Contents - AL-Tax

168 12 Decentralized Ownership of Intellectual PropertyWhile the calculation of asset values is arithmetically simple, it is tedious andtime-consuming in direct proportion to the length of assumed gestation lags andeconomically useful lives. Hence, for the sake of illustration only, we assume thatFS’ marketing intangible assets have a gestation lag of one month and an economicallyuseful life of 2 years. Moreover, we assume that FS expends a uniformamount per month on marketing over the course of a year, determined by dividingits annual marketing expenses by 12. As noted, benefits from these monthly outlaysare realized over the subsequent 24 months. (The gestation lag is very brief becausemost marketing efforts are geared toward directing Internet traffic to FS’ sites.Individuals respond quickly or not at all to these efforts.) Lastly, we assume thatFS invests $19,440,000, $43,524,000 and $112,800,000, respectively, on marketingduring its first 3 years of operations. This set of assumptions generates the amortizationdeductions per annum (in thousands of U.S. dollars) shown in Table 12.1 duringyears 1–3.We determine the division of FS’ adjusted operating profits between FS andUSP under the residual profit split method, given the simplifying assumptions notedabove, in the following steps:1. USP’s software development outlays, expressed as a percentage of consolidatedintangibles-creating expenditures, are consistently in the range of 23.0%–27.0%.2. With identical gestation lags and useful lives, relative intangible asset values willequal relative intangibles-creating expenditures.3. Therefore, under this set of assumptions, USP’s IT platform has a value ofbetween 23.0% and 27.0% of the Group’s combined IT- and marketing-relatedintangible assets.4. The relative values of (a) USP’s IT platform in international markets, and (b) FS’marketing intangible assets, should be approximately equal to the relative valuesof these assets on a consolidated basis if platform scalability benefits FS (as weassume for the time being).Next, we sequentially eliminate certain of our simplifying assumptions. First,USP and FS do perform routine functions. More particularly, in addition to its salesand marketing role, FS performs customer support, payment processing and generaland administrative support functions. USP performs site operations servicesvis-a-vis FS’ international operations. Utilizing several sets of standalone servicesproviders that (a) perform a subset of the same support functions on a fee-for-servicebasis, and (b) do not own intangible assets, we conclude that FS should earn aweighted average markup of 8% over the costs of performing its routine functions.We conclude that USP should earn a markup of 10.0% over the costs of performingsite operations services on behalf of FS. Hence, we reduce FS’ adjusted operatingprofits by (i) the costs that USP bears in rendering site operations services toFS, (ii) the 10.0% return that USP should earn on these routine services, and (iii)the 8.0% weighted average markup that FS should earn in performing its routine