How Income Is Taxed On Transfer Of Intangible Assets

December 14, 2016

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In this blog post, Anjali Karmarkar, a fourth-year law student at Calcutta University and pursuing a Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, describes how income is taxed on transfer of intangible assets.

According to Wikipedia, Intangible Assets are those which “lack physical substance. It includes patents, copyrights, franchises, goodwill, trademarks, trade names, the general interpretation also includes software and other intangible computer based assets. Contrary to other assets, they generally—though not necessarily—suffer from typical market failures of non-rivalry and non-excludability.” Intangible assets have been claimed to be one of the most imaginable contributor to the disproportion between company value according to their accounting records, and company value according to their market capitalization. Bearing in mind this disagreement, it is important to comprehend what an intangible asset truly is in the eyes of a certified public accountant. Numerous efforts and attempts have been made to define intangible assets:

Preceding to 2005 the Australian Accounting Standards Board allotted the Statement of Accounting Concepts number 4 (SAC 4). This announcement did not make available an official definition of an intangible asset but did provide that tangibility was not an indispensable distinguishing characteristic of asset. International Accounting Standards Board standard 38 (IAS 38) which defines an intangible asset as: “an identifiable non-monetary asset without physical substance.” This description is an addition to the formal standard definition, or as a definition, of an asset which necessitates a past event that has given power and rise to a resource and supply that the object or an entity which has a control and from which forthcoming economic benefits are necessarily expected to flow. Consequently, the extra requirement and obligation for an intangible asset under IAS 38 is identifiable. This principle or the criterion, as said otherwise, requires that an intangible asset is distinguishable and separable from the entity or that it arises from a contractual or legal right. The Financial Accounting Standards Board Accounting Standard Codification (as per Wikipedia) 350 (ASC 350) describes an intangible asset as an asset (advantage or an ability), other than a monetary or financial asset, that lacks physical substance.

Globalisation and increased opposition are knocking new types of compressions or pressures on companies and, by extension and further postponement, on the areas that rely solely on their accomplishment. Elasticity or the other term, ‘Flexibility’, the ability to adapt immediately to market expansions and pro-activism in generating future markets are the allocates of this new generation of markets. In response to amplified and enhanced competition and rivalry, companies create and seek to develop “soft” production factors, i.e. factors connected to individual knowledge that can be commonly grouped in what is known as intangible assets (IA).

There is a steady increasing interest from academic world that is, the academic market, policy-makers and the corporate marketplace, commercial environment and its engulfed surroundings, in the influence of intangible assets on financial or economic processes of the twists and turns of globalisation. These assets can be well-defined as “non-material factors” that subsidize to innovative performance in the production of goods or the provision of service area, or that are anticipated to produce future economic reimbursements or benefits to the entities or individuals that regulate their disposition. Their link to globalisation is emphasized and highlighted by the very critical and crucial role of international activities in the development and endurance and survival of SMEs.

Intangible Assets : Intangible assets are nonphysical resources that add forthcoming and future value to a company that holds the same. Intangibles are classified into two categories: limited-life and unlimited-life. Limited life assets consist of goodwill, intellectual property, licenses, copyrights and patents. A trademark, on the other hand, doesn’t expire or get demolished and is characterized as an unlimited-life intangible asset. Intangible assets can’t be demolished or destructed by natural consequences like wind or fire, but they can be lost over a period of time. A company that enjoys a great reputation and a character as an honest, ethical firm may lose that characterization if the new management lowers the standards of service.

Valuation of Intangibles : Estimating the value of equipment and inventory is a relatively straightforward process. Estimating the intangible value is much more subjective. Since 2002, national accounting standards require companies to report the value of their intangible assets on their balance sheets, but it’s often unclear to analysts how the numbers are derived. However, how the items are categorized on the financial statements has a major consequence on the future tax legal responsibility of the company.

Capital Gains Tax : When a company holds an investment which stands lengthier than one year or more, it will qualify for a favourable capital improvement tax thus creating the legal responsibility of the company, which has a thoroughgoing rate of fifteen percent rate; the regular tax has a maximum thirty five percent rate. Many intangibles are usually taxed at the favourable capital gains rate. Nevertheless, if the intangible was remunerated, it is usually taxed at a higher rate. Amortization permits the cost of the intangible to be subtracted and deducted as an expense which is over 15 years. If the intangible has an expected and anticipated advantageous life expectancy longer than fifteen years, it probably isn’t amortized.

The assessment and calculations of the value of intangible assets originates tax lawyers and economists a lot of trouble which is caused due to the valuation of the intangible assets. And when assets cross county borders, situation gets worse. The surprising result is that a substantial number of international enterprises use a transfer pricing method for the valuation of intangible assets that appears not to fulfil with regulations of either home or host tax authorities. Even though this is a matter of the greatest practical concern in the real world situation, the notion of persistence of unfluctuating growth and development of the problematic area clearly raises theoretical question. These dimensions considers the valuation of intangible assets from both perspectives, theory and practice, building its practical recommendations on a sound theoretical analysis of the appropriateness of transfer pricing rules for intangible assets as well as on the appropriateness of transfer pricing valuation standards and methods for the financial and economic reality of multinational or international enterprises.

With professional understanding into the difficulties inherent in the current controlling as well as supervisory and regulatory approaches to valuing intangible asset transmissions within multinational enterprise networks, the author combines three strands of current concerns, namely:

research into the theory of the multinational enterprise, intangible asset valuation, and international transfer pricing;
comparison of transfer pricing policies when intangibles are involved; and
the ongoing policy discussions on the subject among international organizations, tax authorities, and taxpayers.”

(Source : http://www.inderscience.com/info/ingeneral/cfp.php?id=2527)

The price-setting characteristics of multinational enterprises of the question that lies why intangibles are valued; the indefinability of economic fairmindedness standards when every circumstance is dissimilar these are among the stimulating questions raised in this book. As both a thorough summary of the most important ideas, philosophies and key public policies in its particularly specific field and an illuminating and more effectively clarifying demonstration of recommendations as well as topics and questions for further research, International Transfer Pricing and The Valuation of Intangible Assets will greatly bestow advantageous results on the international taxation professionals and specialists, whether in business, government, or academia.

Interesting situations and questions arise under different laws as the mentioned intellectual property rights located in India are transported and trans missioned by a foreign enterprise or a company. In most cases, the documentation and credential for the transfer takes place outside the borders of India or places where the jurisdiction presides and the transmission may take place amongst two entities, which are residents of foreign countries, thus deeming it an international situation of intellectual property.

The various tax implications of such a transfer or assignment mentioned above are complex and have resulted in court cases by various enterprises due to rising complexities, which will increase over the approaching years as supplementary and more such transactions are achieved and assessed in international deals, which takes place as mentioned above. Under section 2(14) of the Income-tax Act, 1961, the term ‘capital asset’ is well-defined to mean property of any kind held by an assessor whether or not connected with his business or profession.

The definition of ‘capital asset’ clearly states that this expression has been allocated a wide connotation according to the given circumstances. “Property of any kind” undoubtedly includes intellectual property, which is but a species of intangible property. Trade marks, brand, goodwill, technical know-how relating to the production of goods and services would all qualify to be treated as capital assets within the meaning of section 2(14) of the Act.

Though tax accountability and legal liability that could only be with respect to two items, viz, trademarks and other brand intellectual property, there was no lawful foundation for apportionment on the ground that the situs of the possessions transferred was virtually in another place. As soon as once the revenue was deemed to accrue or arise in India on account of transfer of capital assets situated in India, the entirety of the consideration received in respect of such transfer had to be treated as the gross income.