The centralisation of brand management activities can further enhance a company's competitiveness. In particular, the centralisation of continual brand management and marketing intangibles can realise substantial value. This value stems from operational synergies through centralised brand management and the creation of new knowledge at a brand management centre (BMC). With a cost-and tax-efficient structuring of such centralisation, the effective tax rate (ETR) of a company can be lowered considerably. Following a successful brand migration, the BMC will typically charge related parties a royalty for the brand management function itself and all of the accompanying marketing intangibles.

The migration of well-established brands and related marketing intangibles is very challenging from a transfer pricing risk perspective. The following exemplary brand migration project shows how these difficulties can be successfully addressed.

Overview of the brand migration project: objectives and issues

This particular brand migration project was part of a group-wide consolidation initiative that included the consolidation of business segments and the planned merger of manufacturing companies, research entities and sales companies. During economic downturns, firms focus on cost-reduction programmes that are designed to increase the profitability of the production process. In addition to eliminating inefficiencies in the marketing process, overhead costs can be screened for potential cost savings. Setting up a centralised BMC leads to significant cost reductions and therefore increases the competitiveness of a company. A centralised BMC is typically introduced to reach the following objectives:

• realising operational synergies in the development of marketing intangibles;

• ensuring tax efficiency by locating new brand value creation in a tax-effective jurisdiction;

• increasing sales by using best practice marketing and branding approaches developed by successful group companies;

• reducing costs by lowering both headcount and capital employed;

• compliance with demand from shareholders for cost and tax-efficient locations for brands; and

• enhancing the possibility of successful litigation in cases of IP infringement.

In order to achieve the objectives outlined above, a brand migration project will have to take into account particular issues that bear transfer pricing risks. However, these risks can be reduced if the brand migration project is structured properly. To complete a successful brand migration project, four key issues have to be addressed effectively.

First, the migration of marketing intangibles might provoke exit taxation if ownership of such marketing intangibles is transferred. The ownership of the marketing intangibles may be decomposed so that the exit taxation risk is mitigated. We refer to the mitigation of the exit taxation risk through decomposition of the intangibles as transfer pricing structuring. Second, the realisation of significant and measurable synergies in a BMC represents an operational issue that is important for ensuring the value creation of future marketing activities. Third, in order to ensure compliance with fiscal regulations, intellectual property (existing and future marketing intangibles) has to be valued in accordance with Organisation for Economic Co-operation and Development (OECD) and US transfer pricing regulations. Fourth, the specific local tax and legal requirements of the new BMC jurisdiction must be taken into consideration.

Framework for brand migration

Potential exit taxation on IP transferred to the BMC is the main challenge of such a project. In essence, brand migration can be structured in two different ways. Either way may be appropriate depending on the fact pattern of the given case. Under the first alternative, gradual migration, only the continual brand management activities are transferred to the new BMC, leading to an increase in the economic ownership of the BMC in future marketing intangibles. Under the second alternative, instant migration, all existing marketing intangibles are transferred to the new BMC, which increases transfer pricing risks, especially regarding exit taxation. When a brand is transferred instantly, the BMC becomes the economic owner of the transferred marketing intangibles.

In order to benefit from differences in the ETR between jurisdictions, it is necessary to allocate the profit generation potential to the BMC. This profit generation potential stems from the economic and beneficial ownership of the marketing intangibles. This ownership needs to be transferred to the BMC whenever applicable.

Under both approaches (the gradual and the instant brand migration approaches), the first project step includes an analysis of the migrated brand. In particular, an analysis requires a determination of how much of the brand value depends on current marketing activities. A portion of a well-developed brand may be the result of historic marketing activities that have nothing to do with current marketing initiatives, resulting in deeply-fixed brand perceptions in the consumers' minds. A transfer of this part of the brand, the core brand value, may not lead to tax efficiencies because there are offsetting net effects of the purchase of the asset and a subsequent charge for its usage that will likely make the benefits not worth pursuing.

Brand value generated by means of current marketing activities (through TV advertisement, for example) creates value in addition to the core brand value. If structured properly, current marketing activities and related intangibles can be transferred successfully to a new BMC. In addition, synergies that stem from the bundling of marketing activities in the BMC will increase brand value. This additional value created by synergies can be claimed by the BMC and therefore be taxed at its location.

The core brand value will remain with the company that generated it. Therefore, the core brand value is typically not transferred to the BMC. However, the responsibility for marketing activities will be transferred from the local companies (sales companies, for example) to the BMC. The described transfer of economic ownership is only possible to the extent that the relevant activities can be allocated to the BMC. This might not be the case for all marketing activities, especially not for all local activities. As a consequence, some economic ownership typically remains with the local sales and marketing companies. Despite the fact that the BMC will be organised as a company with its own tax return, it is still prudent to transfer significant people and the control of future branding (in OECD terms) to the BMC. It is also necessary to transfer other important decision-makers. Risks and assets are assumed to follow significant people, and the concept of a significant people factor is linked to active decision-making.

The new BMC will gain economic ownership in all marketing intangibles that are created by future activities undertaken by the BMC. Economic ownership in this case is defined as the BMC's contribution to the value produced by the intellectual property (independent of whether it owns such intangibles legally or whether other group companies are the legal owners). In parallel, the marketing intangibles economically owned by other group companies will be amortised as marketing activities necessary for their maintenance are stopped. The decay rate for the marketing intangible will have to be defined and might potentially differ between the countries of interest due to local characteristics of the countries and the position of the particular brand within the local market. The existing economic ownership associated with the various migrated brands attributable to the local sales and marketing companies will decrease.

Economic analyses are necessary in order to properly examine the transition period for the brand. The transition period is the period in which the economic ownership of the BMC in marketing intangibles is built up, while the economic ownership of the local companies gradually decreases. A detailed analysis of this transition period is important because the BMC and the transferors (the local companies) may have opposing interests regarding the transfer speed. The value of the transferred marketing intangible depends on various assumptions.

Throughout the transition process, the royalty charged by the BMC to the sales and marketing companies will increase steadily until the economic ownership has been fully transferred to the BMC.

In addition, at the time of transfer, the existing value of the brands and other marketing intangibles (such as know-how) must be determined, and the transferor has to be remunerated accordingly. The remuneration can be structured as a relief from future royalties over the lifetime of the old assets.

In addition to the transfer of economic ownership, beneficial ownership will be transferred to the BMC. Beneficial ownership results from positive externalities and is not fundamentally justified by the economic contributions of its owner. The owner is then free-riding on the endeavours of others. Beneficial ownership is treated in the same manner as economic ownership, the only difference being that the prior owner cannot charge for the beneficial ownership in brand value created through past activities.

Diagram 1: Brand composition

Diagram 2: Transferable brand value

Diagram 3: Depiction of the transition period - economic ownership

Diagram 4: Depiction of the transition period - beneficial ownership

In the case of an instant brand migration (transference of the existing marketing intangibles), the brand value will have to be analysed and marketing activities will be transferred from the local sales companies to the new BMC. The difference between gradual migration and this instant migration approach is that the marketing intangibles will now be transferred immediately because the BMC buys the existing intangibles from the transferor (the local group companies). As a consequence, the economic ownership of these marketing intangibles is transferred to the BMC directly.

Remuneration for the transferred intangibles can occur either via a lump-sum payment, an offsetting royalty charged by the local companies to the BMC or, as a net effect, a relief or reduction of the royalty paid by the local companies to the BMC for the activities undertaken by the BMC. The transfer of existing intangibles results in the risk of exit taxes. These may be incurred by the seller of the intangibles at the time of transfer.

Exit taxation will be reduced by recognising the beneficial ownership in the existing marketing intangibles. Sellers do not have to be remunerated for the loss of beneficial ownership as they did not contribute to its generation.

In order to achieve the operational synergies described above and to benefit from the tax-efficient structuring of the new BMC, the BMC must be classified as an entity that undertakes continual brand management, not only from a business point of view but also from a taxation point of view, in order to ensure compliance with current regulations. From a fiscal perspective, to achieve such a classification, certain preconditions must be fulfilled by the BMC. A non-conclusive list of prerequisites for the successful setup of a BMC would likely encompass the following items.

• Given the new OECD focus on the significant people and control concepts, the BMC has to employ significant people for the development of the future brand value through continual brand management taking control of branding. If functional groups of significant people move from an existing brand management unit to the BMC, there may be important gradations in value contribution among eligible groups, and even individual candidates that should be carefully analysed to model all potential tradeoffs so that the value and tax implications of the transferred assets are optimised.

• The BMC must be endowed with sufficient equity.

• The BMC should assume responsibility for group-wide marketing expenditures.

• The BMC will be best positioned to create new knowledge and know-how of best practice, realising substantial operational synergies. In order to be able to achieve such synergies, the BMC must be responsible for looking for best branding practices in the group, combine the best practices and develop synergies for the future brand value.

• The BMC should employ the significant managers for future branding and should take control.

• The BMC may attract (intellectual property) lawyers to the company and undertake functions for the protection of the brands.

• The BMC may create new competences for the group with respect to intangibles and act as a clearing-house for remuneration for the use of all intangibles within the group.

• Any external know-how that the company may acquire in the future should be based at the BMC.

In line with these prerequisites, as well as the approaches outlined above, if structured coherently and efficiently, five key tasks must be accomplished. First, the marketing intangibles and related activities that will be transferred to the BMC must be identified. Second, these marketing intangibles must be valued. Third, for a successful implementation of the new brand management strategy, the synergies that can be realised must be valued and it must be determined how they can be attributed to the different entities. Fourth, the transition period, as described above, must be analysed. In particular, the upper and the lower boundaries must be analysed and the bargaining situations of the parties involved must be considered. Finally, the optimal tax-efficient location for the new BMC must be determined. This decision can be based on factors such as taxation, attractiveness for employees and convenience. Locations such as Zug and Morges in Switzerland are convenient from a business and a tax point of view. Other suitable locations may be Luxembourg and Ireland.

Recommendations

Brand migration usually results in key benefits for a company. First, there is substantial potential for future synergies and future value to be developed at the new BMC. Correct and robust valuation of these synergies is essential because this represent a new pool of intangible value that can boost the final value of asset migration as a tax planning exercise. Second, if the brand migration has been undertaken with the necessary care, new value will be safely created by the BMC in a tax-efficient location.

There are a large number of pieces and many subtle analytical exercises that must be carefully completed to ensure and achieve credibility upon audit, in particular with regards to the minimisation of tax risks from the transfer of IP to the BMC. Consequently, close and continual collaboration with company budgeting and financial experts is the key to efficiently completing these types of projects. After the complex transition period, the following periods are considerably less time-consuming and result in considerable cost savings. Experience shows that tax risks can be avoided.

As a result, the effective tax rate for brand income depends on the rulings in tax efficient jurisdictions. If structured and chosen wisely, the effective tax rate lies in the range of 4.3% to 12.5%, usually at around 8%.

Alexander Voegele
		NERA Economic Consulting Konrad Adenauer Strasse 17 60313 Frankfurt, Germany Tel: +49 69 710 447 501 Fax: +49 69 710 447 505 Email: alexander.voegele@nera.com Alexander Voegele is chairman of the advisory board of NERA Economic Consulting GmbH. During more than 25 years of advising international corporations and leading law firms on transfer-pricing issues, Alexander has specialised in developing innovative economic structures for transfer-pricing strategies and for the defence of big international transfer pricing cases. Alexander and his NERA colleagues provide economic transfer pricing strategy, pricing of IP and worldwide documentation. Having advised and negotiated numerous bilateral and multilateral agreements, he has particular expertise in structuring European arbitration and advance pricing agreements. He specialises in the valuation of business, intellectual property and financial instruments. Alexander regularly publishes articles and books on transfer pricing and international tax planning and is the author and editor of the leading German commentary on transfer pricing and economic consulting, the Handbook of Transfer Pricing.

Hendrik Fügemann
		NERA Economic Consulting Email: hendrik.fugemann@nera.com Hendrik Fügemann works in the area of transfer pricing and intellectual property valuation at NERA. He specialises in the area of intellectual property valuation in the financial services and telecommunications industries. Before joining NERA, he worked at BDO Dt Warentreuhand AG, as well as Ernst & Young AG in the area of auditing. He also developed securitisation models for loans in the financial services industry. Hendrik studied international management at WHU – Otto Beisheim School of Mangement, from which he received his diploma degree, as well as at Washington University in St Louis (US), ICADE (Spain) and the London School of Economics (UK).

Stuart Harshbarger
		NERA Economic Consulting 1166 Avenue of the Americas 28th Floor New York, NY 10036 Tel: +1 212 345 2812 Fax: +1 212 345 4650 Email: stuart.harshbarger@nera.com Stuart Harshbarger is a vice president in NERA's transfer pricing and intellectual property practices. He consults for private industry, regulated utilities, trade associations, law firms and government agencies, and has been qualified as an expert before US Federal and State courts. Stuart specialises in the economics associated with the manufacturing industries. He has completed global transfer pricing studies for US, European and Japanese manufacturing companies, with an intensive focus on plant costing, performance and profitability metrics. Stuart has also completed transfer pricing studies for over 30 different automotive parts manufacturers. Before joining NERA, Stuart worked for PricewaterhouseCoopers LLP, where he was responsible for completing transfer pricing, intangible asset and management fee studies for companies worldwide. He has also worked at DRI/McGraw-Hill, Argonne National Laboratory, the Washington Gas Light Company and the US Department of Energy, as well as having served as the vice president of the National Economists' Club.