Introduction: The Growing Role of DEMPE in Transfer Pricing
Intangible assets, such as patents, trademarks, and proprietary technology, have become a dominant source of corporate value. According to Ocean Tomo’s Intangible Asset Market Study (2020), intangible assets account for over 90% of the market value of the S&P 500. This shift has led to growing scrutiny from tax authorities, who seek to ensure that profits from these assets are taxed in the jurisdictions where economic value is created.
The OECD’s DEMPE framework—which evaluates the Development, Enhancement, Maintenance, Protection, and Exploitation (DEMPE) of intangibles—has become a key tool in determining how profits should be allocated among entities within a multinational group. Introduced as part of the Base Erosion and Profit Shifting (BEPS) Action Plan 8, DEMPE aims to align profit attribution with economic substance, reducing artificial tax planning strategies and ensuring transparency in cross-border transactions.
Apple’s Tax Dispute: The Latest Developments
One of the most well-known cases involving DEMPE-related tax challenges is Apple’s dispute with the European Commission. The Commission ruled in 2016 that Apple should pay €13 billion in back taxes, arguing that its intellectual property (IP) was legally owned by Irish subsidiaries, but the real development and enhancement functions were performed elsewhere.
In 2020, the General Court of the European Union annulled the decision, citing insufficient evidence that Apple had received a selective tax advantage. However, in 2023, the European Commission appealed to the European Court of Justice (ECJ), keeping the case under continued scrutiny. If the ECJ upholds the appeal, this could have significant consequences for multinational corporations relying on IP structuring strategies to optimize tax liabilities. The case reinforces how DEMPE principles are central to international tax disputes and underscores the shift towards substance-based taxation frameworks.
Understanding the DEMPE Framework
DEMPE ensures that profits from intangibles are allocated based on the actual economic contributions of different entities within a corporate group. It breaks down as follows:
Development (D)
- The creation of intangibles, including R&D, software programming, and product innovation.
- Tax Challenge: If R&D is conducted in a high-tax country but the resulting IP is owned in a low-tax jurisdiction, tax authorities may challenge the alignment between ownership and value creation.
- Example: Pharmaceutical firms often conduct R&D in Germany or the UK but register patents in Switzerland or Ireland, raising questions about profit allocation and compliance with OECD guidelines.
Enhancement (E)
- The process of improving an existing intangible, such as updating algorithms, refining patents, or strengthening brand recognition.
- Tax Challenge: If a group subsidiary enhances an intangible but does not own it, should it receive an arm’s length return for its contributions?
- Example: Google’s continuous refinement of its search engine algorithms raises questions about where economic value is actually created, potentially affecting how taxable income is assigned.
Maintenance (M)
- The activities required to preserve an intangible’s value, including marketing, legal defense, and quality control.
- Tax Challenge: If a marketing subsidiary maintains a trademark’s strength but does not own it, should it be compensated?
- Example: A UK-based luxury fashion house managing global marketing for a brand owned in the Cayman Islands may face scrutiny under DEMPE as authorities analyze whether profits should be reassigned based on actual economic contributions.
Protection (P)
- Legal and administrative actions, such as patent registration, copyright enforcement, and litigation.
- Tax Challenge: Holding IP in a tax-efficient country does not justify significant profits unless protection activities are also performed there.
- Example: Many digital firms hold patents in Luxembourg, but if the legal work is done elsewhere, tax authorities may challenge profit allocations and demand reassessment of where economic value is created.
Exploitation (E)
- The commercial use of an intangible, including licensing, distribution, and direct monetization.
- Tax Challenge: Who should be taxed on royalties—the legal owner or the entity managing commercialization?
- Example: Amazon AWS operates globally, leading to tax disputes over how its technology licensing profits should be allocated to reflect genuine economic activity.
The Global Adoption of DEMPE Rules
United Kingdom: HMRC’s transfer pricing regime applies DEMPE principles through the Master File and Local File requirements. The Diverted Profits Tax (DPT) imposes a 25% tax rate on companies artificially shifting profits abroad, acting as a deterrent for tax avoidance schemes.
United States: The Tax Cuts and Jobs Act (TCJA) introduced GILTI (Global Intangible Low-Taxed Income), ensuring that intangible-related profits held abroad are subject to US taxation, reducing incentives for offshoring IP.
European Union: The EU has used state aid investigations to challenge tax arrangements based on DEMPE principles. Cases involving Amazon, Apple, and Fiat have led to a push for greater substance in IP ownership structures, aiming to curb artificial profit shifting.
China and India: China’s Special Tax Adjustment Measures require detailed DEMPE documentation. India’s Significant Economic Presence (SEP) rules seek to tax foreign digital businesses based on user-based value creation, redefining DEMPE in the digital economy and challenging traditional profit allocation models.
Integrating OECD’s Pillar One and Pillar Two Reforms
Pillar One seeks to reallocate profits of large multinational enterprises to market jurisdictions and Pillar Two enforces a 15% global minimum tax, significantly impacting international tax planning strategies.
- Pillar One: Will impact digital companies and consumer-facing businesses, requiring them to allocate profits based on user activity rather than legal ownership of IP, effectively reducing tax avoidance opportunities.
- Pillar Two: Ensures that profits shifted to low-tax jurisdictions face a minimum effective tax rate, reinforcing DEMPE principles by preventing excessive profit allocation to tax havens.
Conclusion: The Future of DEMPE in International Taxation
As tax authorities tighten enforcement, multinational corporations must align intangible profits with real economic functions. The days of shifting IP profits to tax havens with little substance are numbered, and companies that fail to adapt face higher tax liabilities, audits, and reputational risks.
Looking ahead, the future of DEMPE will likely involve:
- Greater scrutiny of digital and technology firms, with new rules taxing value where users contribute.
- Heightened enforcement in emerging markets, particularly in Asia and Latin America.
- More cross-border tax disputes, requiring robust documentation and proactive compliance.
To navigate these changes, companies must rethink their tax strategies, ensuring that their intangible assets are aligned with genuine economic activity—not just legal structures—while leveraging compliance technology to mitigate risks effectively.