DEMPE Functional Analysis by OECD BEPS guidance on Intangibles


DEMPE, which stands for Development, Enhancement, Maintenance, Protection, and Exploitation, was introduced to provide additional clarity to the existing guidance on intangibles. In 2012 The Organisation for Economic Co-operation and Development (OECD) and G20 started the Base Erosion and Profit Shifting (BEPS) initiative to address perceived international tax avoidance strategies. DEMPE functional analysis was specifically outlined as a framework in the OECD’s guidance of intangibles.

In today’s business environment, intangible assets are vital strategic resources for multinational enterprises (MNEs), driving value creation, competitive advantage, and sustainable growth in an increasingly interconnected and knowledge-driven global economy. If we are talking about Transfer Pricing purposes, an intangible, according to OECD guidance, is “something which is not a physical asset or a financial asset, which is capable of being owned or controlled for use in commercial activities, and whose use or transfer, would be compensated had it occurred in a transaction between independent parties in comparable circumstances”.

BEPS initiative provides comprehensive recommendations and principles for the treatment of intangible assets within MNEs for tax purposes. Some specific points addressed in the OECD’s guidance on intangibles include:

  • Definition of Intangibles: The guidance defines intangible assets and clarifies what types of assets fall under this category. Intangibles can include patents, trademarks, copyrights, trade secrets, customer lists, and other non-physical assets that have value to a business.
  • Functional Analysis: The OECD recommends conducting a detailed functional analysis to determine which entities within an MNE group perform key functions, contribute valuable assets, and assume risks related to intangible assets. This analysis helps allocate profits appropriately based on economic substance.
  • DEMPE Functions: As mentioned earlier, the guidance elaborates on the DEMPE framework, emphasizing the importance of considering development, enhancement, maintenance, protection, and exploitation activities when determining the allocation of profits derived from intangible assets.
  • Arm’s Length Principle: The OECD reaffirms the application of the arm’s length principle in the context of intangibles. Transactions involving intangible assets between related parties should be priced in a manner consistent with what unrelated parties would agree to under similar circumstances.
  • Transfer Pricing Methods: The guidance discusses various Transfer Pricing methods that can be used to evaluate transactions involving intangible assets, such as the comparable uncontrolled price method, the transactional net margin method, and the profit split method. The choice of method depends on the specific circumstances of the transaction and the availability of comparable data.
  • Risk Assessment: It guides how to assess and allocate risks associated with intangible assets, including market risks, operational risks, and legal risks. This ensures that the allocation of profits reflects the entities within the MNE group that assume and manage these risks.
  • Documentation Requirements: The OECD recommends comprehensive documentation to support the Transfer Pricing policies related to intangible assets. This documentation should include detailed descriptions of the intangible assets, the functions performed, the risks assumed, and the economic analysis supporting the pricing decisions.

Before the implementation of the BEPS initiative, functional analyses relied primarily on contractual arrangements to allocate profits among related entities within MNEs. This approach emphasized the legal ownership and contractual terms governing intangible assets and other resources.

In this context, the allocation of profits was often determined based on formal agreements, such as licensing agreements, cost-sharing arrangements, or other contractual arrangements governing the use, development, and exploitation of intangible assets. The emphasis was on ensuring that related-party transactions were consistent with arm’s length principles and reflected the economic substance of the underlying activities.

However, this approach had limitations, as it did not always capture the full economic value created by intangible assets. In many cases, MNEs could exploit gaps in the existing rules to artificially shift profits to low-tax jurisdictions by manipulating contractual arrangements without corresponding economic substance.

The BEPS initiative sought to address these shortcomings by introducing more comprehensive guidelines and principles for the allocation of profits, including the DEMPE framework. This framework focuses on the functional analysis of entities within MNEs, considering the actual functions performed, assets used, and risks assumed about intangible assets. It emphasizes substance over form, ensuring that profits are allocated in a manner that reflects the economic contributions of each entity involved.

DEMPE serves as a guideline for analyzing the functions performed, assets used, and risks assumed by various entities within a multinational enterprise (MNE) concerning intangible assets. The five elements of DEMPE are:

  • Development: Refers to the creation or enhancement of intangible assets. This includes activities such as research, design, and testing.
  • Enhancement: Encompasses activities that increase the value, utility, or marketability of existing intangible assets. This may involve improvements, modifications, or upgrades.
  • Maintenance: Involves activities necessary to ensure the ongoing functionality, durability, or relevance of intangible assets. This could include upkeep, monitoring, or routine management.
  • Protection: Focuses on safeguarding the legal rights and proprietary interests associated with intangible assets. This includes activities related to intellectual property protection, such as obtaining patents, trademarks, or copyrights.
  • Exploitation: Encompasses the utilization or commercialization of intangible assets to derive economic benefits. This involves activities such as licensing, selling, or using the intangible assets in the MNE’s business operations.

The DEMPE framework helps tax authorities and MNEs determine the allocation of profits derived from intangible assets among different jurisdictions based on where the relevant functions are performed, assets are located, and risks are assumed. By considering the DEMPE functions, the aim is to ensure that profits are appropriately attributed to entities that contribute value to the development, enhancement, maintenance, protection, and exploitation of intangible assets. This helps prevent the inappropriate shifting of profits to low-tax jurisdictions without corresponding economic substance.

By embracing the DEMPE functions, the OECD acknowledges the importance of directing attention to entities within multinational enterprises (MNEs) that might not hold legal ownership of intangible assets but have made substantial contributions to their development. These entities may have undertaken key functions and assumed risks that significantly added value to the creation of intangibles. According to the DEMPE approach, such entities should be duly compensated for their contributions. In essence, the OECD recognizes the need to ensure that entities involved in the development, enhancement, maintenance, protection, and exploitation of intangibles receive equitable remuneration commensurate with their contributions under the DEMPE framework.

Before the adoption of the DEMPE approach by the OECD, one could argue that the legal owner of an intangible asset, such as a trademark or a patent, would typically be deemed entitled to a share of the economic benefits derived from the utilization of that intangible. This entitlement stemmed from the conventional understanding that legal ownership conferred certain rights and privileges regarding the exploitation and commercialization of intangible assets. However, the DEMPE approach introduced a nuanced perspective, emphasizing that economic returns should not solely be allocated based on legal ownership, but also on the entities within multinational enterprises that contribute to the development, enhancement, maintenance, protection, and exploitation of the intangible assets. Thus, under the DEMPE framework, entities that perform significant functions and assume associated risks are recognized as deserving compensation commensurate with their contributions, regardless of legal ownership status.

The shift from pre-BEPS contractual allocation to post-BEPS functional analysis represents a broader effort to counter tax avoidance strategies and ensure that profits are fairly allocated among jurisdictions based on economic substance and value creation.

The OECD’s guidance on intangibles provides clarity and consistency in the treatment of intangible assets for tax purposes, helping to prevent profit shifting and tax avoidance strategies that exploit gaps in international tax rules.

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