69. Ilcha is organised in country A. The Ilcha group of companies has for many years manufactured and sold Product Q in countries B and C through a wholly owned subsidiary, Company S1, which is organised in country B. Ilcha owns patents related to the design of Product Q and has developed a unique trademark and other marketing intangibles. The patents and trademarks are registered by Ilcha in countries B and C.
70. For sound business reasons, Ilcha determines that the group’s business in countries B and C would be enhanced if those businesses were operated through separate subsidiaries in each country. Ilcha therefore organises in country C a wholly owned subsidiary, Company S2. With regard to the business in country C:
- Company S1 transfers to Company S2 the tangible manufacturing and marketing assets previously used by Company S1 in country C.
- Ilcha and Company S1 agree to terminate the agreement granting Company S1 the following rights with relation to Product Q: the right to manufacture and distribute Product Q in country C; the right to use the patents and trademark in carrying out its manufacturing and distribution activities in country C; and, the right to use customer relationships, customer lists, goodwill and other items in country C (hereinafter, “the Rights”).
- Ilcha enters into new, long-term licence agreements with Company S2 granting it the Rights in country C.
The newly formed subsidiary thereafter conducts the Product Q business in country C, while Company S1 continues to conduct the Product Q business in Country B.
71. Assume that over the years of its operation, Company S1 developed substantial business value in country C and an independent enterprise would be willing to pay for that business value in an acquisition. Further assume that, for accounting and business valuation purposes, a portion of such business value would be treated as goodwill in a purchase price allocation conducted with regard to a sale of Company S1’s country C business to an independent party.
72. Under the facts and circumstances of the case, there is value being transferred to Company S2 through the combination of (i) the transfer of part of Company S1’s tangible business assets to Company S2 in country C, and (ii) the surrendering by Company S1 of the Rights and the subsequent granting of the Rights by Ilcha to Company S2. There are three separate transactions:
- the transfer of part of Company S1’s tangible business assets to Company S2 in country C;
- the surrendering by Company S1 of its rights under the licence back to Ilcha; and
- the subsequent granting of a licence by Ilcha to Company S2.
For transfer pricing purposes, the prices paid by Ilcha and by Company S2 in connection with these transactions should reflect the value of the business which would include amounts that may be treated as the value of goodwill for accounting purposes.