Transfer pricing related to intangible property

Revista Nº 128 Mar.-Abr. 2005

Sergio Viveros Rubiano(*) 

Jefe de la Oficina de Asuntos Tributarios 

Federación Nacional de Cafeteros de Colombia 

Colombia has not developed special rules for intangibles. As for now, I consider that looking at the U.S. and the OECD approach over this issue will help Colombia in the short term. 

Nota del Editor: Debido a la temática que abordó este artículo, la versión original fue redactada en inglés. Si usted desea conocer la versión en español ingrese a

Rules related to transfer pricing of intangible property have not yet been enacted under Colombian tax law. In consequence, and in search for filing those blind spots of the Colombian tax legislation, I consider of great convenience to make a reference to the rules in the United States as well as to the OECD Guidelines.

A. General aspects

Transfer pricing rules apply to both tangible and intangible property. However, not until the early 1960´s, transfer pricing issues arising from transfers of intangible property were recognized as being separate from those for tangible property(1).

1. United States

Section 482 of the tax code expressly makes reference to the transfer of intangibles. The rule establishes that in case of any transfer or license of intangible property, the consideration for the transfer or license shall be commensurate with the income attributable to the intangible.

In general terms, the transfer of intangible property, by controlled entities, is tested the same way as other controlled transactions. The standard to be applied is that of a taxpayer dealing at arm’s length with an uncontrolled taxpayer(2).


The OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations dedicate a chapter to transfers of intangible property. Chapter VI of the Guidelines, introduced in 1996, discuss a special approach to be taken into account in establishing the arm’s length consideration for transfers of intangible property between related parties(3).

3. Colombia

Tax Code mention intangible property in two different contexts:

a) Article 260-2(5) includes the terms “intangible property” in defining the residual profit split method. Under this method, the profit of a transaction is assigned as follows: 1. The minimum profit is assigned to each related party by using any of the accepted methods, without taking into account significant intangibles, and 2. The residual profit is assigned by subtracting the minimum profit previously mentioned. The residual profit is distributed among the related parties taking into account any significant intangible property used by the parties.

b) Article 260-3 establishes elements to determine if a transaction is comparable, depending on the method used. In case of a sale or license of intangible property, elements such as the type of good, patent, trademark, know how, benefits expected, duration, and protection degree, must be taken into account.

B. Transfers of intangible property

1. United States

By means of jurisprudence, the U.S. Congress realized the need of dealing separately the transfer of intangible property from the transfer of tangibles, between controlled parties(4). Revenue Procedure 63-10 addressed for the first time the impact of intangible property in pricing determinations under the scope of §482(5). The first set of regulations under §482 that related to intangible property was issued in 1968, and not until the tax reform of 1986, §482 included an express mention of intangible property.

Any way of selling or licensing intangible property is given effect for tax purposes, as long it reflects the economic reality of the transaction. However, this liberty in transferring intangible property is limited in three ways:

a) If the transferor retains a substantial interest in the property, the transfer is analyzed as a license.

b) The IRS may consider the profit that the licensor would have realized if, instead of licensing the intangible, it had itself carried on the controlled licensee’s activities (for example, producing and selling goods under the licensed intangible).

c) The third limitation derives from the commensurate with income standard included in §482 since 1986. This concept demands that the consideration must be adjusted periodically if the conditions of the transaction change.


The OECD Guidelines also stress the complexity of determining an arm’s length price in intangible property transactions between associated enterprises. They recognize that associated enterprises may structure such transactions in ways that independent parties would not.

3. Colombia

In general terms, Colombian rules apply the arm’s length principle, under which prices in transactions between related parties must somehow be similar to the prices that independent parties would apply in similar circumstances. The same principle applies for profit margins(6). However, there is no special rule for intangibles.

C. Relationship between tangible property and intangible property

The price of tangible property may have a different value if it has embedded a common name or a trademark. Hence, in order to analyze the arm’s length consideration in a transaction, is necessary to determine the price of the tangible property transferred and the added value that the tangible property has because of having a name or a trademark incorporated.

1. United States

As a general rule, the transfer of tangible property with an embedded intangible is not considered a transfer of an intangible if the controlled purchaser acquires no rights to exploit the intangible, other than a right to resale the tangible good.

However, the intangible portion must be taken into account in finding the arm’s length price of the transaction.

On the other hand, if a purchaser acquires rights over an intangible embedded in tangible property, the transfer pricing analysis must be divided into two, in order to price the intangible rights separately from the tangible property(7).


The general guidelines set out for tangible property also apply in determining an arm’s length price for a transaction with intangible property (8). The circumstances of each deal will determine whether the transfer price for the goods includes a license charge. If such a charge exists, the country of the buyer would ordinarily disallow any additional payments for royalties.

The transfer price of a transaction that involves tangible and intangible property may be agreed as a package price. However, such a price may have to be disaggregated if the intangible gives to the sale of the tangible good a significant value. In this case, the price will have to show which portion of the price corresponds to the intangible in order for the country to apply its withholding tax for royalties(9). In case the buyer does not have any right over the intangible the desegregation is not required because the principle property transferred is the tangible good.

3. Colombia

The Colombian transfer pricing law does not mention the relationship that intangibles and tangibles may have in transactions involving the two types of property.

D. Relationship between services and intangibles

Common transactions include service rendering to related parties that involve an intangible, such as a know how or a technical service. Therefore, is necessary to differentiate between a service and an intangible due to the fact that the tax withholding may be different for compensation of services and payment of royalties for the use of intangible property.

1. United States

The definition of intangible property encompasses only items that have substantial value independent of the services of individuals. In case there is a substantial value of the intangible in the service provided, a separate charge must be given to the intangible.

An intangible may be transferred as part of a service rendered. Several aspects of such a transaction must be analyzed to determine the nature of the transfer, such as whether any intangibles were used or had a substantial value independent from the services rendered, whether there is an appropriate arm’s length charge for the use of the intangible, or whether a separate compensation is required for the services rendered. The result of this analysis will give the value of the compensation of the service and the royalty for the intangible embedded in the service.


If services and intangibles are involved in a transaction, the price shall be disaggregated. Services such as technical assistance and training of employees may involve know-how. Similarly, improvements to the products provided by the licensee to the licensor may also involve an intangible. In these cases, the arm’s length price for services must be analyzed with the rules specifically for services.

In order to decide whether the consideration is a royalty or compensation is necessary to analyze the rights that the marketer has over said intangible. If a marketer has an above normal return for its activities, it is transferring intangible property rather than simply rendering a service. On the other hand, if a marketer is getting only a normal remuneration, similar to that an independent agent would receive, it is being compensated for its services; in this case, it would not be entitled to share in any return attributable to the marketing intangible.

3. Colombia

This issue regarding the relationship between intangible property and services is not mentioned in the current transfer pricing rules in Colombia.

E. Methods suggested to be used when dealing with intangible property

The U.S. rules and the OECD Guidelines both describe several methods that may be used for transfers of intangible property. In contrast, Colombian rules do not specify particular methods for intangible property.

1. United States

Transfer pricing rules are intended to establish an arm’s length consideration for transactions between related parties. It is often not easy to find an uncontrolled transaction that deals with the same intangible that was transferred or licensed under the same circumstances(10).

The regulations outline four (4) methods that may be used to determine the arm’s length prices for transfers of intangible property: the comparable uncontrolled transaction (CUT) method, the comparable profits method, the profit split methods, and any other unspecified reasonable method(11). United States follows the best method rule under which the method applied in each transaction varies depending on the circumstances and the type of intangible transferred or licensed.

a) Comparable Uncontrolled Transaction (CUT) method

The arm’s length consideration for a controlled transfer of an intangible under the CUT method is “the amount charged in a comparable uncontrolled transaction”(12). This amount may be subject to periodic adjustments, as it explained later, under the commensurate with income standard.

If there is an uncontrolled transaction carried out under the same or very similar(13) circumstances, the CUT method is the best method(14).

Assume a U.S. pharmaceutical company licenses a new drug in Perú and in Colombia. The Peruvian company is a subsidiary of the U.S. company, and the Colombian company is an independent enterprise. If the markets in these two countries are very similar and decisive factors are also very similar, the transactions have a good degree of comparability for use in applying the CUT method, and the CUT method is the best method for determining the arm’s length price for the controlled transaction with the Peruvian company. If there is no license of the new drug to an unrelated party, the CUT method may still be used, but the comparability of data is not as precise. In this scenario, it is necessary to take other methods into consideration.

Two intangibles are comparable if they are used in connection with similar products or processes within the same general industry or market and have similar profit potentials.

An intangible’s profit potential is most reliably measured as the net present value of the benefits to be realized through the use or subsequent transfer of the tested intangible, adjusted to reflect the capital investment and start-up expenses incurred during the different stages, the risks to be assumed and other relevant factors(15). Profit potential is not always easy to identify, especially if profits cannot be isolated from other factors that indirectly affect the transaction.

The regulations establish guidelines to identify factors in a transaction that have to be taken into account in order to accurately apply the CUT method(16). Not all the factors have to be exactly the same; they may be adjusted if the essence of the transactions is not affected by the adjustments(17).

If there is more than one comparable uncontrolled transaction, the arm’s length price may be placed inside a range established by the comparables. The price has to follow the interquartile range rules established in the regulations(18).

For example, if the U.S. pharmaceutical company licenses the new drug to unrelated parties in several Latin American countries, the price paid by the Peruvian subsidiary is at arm’s length if it is within the range of prices assigned to the unrelated parties of the other Latin American countries.

b) Comparable Profits Method

It requires a comparison of the operating income that would result from the consideration actually charged in a controlled transfer (reported operating income) with the operating incomes of similar taxpayers that are uncontrolled.

The basic approach of the CPM is to calculate an operating profit that the tested party would have earned on related party transactions if its profit level indicator were equal to that of an uncontrolled comparable(19).

For example, a U.S. company licenses a patent to a subsidiary located in Colombia. The Colombian subsidiary uses that patent to manufacture goods and sells them to other subsidiaries of the U.S. company. The royalties of the Colombian subsidiary may be tested by comparing the operating profits reported by companies in similar circumstances engaged in a similar business, based, for example, on their rates of return on capital employed.

c) Profit Split Methods

The basic approach of this method is to estimate an arm’s length return by comparing the relative economic contribution that the parties make to the success of a venture, and dividing the returns from the venture between them on the basis of the relative value of such contributions(20).

The Treasury Department has called the profit split method as a method of last resort because it is applied either wholly or in part with internal data rather than data derived from uncontrolled taxpayers(21).

d) Other unspecified methods

An unspecified method that uses internal data rather than uncontrolled comparables is generally of a low grade of reliability(22). An unspecified method should be based on prices or profits information that the controlled taxpayer could have realized by choosing a realistic alternative to the controlled transaction. An unspecified method is only applied if it is the best method in the particular circumstances.


Rather than using a best method rule, the OECD establishes a hierarchy of methods to be used in order to obtain an arm’s length consideration in a transaction between related parties(23). The methods to be used depend on the circumstances of the transaction but the Guidelines suggest that the CUP method should be used at first instance.

a) Comparable Uncontrolled Price (CUP) method

This method should be used when the same owner has transferred or licensed comparable intangible property under comparable circumstances to independent parties(24). Offers to unrelated parties or genuine bids of competing licenses in the same industry can also be a guide. The amount charged as a consideration between unrelated parties from the same industry may be used.

b) Resale Price Method (RPM)

This method is based on the price at which a product that has been purchased from an associated enterprise, and is resold to an independent enterprise. The resale price is reduced by the resale margin. What is left after subtracting the resale price margin can be regarded, after adjustments for other associated costs, as an arm’s length price of the original transfer of property between the associated enterprises.

If the associated enterprise sub-licenses the property to third parties or if there is a sale of goods incorporating intangible property, the resale price method (RPM) may also be used.

c) Profit Split Method (PSM)

It is a transactional method that identifies the combined profit to be split between the associated enterprises in a controlled transaction. That split is based upon an economically valid basis that approximates the division of profits that would have been anticipated and reflected in an agreement made at arm’s length.

Cases involving a highly valuable intangible, it may be difficult to find a comparable uncontrolled transaction, and, the guidelines suggest that in this case, the profit split method may be applied(25).

3. Colombia

Article 260-2 of the Colombian Tax Statute includes six methods to be used in order to obtain an arm’s length price in transactions between economically linked companies or between related parties. Taxpayers and the tax authority must follow the method that best fits the circumstances(26).

The current rules do not determine which method should be used in case the transaction deals with tangibles, intangibles or services. However, the method used has to comply with the best method rule.

F. Commensurate with Income Standard

Parties to a transaction agree a consideration based on the circumstances at the moment of signing the agreement. However, circumstances may later change, and the consideration agreed at the moment of signing the agreement may not reflect economic reality in subsequent years. As a consequence, tax authorities have realized a need to adjust the consideration in order to reflect later economic realities.

1. United States

Since 1986, §482 has included a requirement that the consideration for a transfer of an intangible between controlled taxpayers must be “commensurate with the income attributable to the intangible”(27). The U.S. Congress introduced this provision in order to reflect the economic reality of the long-term transactions. Congress realized that conditions may change from one year into another. The success of a product may change in the subsequent years, and industry norms and developments may change. Therefore, it is necessary to include a rule that obliged to taxpayers to adjust the price of intangibles transactions if conditions vary from one year to another.

According to the U.S. Treasury, the commensurate with income standard is a development of the arm’s length principle(28). Independent parties generally agree that prices will be adjusted year by year and rarely make long-term licenses without any possibility of adjusting the royalty clause, especially for intangibles with high profit potential. Thus, transactions between related parties should have a clause that conforms the agreed price to the circumstances of each year. The commensurate with income standard requires an adjustment whenever there is a deviation from the parties’ expectations at the time they entered into the transaction, whether these changes are sudden or have occurred over a period of time(29).

This standard applies whether the consideration is a series of periodic payments or a noncontingent amount payable in a single lump sum at the time of the transfer(30).

The commensurate with income standard is sometimes called a super royalty rule because, as applied to a highly profitable intangible, a very high royalty may be required to appropriately reflect a relatively minor economic contribution by the transferee and achieve a proper allocation of income(31). The fact that the consideration for the first year is at arm’s length does not preclude the IRS from making adjustments for subsequent years(32).

The Treasury Regulations establish three principal safe harbors in which an adjustment does not have to be made to a price:

a) The original transfer price was justified under the CUT method applied with an uncontrolled transfer of same intangible. In this case, an adjustment is not required if the following requirements are met:

1. The intangible transferred in the controlled transaction was also transferred to an unrelated party under the same circumstances, and

2. The price for the first year was at arm’s length, determined by the CUT method using the uncontrolled transaction as the comparable (33) .

For example, if a U.S. company licenses a new drug to its Peruvian subsidiary and at the same time licenses the same drug to a unrelated Colombian party, a later adjustment to the price given to the Peruvian subsidiary is not allowed, provided that the price given to the Peruvian subsidiary was at arm’s length for the first year, as determined by comparing it to the Colombian transaction, and using the CUT method.

b) The original transfer price was justified under the CUT method applied with an uncontrolled transfer of a different but comparable intangible. If all of the requirements established by law are met, a commensurate with income adjustment may not be made for a subsequent year(34).

c) The original transfer price was justified under a method other than the CUT. Under this safe harbor, if a controlled agreement is tested under a method other than the CUT method, a commensurate with income adjustment is not allowed if the legal circumstances are met(35).

Safe harbors b) and c) have two modifications. The first modification is that the last requirement (20 percent threshold) is waived if the reason for the variation from 20 percent is due to an extraordinary event, such an earthquake(36). The second modification applies if a period of five years passes by in compliance with all the requirements and in the subsequent year one or more of the requirements are not met(37).


The OECD Guidelines do not explicitly recognize a commensurate with income rule. However, they recognize that highly specialized intangible property may pose difficulty in finding a similar comparable intangible. Therefore, the valuation of this type of intangibles becomes highly uncertain, particularly in long-term transactions.

Depending on the factors and circumstances involved in the transaction, the anticipated benefit may be considered as a factor for establishing the pricing at the outset of the transaction.

In some cases, unrelated enterprises would not reserve a right to make future adjustment. In some other cases, independent enterprises might find that the forecast of anticipated benefits is not the correct factor to base the pricing in a transaction. In such cases, independent parties may want to adopt short-term agreements in order to have the right of adjusting the consideration at the end of each year, in case subsequent developments arise that vary the profitability of the intangible(38). Independent parties may also want to sign long-term agreements but with a clause that permits an adjustment to the price in case major unforeseen developments change the fundamental assumptions upon which the price was agreed.

When tax authorities evaluate controlled transactions involving intangible property with highly uncertain outsets, they will compare the transactions with uncontrolled transactions of similar characteristics(39). Generally, independent enterprises will reserve the right of adjusting the price in case the intangible property transferred late generates profits greater than predicted at the outset. Therefore, the tax authorities expect controlled transactions to have the same clauses that permit adjustments of the price in subsequent years when substantial changes occur.

The OECD Guidelines recognize that tax administrations may not conduct an audit of a taxpayer’s tax return until several years have passed. In such cases, the tax administration is only entitled to adjust the price of open years(40).

3. Colombia.

The current transfer pricing regime in force in Colombia does not make any provision for periodic adjustments. The rules do not consider the possibility of having a price that is not at arm’s length in subsequent years of a long-term agreement.

(*) Opinión del autor, no compromete a la Federación Nacional de Cafeteros de Colombia.

(1) Cym H. Lowell, Marianne Burge & Peter L. Briger, U.S. International Transfer Pricing, chapter 5 ¶5.01.

(2) Treas. Reg. 1.482-1(b)(1).

(3) Cym H. Lowell, Marianne Burge & Peter L. Briger, U.S. International Transfer Pricing, chapter 16 ¶16.02. (1999 Westlaw 257540).

(4) Epsen Lithographers, Inc. v. O’Malley, 67 F. Supp. 181 (D. Neb. 1946), Nestle Co. v. Commissioner, 22 TCM 46 (1963).

(5) Revenue Procedure 63-10, 1963-1 CB.

(6) Colombian Tax Statute, article 260-1.

(7) Treas. Reg. §1.482-3(f)

(8) OECD Guidelines, 2001 6.13

(9) OECD Guidelines 2001 6.17

(10) There are, however, a few cases. RT French v. Commissioner, 60 TC 836 (1973).

(11) Treas. Reg. 1.482-4(a).

(12) Treas. Reg. §1.482-4(c)(1).

(13) The circumstances may be the same or very similar if there at most only minor differences that have a definite or reasonable ascertainable effect on the amount charged and for which appropriate adjustments are made.

(14) Treas. Reg. §1.482-4(c)(2)(ii).

(15) Treas. Reg. §1.482-4(c)(2) (iii)(B)(1)(ii).

(16) Treas. Reg. §1.482-4(c)(2)(iii)(B)(2).

(17) Ciba Geigy Corporation v. Commissioner 85 TC 172 (1985).

(18) Treas. Reg. §1.482-1(e)(2)(iii)(B), §1.482-1(e)(2)(iii)(C), §1.482-4(c)(4) Ex. 3.

(19) Treas. Reg. 1.482-5(b)(1).

(20) TD 8552, 1994-2 CB 93, 100.

(21) Boris Bittker & Lawrence Lokken: Fundamentals of International Taxation ¶79.10 (2003-2004 WG&L).

(22) Treas. Reg. §1.482-4(d)(1).

(23) Cym H. Lowell, Marianne Burge & Peter L. Briger, U.S. International Transfer Pricing, chapter 16 16.03. (1999 Westlaw 257540).

(24) OECD Guidelines 2001 6.23.

(25) OECD Guidelines 2001 6.26.

(26) Colombian Tax Statute, article 260-2.

(27) Treas. Reg. §1.482-4(f)(2)(i).

(28) Notice 88-123, 1988-2 CB 458.

(29) Notice 88-123, 1988-2 CB 477.

(30) Treas. Reg. §1.482-4(f)(5)(i).

(31) Notice 88-123, 1998-2 CB 458, 473.

(32) Treas. Reg. §1.482-4(f)(2)(i).

(33) Treas. Reg. §1.482-4(f)(2)(ii)(A).

(34) Treas. Reg. §1.482-4(f)(2)(ii)(B).

(35) Treas. Reg. §1.482-4(f)(2)(ii)(C).

(36) Treas. Reg. §1.482-4(f)(2)(iii) Ex. 3(iii).

(37) Treas. Reg. §1.482-4(f)(2)(ii)(E).

(38) OECD Guidelines 2001 6.30.

(39) OECD Guidelines 2001 6.33.

(40) OECD Guidelines 2001 6.35.