Latvian company A has sold a trademark to another Latvian related company B. Company B has licensed back to A the rights to use the trademark. The arm’s length value of the trademark was assessed using a discounted cash flow analysis. After a couple of years, it appears that the sales of the group are unexpectedly higher than assumed for valuation. Can the trademark be revalued in the books of B? What is the effect on transfer pricing?
The valuation of the trademark was assessed using a discounted royalty stream which was based on the forecast at the valuation day. Since the actual revenue stream was better than expected, it seems that there is at least some reason for revaluation of the intangible.
Let us analyse the relevant accounting and tax sources to find out the answers.
Annual Financial Statements and Consolidated Financial Statements Act
According to Article 29 of the of the Act only rights acquired in exchange for consideration may be indicated in the item “Concessions, patents, licenses, trademarks, and similar rights“. As it follows from this rule the intangibles should be recognized at acquisition cost. Furthermore, the Act does not provide any revaluation of the intangible assets. So, therefore, it might be concluded that the accounting rules do not allow to recognize the revaluation of the intangibles.
International accounting standards
According to the International Accounting Standards (IAS 38 “Intangible assets”) measurement subsequent to acquisition: cost model and revaluation models allowed. (https://www.iasplus.com/en/standards/ias/ias38):
- Cost model. After initial recognition intangible assets should be carried at cost less accumulated amortisation and impairment losses.
- Revaluation model. Intangible assets may be carried at a revalued amount (based on fair value) less any subsequent amortisation and impairment losses only if fair value can be determined by reference to an active market. Such active markets are expected to be uncommon for intangible assets.: production quotas, fishing licences and taxi licences. Under the revaluation model, revaluation increases are recognised in other comprehensive income and accumulated in the “revaluation surplus” within equity except to the extent that they reverse a revaluation decrease previously recognised in profit and loss (source: https://www.iasplus.com/en/standards/ias/ias38).
Since the trademark is unique and there is no active market for such intangibles available, the fair value of the trademark could not be assessed. This means that also IAS do not allow the revaluation of the trademark.
Effect on transfer pricing
For transfer pricing purposes the sale of the trademark should be assessed based on the remuneration which refers to the anticipated future income expected to be derived at the time of a transaction (ex-ante remuneration). However, given that the actual outcome of the use of intangible may differ, it is important to test also actual remuneration (ex-post), which refers to the income actually earned by the holder of the intangible.
The OECD guidelines suggest analysing the difference between ex-ante and ex-post remunerations. If there is difference between ex-ante projections and the ex-post results which are not due to unforeseeable developments or events, the differences may give an indication that the pricing arrangement agreed upon by the associated enterprises at the time the transaction was entered into may not have adequately taken into account the value of the intangible and the pricing arrangements adopted.
The sales price of the trademark established prior to the transaction was determined based on the assumptions available at the valuation time. The changes in the market and increase of the sales could not be foreseen at the time when the valuation was made, therefore, the increase in the sales does not mean that the trademark should be revalued.
Given the current accounting and tax treatment of the growth of the trademark value, in order to recognize such increase in value, the company B will most likely have to sell the trademark to another company or probably the company should be reorganized in order to obtain some grounds for the recognition of the new value.