This is the first of two articles concerning Intellectual Property (“IP”). In this article we discuss why IP is becoming an area of increased focus to businesses and regulators, and why its reliable valuation is essential. In a subsequent article we will address specific valuation issues related to IP.
The valuation of IP is often required for taxation, financial reporting and commercial negotiation purposes, but it is often a complex and subjective process. Evolving guidance is also adding to the complexity and difficulty in obtaining a reliable valuation. The issue of IP valuation (and intangible assets in general) is also receiving increasing attention from regulators such as ASIC and the ATO.
What is IP?
Who better than the World Intellectual Property Organization to define IP?
“Intellectual property (IP) refers to creations of the mind, such as inventions; literary and artistic works; designs; and symbols, names and images used in commerce. IP is protected in law by, for example, patents, copyright and trademarks, which enable people to earn recognition or financial benefit from what they invent or create. By striking the right balance between the interests of innovators and the wider public interest, the IP system aims to foster an environment in which creativity and innovation can flourish.”
There are a wide range of different assets that fall under the description of IP including:
- Brand IP – for example trademarks, logos and related design rights
- Technology IP – such as software, patents and medical devices
- Artistic IP – including copyright in books, films and music
The market capitalisation of the ASX 200 is $1,538 billion, compared to a net tangible asset value of $582 million, implying a market value of the total intangible assets (including goodwill) of the top 200 ASX listed companies of $956 million (representing 62% of the ASX 200 market capitalisation). A significant proportion of this is represented by the various IP assets held by those companies.
Why is knowing the value of IP important?
Regulators globally, particularly taxation authorities, are concerned transfer pricing on IP is being used to erode the tax base in higher tax jurisdictions such as Australia. This has led to the introduction of measures such as the Tax integrity multinational anti‑avoidance law (or the Google Tax as it is known) to tax profits routed via international tax havens.
As an assessment of market value is often a key component of IP transfer pricing arrangements, the valuation of IP is becoming an area of increased importance for the ATO. Given the subjectivity and complexity involved, it is also considered to be a high risk area.
Another signal of increased focus by the ATO is the creation of the four-year International Structuring and Profit Shifting compliance program that focuses on a number of companies that have undertaken international restructures or have significant cross-border arrangements.
It is not only tax authorities that are focussed on this area. ASIC has listed one of its focus areas for 30 June 2015 financial reporting as the “recoverability of the carrying amounts of assets such as goodwill, other intangibles and property, plant and equipment”.
Hence valuations of intangible assets and IP are likely to be an important focus area during any audit or compliance investigation.
In this environment it is not surprising that there is an increasing focus on the way IP is valued. As a result, new guidance has recently been developed (and more is being developed). This guidance includes:
- RICS – The Royal Institute of Chartered Surveyors (“RICS”) recently published a global Guidance Note on IP Valuation. The guide explains the need for valuations to integrate the legal, functional, technical and economic characteristics of IP. Together with the Red Book 2014 it attempts to guide accounting and finance professionals as to the extensive considerations and complexity of IP valuation and required competence of the valuer. Click here
- IVSC – The International Valuation Standards Council (“IVSC”) has issued standard IVS 210 regarding the valuation of intangible assets and Technical Information Paper 3, The Valuation of Intangible Assets. Click here
- ATO – the ATO’s guide Market Valuation for tax purposes also provides some high-level guidance in this area. Click here
- OECD – The Organisation for Economic Co-operation and Development (“OECD”) hosted a public consultation on 6 to 7 July 2015 in Paris to consider the arm’s length pricing of intangible assets when valuation is highly uncertain. The OECD is now tasked with the development of an approach to value hard-to-value intangibles (“HTVI”) – the assets for which at the time of their transfer in a transaction between associated enterprises, no sufficiently reliable comparable data exists, and there is a lack of reliable projections of future cash flows or income expected to be derived from the transferred intangibles. Click here
Having reviewed definitions of intangibles that have been developed for legal and accounting purposes, the OECD has concluded that transfer pricing requires its own concept of what constitutes an intangible asset. The OECD also suggested that caution should be exercised in accepting valuations performed for accounting or other purposes when determining arm’s length prices for tax purposes. In particular, valuations contained in a purchase price allocation are not necessarily relevant for transfer pricing purposes according to the OECD.
While the current guidance is not yet fully aligned, many bodies are moving towards global consistency. However, in practice we observe a wide range of approaches to the valuation of IP and intangibles, which are not always applied logically or consistently.
The valuation of IP is an important issue that is facing increased scrutiny for tax and financial reporting regulators. It is also a complex and subjective area in which best practices are still evolving. In our next article we will discuss some of the specific issues faced when valuing IP in practice.