZ Management AG taken into account in terms of transfer pricing?

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Case 2: Third-party compensation IP licensing

1. facts of the case

See basic facts. Assumption that the license payments effectively flow to ABC IP Ltd. in terms of transfer pricing.

Question

• What methods could be used to determine the royalty payments of the technology companies to XYZ IP Ltd?

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Case 3: Third-party compensation IP transfer

1. facts of the case

As part of an intragroup reorganization, the Finexus Group plans to sell the intangible assets (Finexus software platform, technology) together with global marketing and R&D to the newly founded company XYZ Development Ltd. in the UK. The legal department will remain in Switzerland. As the legal ownership of the brand, platform and technology is held by XYZ IP Ltd., both XYZ AG and XYZ IP Ltd. are acting as sellers.

Questions

1. What methods do the OECD Transfer Pricing Guidelines provide for determining the intra-group purchase price?
2. Which company is the seller from the point of view of the transfer pricing guidelines?

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Case 4: Challenges with HTVI and PSM

1. facts³

The CraneX Global Group is a leading multinational company in the construction crane industry. The company develops and manufactures hybrid cranes that combine innovative technologies and high-quality design. This case study analyzes the application of the transactional profit split method (TPSM or PSM for short) and the transfer pricing challenges associated with hard-to-value intangible assets (HTVI). The focus is on the two main companies of the CraneX Group:

• SwissCrane AG (OEM A, Switzerland): Specialized in mobile construction cranes.
• USCrane Inc (OEM B, USA): Leading supplier of tower cranes.

The CraneX Global Group consists of two Original Equipment Manufacturers (OEMs) that develop and produce hybrid cranes. These cranes combine:

• Mobility through the technology of SwissCrane AG.
• Load stability thanks to the know-how of USCrane Inc.

The following intangible assets are central:                

• Patents: Protection of innovative mechanical and technological solutions.
• Software: Control systems to optimize mobility and stability.
• CraneX" brand: a guarantee of quality and innovation.
• Production expertise: Efficient processes and high quality standards.

A newly developed control system for hybrid cranes within the Group is considered a hard-to-value intangible asset (HTVI). The technology promises considerable market advantages, but future sales and profits are difficult to predict. Risks such as technological obsolescence and market acceptance have a significant impact on the value.

The value chain of the CraneX Global Group can be summarized as follows:

• Raw material procurement: parts from third-party and sister companies.
• Production: SwissCrane AG assembles basic components, USCrane Inc. integrates modules.
• Production: SwissCrane AG completes the hybrid cranes.
• Distribution: Direct distribution or via affiliated dealers.

The multinational company has prepared the income statement shown in Table 1 for the new hybrid crane product line (based on management estimates):

Questions

1. Why is the transactional profit split method (TPSM or PSM) a suitable transfer pricing method in this case? 
2. Based on the information in Table 1, determine the routine profit from production (comparable third-party producers without such innovative IP technology achieve a normal market return on production costs of between 8% and 12% with a median of 10%) and the allocation of the residual profit from R&D.
3. What risks do OEMs bear and how are these taken into account in the PSM?
4. Define HTVI. CraneX Global Group decides to sell the IP related to the innovative control technology, which is still at an early stage of development. How can uncertainties be taken into account in the valuation of the corresponding HTVI?
5. What other alternatives for the exploitation of the intangible assets of the CraneX Global Group, in particular the HTVI, could be considered besides a joint commercialization by OEMs A and B or a sale of the IP?
6. Will the OECD's HTVI approach also be applied in Switzerland?

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¹ A software platform is a collection of software components or systems that provide a basis on which other applications, tools or services can be developed and operated. It enables developers to build on it, expand it or integrate their own software solutions.

² The term technology design refers to the technical and functional designs or architecture of technology products or solutions.

³ This case study is based on the article by Stähli Lukas, The Use of the Profit Split Method in Highly Integrated Transactions, International Transfer Pricing Journal (ITPJ), July/August 2018, 280 ff.