Comparable Licenses

When it comes time to consider the price to pay for a license, comparable licenses are an important factor to consider. The amount for which independent parties licensed similar intellectual property (IP) can provide an indication of a reasonable royalty. Market transactions, considered useful for deriving reasonable royalties, are usually between unrelated parties where IP is the focal point of the deal. Transactions most often cited, as useful indications for reasonable royalties, are license agreements, which disclose the compensation terms for other licenses involving the IP being studied. As an alternative, an analysis of licensing transactions involving similar IP is often relied on for deriving reasonable royalties.

Many aspects of market transactions should be studied closely before a specific transaction can be discerned as representing a reasonable royalty, for comparison purposes. The remainder of this chapter considers the appropriateness of using comparable license agreement royalty terms as a proxy for a subject case.

Multinational corporations often transfer IP to foreign subsidiaries. Parent companies often own keystone IP, while their subsidiaries hold licenses allowing them to use the property. These licenses are referred to as “internal,” or “inter-company,” licenses. In the past, these have not typically been reliable market transactions for deriving reasonable royalties. Many of the royalty terms in these types of transactions were structured to shift income into jurisdictions with lower income tax burdens. Hence, the royalty rate did not reflect the economic contribution of the IP as much as they reflected the differential corporate income tax rates, between a multinational corporate parent and a foreign subsidiary. Internal licenses were missing a fundamental element, because the royalty terms were not established by arms-length negotiation, where each party to the transaction argued their self-interests. Many other self-serving issues clouded royalties specified in internal licenses.

This is beginning to change. International taxing authorities are looking at transfer pricing issues, and IP is getting closer scrutiny. Many corporations are commissioning studies to use as the basis of their IP pricing. These studies are based on market transactions, and the investment rate-of-return analyses explored later in this book. Such studies are not common, as the IRS does not closely scrutinize many companies. As more corporations set internal transaction pricing in line with third-party transaction pricing, internal licenses may become useful indications of royalty rates.

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