In the case of a specific brand, ABC, the supplier makes ABC available to the buyer. Say then, the revenue authority proffers an ALP determination process but valuing the brand using a ‘prime premium’ method. How does this basic fundamental analysis assist? In basic terms, the determination of a ‘price premium’ of a product or service looks to taking a product, comparing it to similar products in the same market, proposing a fictitious ‘no name’ product in that same market to represent the extreme price point of difference between the ABC example of product brand and the ‘no name’ product.
Then, if the ABC branded product gave rise to a US$100 sale, this price point is taken and in a survey of consumers of the ABC product, they are asked at what price point will they switch from the ABC product to the ‘no name’ product. Let us say at US$50, the largest price difference in that market is US$50. So, theoretically the ABC product has a price premium of US$50. The same exercise is conducted with the other branded products in that market. Those results should inference the final price premium result of the ABC product. Let us say the end result is US$40. The conclusion is drawn that the ABC product has a ‘price premium’ of US$40. The conclusion is drawn that the ABC product has a ‘price premium’ of US$40 per product in that market. This US$40 is then used to determine the value of the brand in that market. This is then converted to a percentage that is supposed to represent what the ABC brand influence and thus value is in that market.
The revenue authority will typically take the gross market revenue generated by the ABC product (i.e. its sales), excluding other revenue streams from interest and other areas where it is not the branded product giving rise to the revenue.
For example, let us say there is no other revenue stream in our market. Thus 100% of the revenue stream is generated by the ABC branded product. In applying the 40% price premium obtained from a survey between an operating business and its end consumers, 40% of the revenue is said to be driven by the ABC brand, on the product.
Thus, the royalty charge by the owner of the ABC brand should be able to charge 40% for the use of the ABC brand. The revenue authority will argue the ALP price for the use of the ABC brand by a third party using the ABC brand to sell ABC branded products can charge the equivalent of 40% for the use of the ABC brand. Therefore, the ALP price between the supplier of the ABC brand (the legal owner) and the buyer (an associated subsidiary) in that market should charge a 40% royalty for the use of the ABC brand.
I now ask you to deconstruct the comparison royalty rate of the revenue authority against what the basic fundamentals tell us. The transfer pricing pundits at this point will be going crazy with a list of criticisms, all jumbled together, such as:…