For most organizations, intellectual property (IP) is their most valuable asset—especially technology-based companies that offer software and services rather than physical products.
However, the intangible nature of intellectual property means it’s often harder to value, difficult to define, and challenging to price fairly. As such, reliable valuation is essential for multinational corporations engaging in IP transactions. This article provides an overview of IP valuation techniques and best practices for achieving accurate results that comply with global regulations.
Evolving Intellectual Property Regulations
The global tax landscape has seen constant change in recent years, with new regulatory guidelines and increased scrutiny of intercompany transactions causing many multinational organizations to rethink how they structure their IP ownership. The Organisation for Economic Co-operation and Development (OECD) has expressed that misallocation of profits generated by intangibles has heavily contributed to base erosion and profit shifting (BEPS), as many multinationals have transferred their IP to low-tax jurisdictions to minimize taxes and maximize profits.
Action 8 of the OECD's BEPS initiative provides updated guidance on the definition of intangible assets, methods and models to use for valuations, approaches for managing “hard-to-value intangibles” (for which no reliable comparables exist), and aligning IP ownership with value-added services. It also acknowledges that high-value services offered by senior executives that contribute to the development of IP should be valued in ways similar to the valuation of intangible assets.
In 2017, the U.S. passed its first major tax reform in over 20 years with the Tax Cuts and Jobs Act (TCJA). This U.S. tax reform makes it less advantageous for companies to shift the ownership and development of intangible assets outside the U.S. The TCJA introduced the Global Intangible Low-Tax Income (GILTI) provision, which is meant to discourage companies from shifting IP profits to low-tax jurisdictions. With so many changes to the way intellectual property is defined, protected, valued, and priced, it’s not surprising that some organizations are bringing IP back to the U.S. to avoid potential disputes.
Need advice on the most reliable valuation method for your IP assets? Talk to us about how we can help.
Intellectual Property Valuation Methods
There are broadly two approaches that are typically used to value intellectual property.1 Of course, different methods can lead to wildly different results, which is why choosing the most appropriate method is essential for companies engaging in intercompany transfers of IP.
- Income Method: IP valuation is based on future projected cash flows related to the IP.
- Market Method: IP valuation is based on observations of actual third-party transactions of comparable intellectual property to determine a market price.
The OECD’s guidelines specify that, similar to the transfer pricing methods used for determining fair pricing for related-party transactions, multinational organizations must choose the most reliable method for IP valuation. The most reliable method is not necessarily the one with the most optimal financial outcome for the business, but rather the method that is fair to both parties in the IP transaction—and defendable should tax authorities raise questions.
Many factors come into play when determining the best intellectual property valuation method. Availability of data, the type of IP being valued, and business structure all play a role in which method is deemed most reliable. For example, if the data are not widely available to perform a market method (e.g., if there aren’t royalties in the marketplace that can be considered comparable to what’s being valued), then a market method is less reliable. Likewise, without an accurate forecast of future IP-generated profits, an income method would be considered less reliable. Multinationals must balance all these factors to determine which intellectual property valuation model will achieve the most reliable results.
Tips For Achieving Reliable IP Valuation Results
IP valuation is not only the most complex and controversial aspect of what we do, but also where the most significant planning and optimization opportunities exist. Following are some tips for IP asset management and valuation:
- Be pragmatic and rational. We advise being pragmatic and rational in your determination of IP value. If the financial returns attributed to specific intellectual property seem too good to be true, it’s probably because they are. (Tweet this!) If both the buyer and the seller would view the results as too attractive for one party or the other, it’s likely not the most reliable intellectual property valuation model to use.
- Evaluate the potential outcomes. One of the best practices we follow at Valentiam is to conduct testing that will help evaluate the outcomes for both the buyer and the seller. If it appears as though both buyer and seller would view the IP transaction as economically reasonable, we can have confidence that the methodologies we selected are reliable.
- Expect valuations to be disputed. IP valuation is controversial and often subject to disputes by tax authorities. Therefore, taxpayers should approach IP valuation with a defensive mindset. As we mentioned earlier, companies should choose the intellectual property valuation method that is the most defensible in the event of a dispute—not necessarily the one that yields the most attractive financial results.
- Seek expert guidance. Very few companies have an IP valuation expert in-house, and expert help is necessary to avoid potential disputes. Working with a qualified practitioner significantly reduces your chances of an audit adjustment or, even worse, the imposition of penalties. The IRS and many foreign government bodies have the ability to impose penalties if an IP valuation is off by a significant amount. However, the rules that govern the imposition of penalties generally indicate that if a good faith effort to comply with the requirements is made, even in the event of an adjustment, penalties may not be imposed. Hiring a qualified expert to ensure compliance with the applicable valuation regulations can be a taxpayer's best first line of defense.
Access Expert Guidance On Intellectual Property
Today, conducting accurate IP valuations is more challenging—and also more essential—than ever before. With the help of a seasoned consultant, your company can be confident it is using the most appropriate intellectual property valuation methods, significantly reducing the risk of disputes or penalties. The world’s leading corporations trust Valentiam specialists to provide expert value opinions for all business assets, including intellectual property—we can do the same for your organization. Let’s talk about your unique IP challenges and how we can work together to optimize your company’s global business.
1 A third approach, the Cost Approach, is seldom used for valuation of IP.