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164 12 Decentralized Ownership of Intellectual Property FS has sole responsibility for developing international markets (with the exceptionsof Germany and Japan) at its own cost and risk. FS is contractually obligated to develop and promote USP’s brand identity ininternational markets (heretofore unknown outside of the United States), andindemnifies USP against all losses, damages, expenses and other costs incurredas a result of alleged claims of improper use of USP’s brand name.Under the terms of its JV agreement with FS, USP is entitled to 20% of FS’operating profits. Since USP and FS entered into this agreement, FS has establisheda number of greenfield sites in various countries. USP also purchased two otherfirms providing similar or complementary information services and forums, andagain contributed the acquired companies’ shares to FS on a cost-free basis. USPhas joint venture agreements with third parties in Germany and Japan; hence theirexclusion from FS’ territory in the intercompany JV agreement. (These third partyJV agreements pre-dated FS’ JV agreement with USP.)Due to the sheer size of the U.S. population, the fact that Silicon Valley was thelaunching pad for vast numbers of Internet start-ups and, relatedly, because U.S.consumers were among the first to fully embrace the Internet, the U.S. website hasremained the largest of the Group’s individual sites. Because it was the Group’s firstsite, it has also traveled further along the trajectory of development and maturation.Primarily in response to flagging interest among U.S. users, USP recently acquiredtwo domestic companies with complementary e-commerce businesses. Both acquisitionswere stock transactions, and the acquired companies do not have overseasoperations. FS’ sites now collectively rival the size of the U.S. site (and generatecomparable revenues and free cash flows), although they are individually muchsmaller and the markets less mature.USP has invested considerable sums in its IT platform over the past several years,primarily for purposes of refining the U.S. user interface and building scalabilityinto its system. The latter is an important issue in the United States, but much lessso in foreign markets, because the user networks are much smaller in these markets.Investments in IT are only one-quarter of those in marketing on a Group-wide basis.Such marketing is primarily Internet-based, and is designed to maximize traffic tothe Group’s sites.12.2 Transfer Pricing IssuesThis case raises the following transfer pricing issues:1. Should FS compensate USP for its contribution of the three acquired foreigncompanies’ assets, and should USP compensate FS for its partial financing ofUSP’s two domestic acquisitions (both of which were much larger than the foreigntarget companies at the time of their acquisitions)?2. How much should FS pay USP for:
12.3 Analysis Under Existing Regime 165 Rights to use USP’s IT platform and its upgrades to server-side and client-sidesoftware on an ongoing basis; USP’s customization of its platform undertaken on FS’ behalf; and, USP’s performance of site operations functions on FS’ behalf.3. Should FS compensate USP for its rights to use the latter’s brand identity ininternational markets, and if so, what constitutes arm’s length consideration?12.3 Analysis Under Existing RegimeThe range of potential approaches to the transfer pricing issues listed above dependin part on whether one treats FS and USP as joint venture partners or purely standalonecompanies.12.3.1 Assuming USP and FS Act to Maximize TheirIndividual ProfitsIf we assume that FS and USP each act to maximize their individual profits ratherthan their combined profits, certain of the transfer pricing issues can be addressedfairly simply.FS and USP should compensate one another for their respective contributions ofassets and acquisition financing. The fair market value of assets contributed by USPto FS is straightforward, inasmuch as these contributions took place shortly afterthe acquisitions (all of which were cash transactions), and a market price thereforeexisted.FS’ contributions to the financing of USP’s domestic acquisitions are more complex.As noted, these transactions were stock acquisitions. When the first suchacquisition took place, FS’ cash flows accounted for approximately 30% of Groupwidecash flows. When the second such acquisition took place, FS’ cash flowsaccounted for close to 40% of Group-wide cash flows. At both points in time,the Group’s international sites were growing substantially more rapidly than USP’sdomestic site.An implication of these facts is that a substantial part of the future cash flowstream represented by the Group’s stock, used to acquire the domestic target companies,will be generated in international markets. Therefore, in effect, USP and FSjointly acquired the domestic companies, jointly own their assets, and should dividethe cash flow attributable thereto in proportion to their respective ownership interests.(Alternatively, USP could purchase FS’ interests outright.) One might argueinstead that an implicit back-to-back securitization transaction has taken place: First,FS issued USP notes entitling the latter to a portion of its future cash flows, inexchange for the face amount of the notes up front; second, USP transferred thesenotes to the sellers of the domestic target companies as partial consideration. Underthis scenario, USP owes FS the face amount of the notes (and foregone interest).
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Transfer Pricing and Corporate Taxa
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Elizabeth KingBeecher Consulting, L
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AcknowledgementsI have worked with
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xContents3.5.3 SummaryandPracticalI
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xiiContents8.3 Analysis Under Exist
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Part IEconomic and Accounting Rates
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Chapter 4Some Alternative Approache
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4.6 Franchise Model 63relationship
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Part IIICase Studies
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Chapter 7Performance of Intercompan
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7.1 Summary of Key Facts 103orders,
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