Intellectual Property and Taxation – Sudhir Raja Ravindran

By   March 23, 2016

Intellectual property such as patents, trade secrets, copyrights, trademarks, trade names and designs are increasingly becoming valuable business assets. Intellectual property for the purposes of taxation is classified as an Intangible fixed asset acquired or created, for use on a continuing basis in the course of business activities. Creation, development, acquisition,Utilization and sale of intellectual property assets cause various interactions with different forms of taxation, and have significant tax consequences. Taxation relating to intellectual property falls under a number of headings like business profits, fees for services, rents and royalties, dividends and capital gains, employee salaries, etc.

The tax net prevalent in India is quite broad in which intellectual Property gets entangled at multiple instances, to exemplify tax credits for research and development (R&D), allowances and reimbursements for creation of intellectual property assets, services tax for royalty, etc. The whole cycle of intellectual property creation, development, acquisition and utilisation are thus affected by the system of taxation.

There are many tax rules that are applicable to intellectual property, some of which are quite specialised. For instance, the tax system currently includes some rules designed to encourage particular activities such as R&D. Tax law allows deduction for many of the costs of research and development expenditures, and under certain circumstances, even a tax credit. Tax law also contains a collection of specialised rules for depreciation or amortisation of the acquired intellectual property. To encourage (for e.g., Andhra Pradesh, Kerala, Tamil Nadu) reimburse up to 50 percent of the expenditure incurred in obtaining the patent (limited to a maximum sum), to enable the industry to protect the inventions made by them. The tax man should ensure that the R&D relief and the new intellectual property rules are aligned so that expenditure on the creation of intangibles, which does not qualify for special treatment, is not included.

The tax treatment and tax incentives differ according to the type of Taxation. Modes of intellectual property transfer and methods of payments May give rise to different tax obligations affecting the transfer, by increasing the cost of the actual transfer. The sale and licensing of intellectual property can produce capital gains, but often generates ordinary income. The interest in intellectual property that is transferred to others when treated as “Property” for tax purposes can significantly affect the tax results. If Intellectual property is acquired or sold for stock or options in one company or another company or in exchange for other intellectual property, such transactions could have tax consequences for the seller.

In a “knowledge-based economy” [a term that was coined by the Organisation for Economic Co-Operation and Development (OECD)] Where knowledge, information and technology foster economic growth, Intellectual property are pivotal resources, the inordinate importance ofIntellectual property and the increasing transformation of corporate assets from tangible to intangible warrant and necessitate special tax treatment for intellectual property.

The intangible character of intellectual property which has given it the flexibility to assume the importance in the “knowledge-based economy” also poses a daunting task for the tax authorities. The intangible character of such property leaves them open to relocation, reconstruction, reformulation and general manipulation by taxpayers in order to achieve desirable tax outcomes.1(Michael Walpole,” Current Issues in the Taxation of Intangible: An Attempt to Tax “scotch Mist ?”, A tax Discussion Paper No 7, November 2001. Available at SSRN:

The distinction between capital and revenue, one of the fundamental principle of the tax system is being increasingly challenged, by tax rules framed to encapsulate intellectual property. Wherein rules are bringing previous “capital” items within an income regime and providing relief on an ongoing basis and taxing disposals to income rather than capital. This raises the question of whether the distinction remains sensible or whether an income regime should be adopted throughout.2(Christopher Sanger, “Business tax-a vision for the future?” Tax Adviser, the Chartered Institute of taxation, April 2002. Commenting on the UK governments new rules for intellectual property further to Finance Act 2002. Available at The rapid worldwide harmonization and acceptance of intellectual property post WTO, has resulted in the tax system struggling to keep to keep up and capitalist on the commercial viability of intellectual property.

As intellectual property assets gain significance as a source of wealth and income generation for today businesses, it is imperative to consider the tax treatment of intellectual property. What comes under the purview of taxation is not only traditional intellectual property such as patents, copyrights, trademarks, trade secrets and computer software, etc, but also other forms of intangible assets such as franchises, covenants not to compete, governmental licenses, consumer and business information, goodwill and going concern value, etc. The capitalization and amortization requirements applicable to expenditures incurred in the development of Intellectual property and intangible assets are different from that of tangible property. The tax characterization of intellectual property may be different from its commercial characterization, which is an outcome of the special rules that apply to transfer of intellectual property.

In essence, intellectual property is a limited monopoly granted by governments. This limited monopoly enhances the value of the intellectual property assets. The limited m

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