OECD Tax Audit Risks for Cross Border Intangible Layout Transfers
Cross-border transfers of physical layout files trigger high-risk OECD transfer pricing audits unless backed by contemporaneous DEMPE labor logs and arm's length valuation.
Functional Control Test
Meaning
Governance audits verify that the entity claiming profit from an asset also manages the risks and makes the primary decisions related to that asset. The functional control test examines whether a company subsidiary has the technical expertise and authority to oversee the development of a product. This evaluation governs the legitimacy of profit shifts between entities and stops applying when the transaction involves only the sale of finished goods to an independent distributor.
Risk Management
Auditors look for evidence that the entity can identify and mitigate the financial risks associated with a hardware design project. Passing the functional control test requires showing that the local management team can decide to stop a project if the technical hurdles become too high. Simply signing a contract prepared by a parent company is insufficient to prove control.
Decision Authority
Minutes from board meetings and project review documents demonstrate where the real power over the intellectual property resides. During a functional control test the examiner verifies that the personnel listed as managers have the qualifications to understand the radio frequency engineering challenges involved. Control exists only when the entity has the power to hire and fire the technical contractors performing the work.
Personnel Capability
Employee records and training logs provide proof that the entity has the staff necessary to perform the oversight functions. The functional control test fails if the subsidiary has no employees with the expertise required to manage a complex electronics integration. Maintaining a small office without technical staff is a common reason for a failed audit.