Basics of DEMPE Analysis in Transfer Pricing

Intangibles: DEMPE Analysis

DEMPE Analysis is a key framework in transfer pricing that examines the Development, Enhancement, Maintenance, Protection, and Exploitation of intangible assets. For a Multinational Enterprise (MNE), intellectual property, patents, and trademarks represent significant economic value.

The DEMPE analysis framework is introduced by the OECD’s Base Erosion and Profile Shifting (BEPS). It is important for any MNE to understand how the value of intangible assets is created and distributed. This analysis helps align the transfer pricing outcome with value creation. To ensure that profits are allocated as per the actual economic activities performed, the DEMPE analysis helps determine which entity in the MNE is entitled to returns generated by intangible assets.

Understanding DEMPE

1. Development: This involves the creation, acquisition, or substantial improvement of intangibles through research and development (R&D), which incurs significant costs and risks.
2. Enhancement: This process covers activities that improve the value or utility of an intangible, such as technology updates and brand building.
3. Maintenance: It involves activities required to preserve the value and usefulness of intangibles through software updates, brand management, customer support, etc.
4. Protection: This function involves safeguarding from infringement or unauthorized use with the help of legal defence, securing patent and trademark registration and protection.
5. Exploitation: It refers to utilising the intangibles to generate revenue through direct sales, licensing, or other commercial activities.

Conducting a DEMPE Analysis

1. Identification of Intangible Asset: The first and foremost important step is to identify the intangible assets by understanding the true nature of intangible assets, their legal ownership and the rights associated with them.
2. Mapping of DEMPE Functions: This step is also important to identify which entities will qualify for DEMPE analysis from the MNE group. Mapping helps in clearly understanding the roles, responsibilities, and contributions made by each entity within the MNE.
3. Assessing Risks and Control: It is important under the DEMPE analysis to evaluate which entities are taking more risks, such as development and legal risks, and which are controlling the risk.
4. Determining Contribution and Compensation: Those entities within the MNE that are performing important DEMPE functions must be compensated in an appropriate manner; hence, it is important that the returns are aligned with the value creation. The outcome of DEMPE analysis must be aligned with the Arm’s Length Price (ALP) principle.
5. Conducting Comparability Analysis: It is important to ensure that the terms and conditions that are agreed upon within the MNE are consistent, if agreed with the independent parties.
6. Documenting and justifying allocations: It is important to maintain the proper documentation of allocation of profits as per DEMPE analysis. It helps in compliance and transfer pricing audits.

By clearly mapping DEMPE functions and allocating profits accordingly, MNEs can ensure that value creation is accurately reflected in returns. Tax authorities benefit from greater transparency and reduced disputes, making audits more predictable and less contentious

Challenges in DEMPE Analysis

1. Complexity: Intangibles are inherently complex arrangements and involve overlapping functions that make it difficult to accurately assess the contributions made by each entity to the DEMPE analysis.
2. Valuation: Determining the ALP is in itself a complex procedure and becomes even more challenging when it comes to intangibles, as they are unique and non-comparable.
3. Compliance and Legal: The DEMPE analysis should aim at ensuring compliance with tax provisions and maintain proper documentation as per the standard of the country wherein the unit of the MNE is located. Legal vis-à-vis economic ownership conflicts also create a major challenge while conducting the analysis.

The DEMPE analysis is an important tool to ensure correct outcomes regarding intangibles, accurately reflecting value creation by a unit of an MNE. A thorough DEMPE analysis also strengthens a company’s position during transfer pricing audits by providing documented evidence of functional contributions, risk ownership, and arm’s length pricing alignment.