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Introduction to DEMPE functions

What is DEMPE?

DEMPE stands for Development, Enhancement, Maintenance, Protection and Exploitation. DEMPE is designed to help both taxpayers (including multinational enterprises or ‘MNEs’) and tax authorities achieve an accurate assessment of intangible asset transactions to help with the determination of appropriate transfer pricing. By identifying the entities that perform DEMPE functions in a transaction, MNEs and taxpayers in general can ensure that they are complying with the OECD’s BEPS guidelines.

There are three factors to consider when determining who is performing what function, which are:

  1. control,

  2. funding, and

  3. risk.

Per DEMPE function it should be determined: who has control, who is funding, and who is incurring the risks related to the function. The determination of the functions performed and the consideration of the factors are combined in a DEMPE analysis. Such a DEMPE analysis should be prepared on a case-by-case basis and should be substantiated by objective documents such as annual reports, board meeting notes or any other internal documents that could provide further substantiation.

After having performed a DEMPE analysis, it can be determined which entity is entitled to the profits resulting from an intangible asset. However, it can also be concluded that multiple entities perform considerable DEMPE functions. In that case, multiple entities are entitled to the profits resulting from an intangible asset. The OECD Guidelines set out that the Profit Split Method is the most appropriate method for allocating the profits in such circumstances.

What are the implications of DEMPE for MNEs?

Before the DEMPE concept was introduced, the legal owner of an intangible was entitled to essentially all the returns generated by that particular intangible (e.g. intangible asset, such as a brand name or logo). This meant that, in practice, the owner of a brand could set up their company in a country (say country A), but also register their trademark in a low-tax environment so that they could charge royalties to the business in country A for any income related to the intangible asset registered in the low-tax environment. With the old model, the intangible asset owner would be entitled to the income effectively generated by the business in country A.

Now, however, any income that is generated as a result of that intangible asset is owned by all the parties that perform the DEMPE functions. This for example implies that for transfer pricing purposes, legal ownership of intangibles, by itself, does not confer the right to retain returns derived by the MNE group from exploiting the intangible. As a result of the contractual arrangement between the MNE entities, these returns may initially accrue to the legal owner of the intangible assets. However, if the legal owner performs no DEMPE functions, but acts only as a holding entity, the legal owner will not be entitled to any portion of the returns, other than compensation for the holding activities, if any.

DEMPE has significantly changed the way in which MNEs should determine arm’s length conditions for controlled intangible asset transactions between related parties. Appropriate compensation of entities that have performed DEMPE functions that contribute towards the profit generating value of an intangible is now a key consideration in establishing arm’s length transfer pricing.

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