Valuation of Intangibles

he valuation of intangibles is important in a wide variety of areas. For transfer pricing tax purposes, intangible valuations are the basis for determining either ongoing royalty payments or buy-in payments for cost-sharing arrangements. In corporate acquisitions, intangible valuations have important implications for purchase price allocations.

• Analysis of Third Party Licensing Arrangements Buy-ins and Cost-Sharing Arrangements
• Purchase Price Allocations
• State Tax Analyses
• Unique Situations

Analysis of Third Party Licensing Arrangements

License agreements among unrelated third parties are generally viewed as the best measure of the prices that should be charged in related party transactions. Over the past decade, ECS has carried out numerous studies that have located, examined and used such third party agreements as the basis for setting intercompany prices.

• ECS assisted a consumer products company that had collected a large number of technology and trademark license agreements with the evaluation of those agreements and their subsequent use as the basis for determining intercompany royalty rates. ECS’ analysis included numerous interviews and was used by the company in reaching a favorable agreement with the IRS.

ECS’ proprietary database currently includes in excess of 400 trademark and technology license agreements that are in the public domain and that have been identified during past analyses focused on determining intercompany royalty rates. This database expands every year as new projects are carried out.

Buy-ins and Cost-Sharing Arrangements

U.S. transfer pricing regulations require that participants in cost sharing arrangements receive arm’s length compensation (a "buy-in") for any existing intangibles contributed to the cost-sharing agreement. ECS has developed a set of proprietary tools to determine arm’s length payments for intangible property. These tools allow for the development of customized approaches, depending upon the nature of the intangible, the attributes of the economic and business environment, and the nature of available data.

• A large multinational company retained ECS to determine the buy-in payment due the U.S. company from its off-shore cost-sharing affiliate for a bundle of related technologies. ECS examined the attributes of the technologies separately, including their useful economic lives, to calculate an arm’s length value. ECS’ analysis became an integral part of the taxpayer’s documentation of the buy-in.
• ECS was retained to review and critique the arguments used by the IRS to adjust the buy-in payment of a large computer-related company. ECS found that the IRS’ methodology was inappropriate from both a transfer pricing and an economic perspective. ECS’ analysis formed the basis for the taxpayer’s response to the IRS.

Purchase Price Allocations

Companies are generally required to allocate the purchase price of acquired corporations among tangible and intangible assets. Typically, this allocation is derived from fair market value estimates for the identifiable tangible and intangible assets held by the acquired firm. ECS brings a strong economic focus to purchase price allocation and valuation issues. This is particularly important when the intangibles of the acquired company are subsequently used by non-U.S. participants in a cost sharing agreement, or licensed to an affiliate.

• ECS reviewed a taxpayer’s inventory valuation methodology, at the request of the IRS, and found that the taxpayer’s documentation was based on assumptions that were not consistent with its actual business practices. A substantial adjustment was made to the taxpayer’s inventory value.

• ECS carried out a purchase price allocation analysis to determine the value of in-process R&D for a major U.S. semiconductor producer. ECS’ valuation was used for both tax and financial statement purposes.

State Tax Analyses

State tax liability is also often affected by the transfer prices charged among operations located in different states. All the tools discussed above can be used in state tax analyses as well.

• ECS collected and evaluated a set of third party licenses that was used to determine the royalty rate that an intellectual property holding company located in a specific state could expect from operating companies in other states. This arrangement has allowed ECS’ client to realize substantial savings in state taxes.

Unique Situations

All intangibles are unique, and some transactions involving intangibles are also unique. With its economic approach to the valuation of intangibles, ECS has successfully handled a wide variety of unique situations for which "cookbook" approaches would not have produced appropriate valuations.

• ECS provided the analysis to value the intangibles developed in establishing a new television network, at the point at which new partners were added to the startup venture. ECS’ analysis required an examination of the cable television market, and was used to determine the capital gains of the initial investors in this project.

• ECS was asked to determine the value of specific bandwidth and location intangibles for satellite transponders that were sold under sale/lease-back transactions. ECS’ analysis was used by the IRS to evaluate the analyses prepared by several taxpayers.