Regulatory framework for evaluating the contributions of related parties to the value of intellectual property focuses on five specific operational functions. The application of dempe intangible asset analysis allows tax authorities to determine how profits from assets like patents, trademarks, and software should be distributed among different entities in a multinational group. It moves beyond legal ownership to examine who actually performs the development, enhancement, maintenance, protection, and exploitation of the asset.
This approach prevents companies from shifting profits to low-tax jurisdictions where they have no real operational substance. The State Taxation Administration in China uses this method to ensure that the local subsidiaries receive a fair share of the global profit based on their technical and commercial activities. It is a central component of transfer pricing audits and the preparation of local files.
The analysis requires a detailed mapping of the people, the risks, and the capital involved in the lifecycle of the intangible asset. If a Chinese entity provides the funding and the engineering talent to improve a piece of software, it should be compensated accordingly regardless of who holds the legal title.
Identification of the parties responsible for the core activities of the asset is the first step in the assessment. In a dempe intangible asset analysis, the development function refers to the creative and technical work that brings the asset into existence. Enhancement involves the subsequent improvements and updates that increase the value of the asset over time.
Maintenance covers the day-to-day work needed to keep the asset functional and relevant in the market. Protection relates to the legal and administrative efforts to defend the intellectual property against infringement and to maintain registrations. Exploitation is the commercial use of the asset to generate revenue, including licensing and sales.
The tax bureau examines the payroll records, project logs, and management reports of the Chinese company to see which of these functions it performs. A company that only provides the legal registration service but none of the technical work will not be entitled to a large share of the royalty income.
Assessment of who makes the strategic decisions regarding the asset is often more important than who performs the manual work. Under the rules of dempe intangible asset analysis, the entity that exercises control over the risks and the functions is the one that deserves the economic reward. This means the tax authorities look for the managers who have the authority to start or stop a development project and the ability to hire or fire the technical staff.
If the Chinese subsidiary only follows instructions from a foreign headquarters without any independent decision making power, its share of the profit will be limited to a routine service fee. The presence of local directors with technical expertise is a strong indicator of control.
Determination of the arm’s length price for the transfer or use of the asset depends on the results of the functional study. When the dempe intangible asset analysis shows that the Chinese entity has made a significant contribution to the value of a global brand or technology, the tax bureau will demand a higher profit margin for that entity. This can lead to the adjustment of royalty rates paid to foreign affiliates or the reallocation of sales income.
Companies that fail to provide a robust analysis in their transfer pricing documentation risk heavy penalties and double taxation. The final allocation must reflect the economic reality of the business operations rather than the legal structure of the contracts. Each party’s share is calculated based on the relative value of their specific contributions to the overall success of the intangible asset.
Cross-border software grants require Technology Contract Registration to secure VAT exemptions before State Taxation Administration outbound tax recordals unlock bank remittance.
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