Fair valuation of trademarks, technology, patents,databases, domain names, websites, brands, software and other intellectual property for financial reporting as well as strategic decision making purposes.
The fair value of intellectual property (IP) portfolios that companies are planning to transfer as part of their tax planning is a vital consideration for tax and transfer pricing professionals. The transfer may involve the intellectual property moving to an overseas branch, an incorporated legal entity overseas or simply between legal entities in the same country.
Regardless of the details of the transfer, there are tax implications in both India and any overseas jurisdiction involved. It is not always solely a question of the fair value of the intellectual property at the date of transfer, as there may also be the consideration of value created within the intellectual property before and after a specific date.
Intellectual Property Valuation Approach
Fair value is defined in ACS 820 and IFRS 13 as" the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date."
One or a combination of three main approaches is normally used in order to calculate the fair value of intellectual property – the Income Approach, the Market Approach and the Cost Approach.
The Income Approach indicates the fair value of intellectual property based on the value of the cash flows that the intellectual property might reasonably be expected to generate.
The Market Approach indicates the fair value of intellectual property based on a comparison of the intellectual property to comparable intellectual property transactions in the market.
The Cost Approach indicates the fair value of intellectual property based on the concept of replacement cost. The premise of the Cost Approach is that a prudent investor would pay no more for intellectual property than the amount for which he could replace the intellectual property with a new one having the same utility to the investor as the existing intellectual property.
The following graphic summarizes the three valuation approaches as they apply to intellectual property assets:
The Market Approach is typically difficult to apply to intellectual property assets since transactions of truly comparable assets are rarely available. In addition, the Cost Approach is inappropriate for most intellectual property as it fails to capture expected returns on the asset. Nevertheless, it may be appropriate for intellectual property that does not directly generate cash flows, e.g., software for internal use.
The Income Approach is the most common technique used to value intellectual property assets, because it captures expected future returns to the owner and is also able to estimate value for unique assets when market transaction data is not available. Market data may often be obtained to estimate the income stream that might reasonably be expected to be generated from a particular intellectual property asset.
Broadly speaking, there are two main methods into which the Income Approach can be classified; These are the Direct method and the Indirect method.
Direct Income Approach: Cash flows, or earnings, generated by a technology or brands, or expenses saved through the ownership of the asset, are estimated directly by reference to market benchmarks.
Indirect Income Approach: Value is estimated from the residual earnings after fair returns on all other assets employed have been deducted from the business’s after-tax operating earnings.
For some assets, such as trade name and technology wherever possible, Relief-from-Royalty Method (a Direct Income method) is considered as the preferred method. This method measures the after-tax royalties or license fees saved by owning the asset.
However, in the absence of pure-play comparable royalty transactions, or for some other assets, the multi-period excess earnings methodology (MEEM) is widely used.