The relief from royalty method is a widely used approach for valuing intangible assets such as brands, patents, and proprietary technologies. In Canada, this method is frequently applied for financial reporting under IFRS and for tax compliance purposes.
How the Method Works
The core principle is simple: if a company did not own its intangible asset, it would need to license it. The avoided royalty payments represent the asset’s value.
Applying the method involves two steps:
Determine a license rate that independent parties would agree to in an arm’s length transaction.
Apply the rate to a base amount, usually revenue tied to the intangible asset.
The present value of future royalty savings is then calculated using a discount rate.
Requirements for Application
Reliable application depends on:
A detailed financial forecast for revenue and expenses linked to the asset.
Benchmark data from comparable license agreements.
A discount rate reflecting the cost of capital.
Data quality is critical, careful selection of comparable transactions is essential.
IFRS vs. Tax Considerations in Canada
IFRS: Allows flexibility in selecting a reasonable royalty rate within a range. The focus is on providing transparent information to capital markets.
Tax law: Requires strict adherence to the arm’s length principle to prevent artificial shifts in taxable income. Documentation and justification of the royalty rate are key, especially under transfer pricing rules.
Takeaway for Canadian Companies
The relief from royalty method offers a transparent way to value intangibles. Its simplicity is a strength, but applying it well requires sound forecasts, reliable benchmarks, and careful compliance with both IFRS and tax rules.
Aspen Valuations provides Canadian companies with defensible relief from royalty analyses that meet both financial reporting and tax compliance requirements.
