Intellectual property is one of the most important assets of many well-known major companies. However, in India the role and value of intellectual property in business is not fully understood yet. The taxation of intellectual property is a rapidly developing ﬁeld requiring both intellectual property and tax practitioners to keep up with latest developments. Recent years especially have seen dramatic changes in tax laws affecting intellectual property transactions and litigation.
The cross border movement of multinational companies with their Intellectual Property rights (IPRs) offers much scope for the taxation of these rights and thus a considerable income for technology receiving countries. India opened its economy in 1991 with a bundle of tax reductions in customs and central excise duties, lowering the corporate tax, widening the tax net and is also one of the founding members of the WTO in 1995. The taxation of goods, services and income is a concept that has been prevalent for a long time, all over the world. Different categories are taxed with different objectives and purpose. Sometimes economies may want to discourage the use of foreign goods within their countries and consequently therefore the tax on imported goods will be high. However, interestingly, taxing of intellectual property is a recent phenomenon across the globe. Developments in science and technology and rapid communication have made it accessible to every country. In India intellectual property is taxed in many ways, though indirectly.
Technology transactions have been intensified with the advent of more and more foreign collaborations and technologies coming into the country. Technology transaction including commercialisation, licensing and assignment are another grey area where the industry needs clear guidelines and expert assistance, in taking decisions in technology transfer. Tax treatment and tax incentives differ according to the type of taxation. IP transfer and mode of payment may increase the tax liability. When the interest in the intellectual property is transferred to others and is treated as a transfer of ‘property’ for tax purposes, it can significantly affect technology transfers. Share transfer in the exchange of IP rights could have tax implications.
There are a number of corporate routes that a foreign company could adopt to enter the Indian market. Licensing the use of trademarks and technical know-how is the most easy and indirect among these corporate routes. Ordinarily licensing involves two parts: Licensing of technical know-how, Licensing of Intellectual Property Rights. The technical licensing between Indian Companies and foreign companies come under the Automatic Approval Route, if the payment terms satisfy the Government of India Guidelines. The Press Note(No.12 of 1991 Series dated 31.8. 1991) by the Indian Govt. has clarified the procedure in respect of foreign technology collaborations: Procedure in respect of foreign technology agreements. The government of India tabled a Statement on Industrial Policy in both the Houses of Parliament 24.7.1991. The statement has substantially liberalized the provisions and simplified the procedure governing Foreign Technology Agreements. The relevant portion of the Statement dealing with Foreign Technology Agreements is 39C, Foreign Technology Agreements:
1. Automatic permission will be given for foreign technology agreements in high priority industries upto a lump sum payment of Rs. 1 Crore, 5 per cent royalty for domestic sales and 8 per cent for exports, subject to total payments of 8 per cent of sales over a 10- year period from the date of agreement or 7 years from commencement of production. The prescribed royalty rates are net of taxes and will be calculated according to standard procedures.
3. In respect of industries other than high priority industries, automatic permission will be given subject to the same guidelines as above if no free foreign exchange is required for any payments.
4. All other proposals will need specific approval under the general procedures in force.
5. No permission will be necessary for hiring of foreign technicians, foreign testing of indigenously developed technologies. Payment may be made from blanket permits or free foreign exchange according to RBI guidelines".
Press Note No. 10 of 1991 Series issued on 14.8.1991, set out the procedures for approval of foreign technology agreements, hiring of foreign technicians and foreign testing of indigenous raw materials and products and indigenously developed technologies. In that Press Note, it has been stated that applications for automatic approvals under paras 39C (i) and (ii) referred to above would be made to the Secretariat for Industrial Approvals (SIA) in the Department of Industrial Development. In the interests of entrepreneurs, this procedure has now been modified as below. Procedures relating to other matters, however, remain the same as in Press Note No.10.
The position of the Tax Code on the tax consequences of transactions involving goods, works and services leaves ambiguities for the taxation of transactions involving intellectual property. For example, in the case of export of intellectual property rights through electronic communication channels, whether the supplier can receive VAT deductions. At the same time, VAT deductions may be received in the case of export of intellectual property rights as a part of goods or equipment.
It is important to note the significant additional tax sums charged by the tax authorities and challenged in court cases connected to usage of trademarks by distributors, or cases of the tax inspectorates challenging the expenses or pricing model of intellectual property. The lack of clarity in legal procedures in Indian tax law for reclassifying transactions for tax purposes also significantly complicates the issue of assessing the tax consequences of transactions involving intellectual property.
At the same time, even in Indian practice, issues surrounding the taxation of intellectual property rights are exerting a greater influence on purchasing and sales structuring and pricing, and on the tax consequences of transactions. For example, the introduction of VAT exemption for the sale of rights to use the results of intellectual activity under license may influence the system of establishing relations by contract between the parties of such a transaction. This exemption may significantly simplified delivery of software products through electronic communication channels, because it may cancel the duty of the buyer to act as tax agent for VAT.
Also, the possibility of applying the exemption has raised the competitiveness of suppliers who can offer customers the opportunity to purchase the rights to software products without VAT. Many of India's international agreements on avoiding double taxation contain special articles releasing royalties from taxation at the source of payment. This allows us to consider intellectual property rights as a convenient tool for tax planning.
Intellectual property rights therefore have more value than any other asset for the company that possesses them. For example, intellectual property rights can simultaneously be used as a source of current income, an element of tax planning and an important reserve to increase the company's capitalization.
This means that the issue of determining the tax consequences for transactions involving intellectual property rights, and the legal procedures for reclassifying transactions for tax purposes in the Tax Code, are rather pressing. It is absolutely necessary to bring these questions to the attention of the professional community and the authorities.
The global scenario of IP taxation affected considerably with the enactment of the American Jobs Creation Act of 2004, Tax Relief and Health Care Act of 2006, Congress created and/or the Tax Increase Prevention and Reconciliation Act of 2005, and the extended a host of new tax incentives and planning opportunities for intellectual property development, acquisitions, and assignments. Congress inaugurated favorable rules for musical copyrights and new incentives for ﬁlm production. The legislators also extended tax breaks for computer software, and instituted new tax rules governing charitable donations of intellectual property. Congress also enacted a myriad of international tax rules affecting intellectual property, including new tax breaks for U.S. software developers. This cumulative supplement provides comprehensive coverage of these and other major congressional changes, including a new chapter dealing with charitable contributions of intellectual property.
The Internal Revenue Service and Treasury Department have issued a stream of new regulatory and administrative materials providing necessary guidance for planning intellectual property transactions. Shortly after the main text was published, the Treasury Department promulgated comprehensive regulations on the capitalization and amortization of intellectual property creation and acquisition costs, as well as new regulations dealing with the research and development credit. More recently, the Treasury Department promulgated a host of new regulations impacting international transactions, many of which relate to transfer pricing rules for controlled intellectual property transactions. For example, the Treasury Department has issued new regullations on the treatment of services transactions that affect a transfer of intellectual property and on the difﬁcult issues of ownership and developer-assister determinations under section 482. This cumulative supplement summarizes these and other recently promulgated regulations, as well as the latest IRS rulings governing domestic and international intellectual property transactions. Additionally, in recent years, states have been more aggressive in addressing intellectual property holding companies, trademark holding companies, and electronic commerce transactions. This supplement summarizes recent state legislation, court decisions and administrative rulings impacting the popular intellectual property holding company.
In relation to general tax law in India, there is no specific definition of intellectual property in the Income Tax Act, 1961 (the “Act”). However, the Act differentiates between tangible and intangible assets in the definition of “block of assets” which is used for the purpose of computing depreciation on a class of assets and which may comprise of both of those types of assets. ‘Intangible assets’ are defined to include ‘know-how, patents, copyrights, trademarks, licenses, franchises or any other business or commercial rights of similar nature. While in the Income Tax Rules, 1962, (“Rules”) relevant to transfer pricing, the definition of ‘property’ includes ‘intangible property’ but intangible property has not been separately defined. However, in the form that needs to be submitted to the tax authorities called ‘particulars relating to international transactions required to be furnished under the Income Tax Act’, transactions in intangible property are described as those which relate to ‘know-how, patents, copyrights, licenses, etc’.
In a recent decision by the Delhi High Court in Commissioner of Income Tax v. M/s Eicher Limited (formerly Royal Enfield Ltd.), it was held that the payment of non compete fee by the assessee was a business expenditure and not a capital expenditure. Direct expenditures are involved in case of creating know-how. In most jurisdictions of the world it is written off as revenue expenditure for business. Companies can treat the expenses for creating intellectual property as a capital expenditure and write it off over a period of time. It will show intellectual property as an asset. Whenever there is acquisition or creation of intellectual property, the money flow will be shown as an asset. The R&D expenses are usually written off by the companies under the concept of materiality.
The lack of a comprehensive policy on intellectual property taxation acts as a disincentive to technology transfer and IP creation in India. So a comprehensive Intellectual Property taxation regime should be developed, that could achieve a pro-growth momentum in the country. A uniform IP tax policy should be adopted throughout the states. All the present taxing system in different statutes and various landmark court decisions may be incorporated in the new legislation.