In this article, Nivedita Arora pursuing Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, discusses how to tax income from transfer of intangible assets.

Introduction

The author tries to explain what are intangible assets, their definition and how income on transfer of intangible assets is taxed depending on whether the owner of such assets resides within or outside India.

What is an intangible asset?

In lay man’s language, assets that are not physical in nature such as patents, trademark, goodwill, copyrights and intellectual property rights are referred to as intangible assets.

These intangible assets can further be classified as definite and indefinite assets depending on the time period. Indefinite intangible assets are those which exist for a longer period of time such as company’s brand name or trademark and don’t get expired or destructed by natural consequences or acts of God. However, definite intangible assets are those which exist for a defined and shorter period of time. Few examples of definite intangible assets are goodwill, copyright, patents, intellectual property etc. Intangible assets are shown on the balance sheet along with the tangible assets and add to the company’s future worth and can be more valuable than tangible assets.

Definition

There is always a difference between the market value of the company as per the accounting records and as per market capitalization. This difference is caused due to the valuation of intangible assets. Thus we need to understand what an intangible asset actually means as per accounting standards and how is it valued.

According to the Financial Accounting Standards Board Accounting Standard Codification 350 (ASC 350), an intangible asset is defined as an asset which is not a monetary asset and lacks physical existence.

International Accounting Standards Board standard 38 (IAS 38) defines an intangible asset as identifiable non-monetary assets without physical existence. The objective of IAS 38 was to provide accounting treatment for the intangible assets which was not specified earlier is another IFRS. Thus IAS 38 requires that intangible assets that meet the specified criteria will be recognized as intangible as per IAS 38. The IAS 38 gave detailed guidelines about how to measure the value of intangible assets and what all disclosures have to made regarding intangible assets possessed by the company.

The three main attributes of an intangible asset are:

• Control
• Future economic benefits.
• Identifiability.

Identifiability according to IAS 38.12 refers to an intangible asset that

• Can be separated and sold, transferred, licensed, exchanged etc.
• Arises from contractual or legal rights.

Valuation of intangible assets

Valuation of tangible assets such as goods, inventory, machinery, land and building is a very simple and straightforward process. However, the valuation and assessment of intangible assets is a complicated process and it is even more difficult when the assets are outside the boundaries of the country and the national accounting standards require the companies to report the value of intangible assets on their balance sheets since 2002. However how the assets are classified as whether tangibles or intangibles on the balance sheet has a major consequence on the tax responsibility of the company.

Due to the globalization and increased rivalry, it is essential to value intangible assets for tax purposes. If a company keeps an asset for a longer period of time, say more than one year, it is considered to be taxable at a favourable capital tax improvement rate, thus making the company liable to be pay tax. Thus, intangible assets are also taxed at favorable capital gains rate.

A few organizations use transfer pricing method which is unreliable, inaccurate and does not fulfill the criteria and regulations of either the home country or the country where the valuation of intangible assets is done.

The three main concerns required for accurate and reliable  valuation of intangible assets:

• Research is needed in the theory of multinational enterprise, valuation of intangible assets and international transfer pricing techniques.
• Comparison of various transfer policy pricing where intangibles are involved.
• Various policy discussions that are undertaken on this subject by various tax authorities, international organizations and tax players.[1]

There is no clarity on how to tax income on transfer of intangible assets where the assets are situated outside India.

The Delhi High Court in 2011 in the case of CIT vs. Mediaworld Publications Pvt. Ltd. held that the transfer of intangible assets is taxable as the income arising out of transfer of such intangible assets is capital gains and not business income.

The High Court gave this judgement in favour of the taxpayer and held that the sale of intangible assets such as trademark and copyright, and income arising out of such sale is referred to as long term capital gain.

According to section 2(14) of the Income-tax Act, 1961, (referred to as ‘The Act’) ‘capital asset’ is defined as the property of any kind held by an assessor whether or not connected with his business or profession.[2]

Thus, according to this definition of ‘capital asset,’ we can infer that any property of any kind includes intellectual property, which is a kind of intangible asset. Trade marks, brand name, goodwill, copyrights, patents, technical know-how relating to the production of goods and services will also come under the definition of capital assets according to Section 2(14) of the Act.

If the income arose in India on account of transfer of capital assets situated in India, then the entire amount of consideration received on account of such sale or transfer was treated as gross income and was thus taxable.

According to section 2(14) and 2 (11) (b) of the Income Tax Act, 1961, the High Court has held that trademark, brand name, copyrights and goodwill are considered intangible assets of the business and are means of earning profit for the company.

The High Court clearly stated that the assets and contracts in the business and the transfer of the intangible assets, which formed major constituents of the agreement were transferred by the taxpayer.

On the basis of the aforesaid facts the High Court held as follows that the consideration received by the taxpayer is a long term capital gain and thus, accordance with the provisions of the proviso to Section 28 (va) of the Act, Section 28 (va) of the Act would not be applicable in the instant case. Thus the Court held that the sale of intangible assets will be considered capital gain and thus taxable.

“In a recent Delhi High Court judgment in July 2016, CUB Pty ltd. vs Union of India it was held that the situs of an intangible property is the place where the owner of the property resides, and a transfer of such property by a non-resident owner to another non-resident would not be taxable in India.”[3] Such decision was taken because there is no provision in the Income Tax Act, 1961 regarding situs of intangible assets such as trademarks, intellectual property rights, goodwill etc. thus the income arising out of transfer of such intangible assets outside India can not be taxed in India, if the owner of such assets is not a resident of India. However, if the owner of such intangible assets is an Indian, then the income accrued from transfer of such intangible assets can be taxable in India.”[4]

There is no such difficulty while valuing tangible assets as they exist at a specified location however, intangible capital assets don’t exist at a specified physical location and thus their valuation becomes difficult. Thus the Honourable Court held that adopted the concept the well-accepted principle of ‘Mobilia sequuntur personam’ for this case. The situs of the owner of an intangible asset was considered as the closest approximation of the situs of an intangible asset. Thus, considering the facts of the present case the title and interest in trademark ‘Foster’ in India was transferred by its non-resident owner, income arising from such transfer was not held taxable in India due to absence of any provisions related to this in the Income Tax Act, 1961.[5]

This judgement has brought several interesting questions and controversy due to the conflict with amendments to Section 9 of the Income Tax Act, 1961. Thus, there is a need to insert various provisions regarding in Explanation 5 to section 9(1)(i) providing clarity in respect of other intangible assets.

Thus, the conclusion is that the income arising on transfer of intangible asset outside India, if the owner is not the resident of India is not taxable in India unless any other specific domestic law applies to the contrary to tax such income. The Explanation 5 to section 9(1)(i) is confined to tax the income arising on transfer of shares or interest in a company and it cannot be extended to the transfer of any other intangible assets. Thus, as there is no provision in the Act, the situs of the intangible property is determined by the owner of such property and if the owner of the intangible property is not resident of India, then income on their transfer is not taxable. [6]

Conclusion

The income arising out of transfer of capital gains is taxable if the owner is a resident of India is taxable. However, clarity is still needed on how to tax income on sale or transfer of intangible assets where the owner of such assets is not a resident of India.

References

[1] https://blog.ipleaders.in/income-taxed-transfer-intangible-assets/

[2] Section 2(14) of the Income-tax Act, 1961,

[3] http://indiacorplaw.blogspot.in/2016/08/taxation-of-income-from-transfer-of.html

[4]  CUB Pty ltd. vs Union of India 2016 SCC Online Del 4070

[5] https://www.taxmann.com/budget/t23/situs-of-intangible-asset-–-clarity-needed.aspx

[6] https://www.taxmann.com/budget/t23/situs-of-intangible-asset-–-clarity-needed.aspx