Intangibles

Brand

The most common intangible asset that we deal with is brand. In this context it needs to be recognised that while New Zealand may have 40m sheep it only has 4m consumers. This creates a very real constraint on the potential value that may be applied to brands and the consequent royalties that may be derived. A further issue that seems to be roundly ignored is that any substantial business carries with it goodwill. Attributing all intangible value to a brand can only be done by ascribing a nil value to goodwill. In the context of any well established business such a position is hard to support.

R&D

New Zealand spends less of its GDP on R&D than most other OECD countries. Private R&D is mostly concentrated in the primary sector where there is comparative advantage over many other countries - both dairy production and processing have experienced considerable growth in their R&D expenditures. Overall, the predominant focus of R&D in NZ has been on technically sophisticated processing to reduce commodity costs rather than embedding knowledge in a product or service to create a sophisticated export that captures a high price.

Due to the comparatively low level of intellectual property ("IP") creation in New Zealand, the risk of high-profit intangibles being transferred outside our tax jurisdiction without adequate consideration is low in comparison with other OECD Countries (for example, this is a central concern for the US IRS).

One way of identifying intangibles created locally is through close examination of remuneration data (high pay for special skills leading to greater value added/non-routine intangibles). We pay close attention to such data to ensure that due recognition is being given to the creation of valuable intangibles in New Zealand.

In common with the ATO, we are spending more time on issues involving the inbound licensing of intangibles. The intangibles need to be clearly identified and companies must be able to demonstrate that they add significant and substantial value if large royalty payments are to be substantiated. We are asking similar questions to those raised by the ATO in this regard:

1. Have all intangible profit drivers been individually identified (including goodwill and any licensed IP)?
2. What is the value of all intangibles owned and used by the company and have they been valued by a professional firm?
3. Is the IP protected?
4. Who bore the cost of creating the IP?
5. How and to what extent does the IP contribute to the profit?
6. Has any IP been assigned and if so what was the consideration?
7. How is the IP documented?
8. If a royalty is paid for the use of any IP, does the taxpayer produce appropriate profits for its functions, assets (including its own intangibles) and risks after payment of the royalty?

International royalty rates should be supported by robust contemporaneous analyses of future profits or cost savings from use of the intangibles. Rates should be routinely cross-checked to local bottom-line profitability. If a licensee is deriving only a normal rate of return or even less, why would the licensee bother to acquire the rights in the first place?

It is now common practice between tax authorities to use a residual profit split methodology for computing appropriate royalty levels. Essentially this methodology is applied to the licensee (as the tested party) and attributes to that party a routine profit for the type of operation which it undertakes plus some appropriate share of the residual profit. The remaining profit is then treated as the royalty to be paid to the licensor. There are minor variations to this approach and it is recognised that this method can only ever approximate what arm's length parties might agree.

Most R&D by foreign-owned MNEs in New Zealand is carried out on a contract basis. We see very few cost contribution arrangements. In respect of contract R&D, we of course expect a fair and reasonable mark-up on costs incurred, especially given the considerable cost savings that arise from carrying out such high quality activities in New Zealand compared with other western economies.

Find out more

For further reading on this subject, we recommend:
• "The New Zealand Tax Planning Report" article by Robyn Russell and Keith Edwards published in December 2004, and
• "The New Zealand Transfer Pricing Environment for Intangible Property" by Leslie Prescott-Haar and Keith Edwards published in October 2007 for the International Fiscal Association's Congress in Kyoto.

Date published: 14 May 2008

Back to top