Comparables are similar to the “intangible assets”  under consideration with respect to similar product and profit potential. For example, we can determine an arm’s length range of values for certain intangible assets by using comparable royalty rates reflecting similar property, profit potential, duration, exclusivity, and territory of the license. 

In general, U.S. Treasury Regulations Section 1.482-1(d) provides the “standard of comparability” with respect to (a) property or services, (b) functions performed, (c) contractual terms (e.g., form of consideration, rights to updates, duration, territory, collateral transactions, such as purchase of active ingredients in pharmaceutical licenses, or equity investment by the licensor in the business of the licensee), (d) risks assumed, and (e) economic conditions (e.g., similarity of geographic markets, market size, and market share of the licensed product sold by the licensee).  In particular, Section 1.482-4(c)(2)(iii) provides that specific factors must be considered under the comparable uncontrolled transactions (CUT) method, including comparison of product and similarity of profit potential between the tested intangible license and the proposed comparable licenses. 

In most cases, data to satisfy the similar profit potential requirement under the CUT method are not available.  Therefore, we can use comparable royalty rates under an unspecified method.  Section 1.482-4(c)(4)(Example 3(iv)) illustrates a case in which the U.S. Internal Revenue Service (IRS) uses a database of license agreements filed with the SEC, such as RoyaltyStat, in order to identify comparable royalty rates to determine the value intangibles.  Unfortunately, this example has misled many practitioners in making a heroic (or implicit) assumption that the selected agreements have similar profit potential.  The article below shows an unspecified method using comparable royalty rates (combined with one-period ahead forecast of net sales attributed to the licensed intangible) in order to determine an arm’s length value for the intangible property under examination.  This method is considered unspecified because the selected royalty rates do not satisfy the particular standards of a CUT analysis in that similar profit potential, measured by net present value calculation, is not established.