Contents - AL-Tax

24 3 Overview and Critique of Existing Transfer Pricing MethodsAs previously noted, markets can generally be considered competitive for practicalpurposes if products or services are homogenous, incumbent firms can readilyexpand or new firms can enter, buyers or services recipients are well informed as totheir alternative sources of supply or services, and switching suppliers or servicesproviders is not excessively costly. Conversely, if products or services are differentiatedin any material way, there are barriers to entry and expansion, buyers are notespecially knowledgeable about the alternatives available to them, or firms wouldbear significant switching costs if they opted to segue to another supplier, prices orservices fees may persistently differ across suppliers. Whether a given market canbe characterized as competitive in a de facto sense is very much a matter of facts andcircumstances. Moreover, although prices will generally be equalized more rapidlythan economic rates of return in competitive product markets, there may be some“stickiness” in the adjustment process, which one should consider in determiningwhether price comparisons are valid in a given instance.Items of intellectual property are inherently distinctive to greater or lesserdegrees, and closely similar alternatives available from different entities are unlikelyto exist (with the important exceptions of franchise arrangements and trademarks).By definition, truly unique intangible assets are not available from more than onesource. Moreover, licensees generally cannot obtain rights to highly valuable “comparable”intellectual property from separate licensors. Therefore, absent internalarm’s length licensing arrangements, the comparable uncontrolled transactionsmethod will rarely apply to these types of intellectual property transactions, aspractitioners have generally found.However, even if, by some quirk of fate, external arm’s length licensing transactionsinvolving the same rights to comparable intangible property as those transferredintra-group could be found, the royalty rates charged in the external transactionsmay not be a satisfactory measure of an arm’s length royalty rate in thecontrolled licensing arrangement at issue. Royalty rates are negotiated bilaterallybetween individual pairs of firms, and the parties to these private transactions do notgenerally make information on the terms and conditions agreed on publicly available.14 Relatedly, buyers may incur significant costs simply to ascertain whethersubstitutable alternatives exist; such costs may deter them from doing so. Therefore,market pressures that might serve to equalize royalty rates across licensors rarelycome into play. Moreover, the comparability criteria set forth under the comparableuncontrolled transactions method in the U.S. regulations would not suffice to ensurethat two separate licensors would independently negotiate the same royalty rate andterms for the same set of rights to comparable intellectual property.Different prospective licensees of the same intangible asset available from a singlelicensor may also ascribe substantially different values to it, depending on how14 U.S. firms can, and frequently do, request confidential treatment of information relating to thelicense or sale of intangible assets. If granted such treatment, they generally redact royalty ratesfrom their public filings with the Securities and Exchange Commission.