Intellectual Property in a Preferential Tax Jurisdiction: When Is an IP Structure Sustainable?

For transfer pricing purposes, formal legal ownership of an intangible is an important starting point, but it does not by itself determine which entity is entitled to retain the economic return generated by the asset. The OECD Transfer Pricing Guidelines require consideration of the functions relating to the Development, Enhancement, Maintenance, Protection and Exploitation of the intangible, commonly referred to as DEMPE, together with the assets and risks associated with those functions.  

Preferential tax treatment does not automatically follow from locating the legal owner in a particular jurisdiction. Under IP regimes applying the modified nexus approach developed through OECD BEPS Action 5, the tax benefit is linked to qualifying R&D expenditure and qualifying IP assets. Marketing-related intangibles such as trademarks do not qualify for benefits under the nexus approach.  

Economic Substance of an IP Holding Entity 

The sustainability of an IP structure depends on economic reality rather than corporate documentation and place of incorporation alone. There is no universal rule requiring every IP owner to perform every relevant function through its own employees. Functions may be outsourced to related entities or independent service providers, but the transfer pricing analysis must establish which entity actually performs and controls the material functions and assumes the corresponding risks. 

Where the legal owner outsources DEMPE functions, the analysis must determine whether that owner genuinely exercises control over the relevant functions. If the legal owner neither performs nor controls those functions, legal title alone does not entitle it to the economic return attributable to their performance or control. Its remuneration must reflect the functions it actually performs, assets it actually uses and risks it actually assumes.  

Within the European Union, Article 6 of Council Directive (EU) 2016/1164 (ATAD) is also relevant. For corporate tax purposes, Member States must disregard an arrangement or series of arrangements where the main purpose or one of the main purposes is obtaining a tax advantage that defeats the object or purpose of the applicable tax law and the arrangement is not genuine having regard to the relevant facts and circumstances. An arrangement is non-genuine to the extent that it is not put in place for valid commercial reasons reflecting economic reality.  

DEMPE Analysis and Allocation of IP Returns 

DEMPE refers to the Development, Enhancement, Maintenance, Protection and Exploitation of an intangible asset. 

The analysis extends well beyond identifying the entity in whose name a trademark or patent is registered. It considers who takes the material decisions relating to development, who finances and controls the relevant activities, who manages protection and enforcement, who determines commercial exploitation, and who genuinely controls the economically significant risks. 

A legal owner may outsource individual DEMPE functions without automatically losing entitlement to returns from the intangible. The critical issue is which entity actually controls the outsourced functions and associated risks. Where an entity merely holds legal title but neither performs nor controls the relevant functions, legal ownership alone does not justify allocating residual profit to that entity.  

The assessment is therefore fact-specific. The existence or absence of sufficient substance cannot be determined solely by reference to the number of employees, an office address or the jurisdiction of incorporation. 

How Should Intra-Group Royalties Be Determined? 

Royalties between associated enterprises must comply with the arm's length principle. A royalty rate should not be determined solely by the development cost of the IP asset or by a preferred allocation of profit within the group. 

The controlled transaction must be accurately analysed by reference to the functions performed, assets used and risks assumed by the parties. Depending on the circumstances, relevant transfer pricing methods may include the Comparable Uncontrolled Price method (CUP), the Transactional Net Margin Method (TNMM) and the Transactional Profit Split Method. The appropriate method must be selected on the basis of the particular transaction rather than through a mechanical preference for a specific methodology.  

A high royalty that leaves the operating company with a limited profit is not, by itself, proof that the arm's length principle has been breached. Such an outcome nevertheless requires economic support consistent with the parties' actual functions, assets and risks and an appropriate transfer pricing analysis. 

BEPS Action 13 establishes a standardised transfer pricing documentation framework that includes a Master File and Local File, together with Country-by-Country Reporting for relevant groups. Whether a particular taxpayer is legally required to prepare or file these documents depends on the domestic legislation, thresholds and procedural rules of the relevant jurisdiction.  

Hard-to-Value Intangibles and DAC6 

Hard-to-Value Intangibles (HTVI) are subject to specific transfer pricing scrutiny where, at the time of the transfer, reliable comparables are unavailable and projections of future cash flows or income, or the assumptions used in the valuation, are highly uncertain. 

For the purposes of Council Directive (EU) 2018/822, commonly referred to as DAC6, a cross-border arrangement involving the transfer of HTVI between associated enterprises is a specific transfer pricing hallmark under Category E.2. Where the arrangement falls within the definition of a reportable cross-border arrangement, the relevant reporting obligations apply in accordance with the national legislation implementing DAC6. The mere fact that an intangible is difficult to value does not create a standalone disclosure obligation outside those conditions.  

Who Actually Controls the Risks in an IP Structure? 

Contractual allocation of risk is relevant but is not conclusive on its own. Transfer pricing analysis considers the actual conduct of the parties and identifies which entity has the capability to make the significant decisions relating to a risk and actually exercises that control. 

Financial capacity to assume the risk is also relevant. Where an entity is contractually described as bearing a particular risk but lacks the practical ability to control it or the financial capacity to bear its consequences, the contractual allocation alone does not determine the arm's length allocation of income. 

Passive financing or formal ownership of an intangible therefore does not automatically entitle an entity to residual profit. Its remuneration must reflect its actual economic contribution.  

Territorial Protection of Intellectual Property Rights 

The tax analysis of an IP structure cannot be separated from the legal protection of the underlying intangible. Patent and trademark rights are territorial, and their scope must be established in the markets in which the asset is used or licensed. 

The Madrid System administered by the World Intellectual Property Organization (WIPO) facilitates the filing and management of international trademark registrations, but it does not create uniform worldwide protection automatically. Each designated national or regional IP office determines protection under the law applicable in its territory.  

The Patent Cooperation Treaty (PCT) likewise does not grant an "international patent". It provides an international filing procedure, after which the grant of patent rights remains a matter for the competent national or regional patent offices.  

For European Union trade marks, failure to make genuine use may result in revocation. An EU trade mark becomes vulnerable to revocation for non-use after a continuous five-year period under the conditions of the EU trade mark regime. That five-year period should not be presented as a universal rule applying to every national trademark system.  

Whether a licence must or should be recorded, whether a licensee has standing to bring infringement proceedings and how a licence operates against third parties depend on the law applicable in the relevant jurisdiction. The territorial scope of the rights and the integrity of the licensing chain should therefore be reviewed for each relevant market.  

Withholding Tax and Beneficial Ownership of Royalties 

Cross-border royalty payments require an analysis separate from transfer pricing because withholding tax and domestic or treaty-based anti-abuse provisions may apply. 

Within the European Union, Council Directive 2003/49/EC provides an exemption for qualifying interest and royalty payments between associated companies of different Member States where all applicable conditions are satisfied. The recipient must be the beneficial owner of the income and the companies must meet the Directive's requirements concerning legal form, tax residence and taxation. The associated-company test generally requires a direct minimum holding of 25%, although Member States may replace the capital-holding criterion with a voting-rights criterion.  

The Directive does not govern payments to recipients in third countries. In those cases, the withholding tax position must be determined under the domestic law of the source jurisdiction and the applicable double tax treaty. 

The applicable treaty may contain additional conditions and anti-abuse provisions. Where a Principal Purpose Test (PPT) forms part of the relevant treaty through the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS or through bilateral treaty provisions, treaty benefits may be denied where one of the principal purposes of an arrangement is to obtain the benefit and granting it would be contrary to the object and purpose of the relevant treaty provisions.  

ATAD and Controlled Foreign Company Rules 

Low taxation of an IP entity may also be relevant under controlled foreign company (CFC) rules. CFC treatment does not automatically arise merely because a company receives royalty income or is established in a low-tax jurisdiction. 

Article 7 of ATAD contains specific conditions relating to control and taxation. The Directive uses a threshold of more than 50% of voting rights, capital or entitlement to profits, whether held directly or indirectly in accordance with the relevant provision, together with a separate tax condition. The ultimate tax consequences depend on the national legislation implementing the CFC framework in the relevant Member State.  

It is therefore not accurate to assume that every stream of passive royalty income will automatically be included in the taxable base of a parent company. The relevant statutory conditions must first be satisfied. 

Pillar Two and the Global Minimum Tax 

For large groups, the location of IP assets must also be considered in the context of the Pillar Two global minimum tax. Within the European Union, the framework is implemented through Council Directive (EU) 2022/2523. 

The Directive generally applies to constituent entities of multinational enterprise groups and large-scale domestic groups with annual revenue of at least EUR 750 million in the ultimate parent entity's consolidated financial statements in at least two of the four fiscal years immediately preceding the tested fiscal year, subject to the exclusions contained in the Directive. The minimum tax rate for purposes of the regime is 15%.  

A nominal tax rate below 15% does not mean that the difference to 15% is mechanically imposed as a top-up tax. The GloBE rules contain a separate methodology for calculating the jurisdictional effective tax rate and any top-up tax, together with applicable exclusions and other mechanisms. The OECD framework continues to be supplemented by administrative guidance, including the 2026 Consolidated Commentary to the Global Anti-Base Erosion Model Rules.  

For groups within the scope of Pillar Two, an IP structure relying predominantly on a low nominal corporate tax rate must therefore also be evaluated by reference to its effective taxation under the GloBE framework. 

When Is a Cross-Border IP Structure Sustainable? 

An IP structure is more robust where legal ownership is aligned with the actual economic contributions of the participating entities, intra-group transactions are priced on an arm's length basis, risks are genuinely controlled by the entities to which they are allocated, and the documentation reflects the parties' actual conduct. 

The applicable IP regime, transfer pricing rules, CFC provisions, withholding taxes, tax treaties, Pillar Two where relevant, and territorial protection of the underlying intellectual property must be considered separately. The same corporate structure may therefore produce materially different consequences depending on the jurisdictions involved, the type of intangible and the functions actually performed. 

A formal transfer of a trademark, patent or other intangible to an entity in a preferential tax jurisdiction is consequently not a standalone tax strategy. A sustainable structure requires consistency between legal form, economic reality, contractual arrangements, transfer pricing and the legal protection of the relevant IP rights. 

Legal Assistance with Cross-Border IP Structures 

Vassilev & Chisuse Law Firm advises on cross-border corporate structuring, transfer pricing and intellectual property protection. Legal assistance may include an initial assessment of an intellectual property ownership and licensing structure, a review of existing contractual arrangements and an assessment of the applicable legal and tax requirements.  

This material is intended for general information purposes only. It does not constitute individual legal, tax, financial or investment advice. The tax consequences of any specific IP structure depend on the applicable domestic law, relevant tax treaties and the particular facts and circumstances.