In the era of outsourcing of manufacturing and services by rich Countries, the taxation authorities are very much concerned with transfer of Intellectual Property. IP in the form of Technology is either licensed or sold/assigned. In case of licensing, the income is by the way of royalty and in case of Assignment the income is by the way of one time sale value. Arms length Principle applies for Affiliated Party for cross border Transactions. Transaction value is compared with the valuations either on cost approach or on income approval or on Market approach which involves complexities. Selling or Licensing of IP to another Country is taxed not only in the Country of origin but also in the receiving Country by way of custom duty and withholding tax on Royalty. Both countries may also levy indirect taxes (VAT or Sales Tax) and stamp duties.
Territorial Jurisdiction & Taxation
The tax treatment of IP rights is dependent on the territory in which the rights are owned. Since there are different tax treatments of IP rights between territories, the territory in which the rights are owned will affect the earnings of a MNC.IP may make easy move from one location to another as a tool of tax planning. This is why the pricing of international IP transactions has always been as issue of fundamental importance. This is a big area of focus of tax authorities in transfer pricing investigations. Since IP rights are portable assets, it is, in principle, possible to locate these rights in a territory that has a favorable regime for the taxation of IP and the profits derived there from.
Transfer Pricing Complexities in Licensing / Assigning Technology
OECD Guidelines 1995 require related Companies to price intercompany transaction as if they were two independent parties in the same or similar circumstances. This requires evidences of what third parties have done or would do if they were in the Taxpayer’s position or in other words the transferor needs to provide Market Comparable Data. The Arm’s length nature of the royalty can be compared with the arrangement the owner of technology has with independent third parties or by identifying similar transactions in the market place. However there are practical difficulties in getting similar technology data in the market because of uniqueness of technology.
Complexities in the valuation of technologies for Transfer Pricing
The residual period of the life of patent.
Obsolescence or uncertainty of technology.
The after sale service or the conveyed sale of spare parts and components.
Bundling of various IPs together say brand value at one jurisdiction and patent at another jurisdiction.
The valuation principles are subjective but the most practical approach in case of IP is the economic benefit on the income approach.
Cost sharing of R & D between different Institutions or entities.
Know how and Technical Services involve the questions of determination of taxability as IP or as of services.
Tax Planning in Cross Border IP Transaction
Certain countries have lower rate of taxes especially Netherlands, Ireland and Sweden
Create the IP Assets in the tax jurisdiction where the tax rate is low and get the advantage of such tax havens because of tax competitiveness amongst countries
In certain cases through holding subsidiary structure, dividend income is considered as substitute for Royalty to avoid withholding tax and the income tax in corresponding jurisdictions.
Taxation of Intellectual Property in India
Income Tax Act, 1961 (IT Act),
Service Tax (ST)
Value Added Tax (VAT),
Customs Tariff Act, 1975 (CT Act), and
Central Excise Act, 1944 (CE Act)
IP and Indian Taxation
The definition of ‘block of assets’ under Section2 (11) with effect from 1.4.1999, reads as follows:
“Block of assets means a group of assets within a class of assets comprising
a) Tangible assets, being building, machinery, plant or furniture
b) Intangible assets, being know-how, patents, copyrights, licenses, franchises or any other business or commercial rights of similar nature is subject to a rate of depreciation of 25% under Section 32(1)(ii)
Know-how means any industrial information or technique likely to assist in the manufacture or processing of goods or in the working of a mine, oil well or other sources of mineral deposits (including searching for discovery or testing of deposits for the winning of access thereto)
Various Provisions of IT Act 1961
• Deductions for Expenditure on Scientific Research including weighted deductions, Section 35
• Deduction of Income of individual Residents from Copyrights & Royalties, Section 80 QQB and 80 RRB respectively. Deduction allowed for whole of income subject to maximum limit of Rs. 3,00,000 only.
• Tax on Royalty and Technical Service Fees in the Case of Foreign Companies under Section 115A is charged at 10%.
• Withholding Tax varies between 10 to 20 % for Royalty and Technical Services for payment made to Non-Residents or Foreign Companies as per provisions of Section 195 of IT Act 1961.
• Special Provisions for Computing Income by Way of Royalties, etc., in the Case of Non-Residents, Section 44DA
• Transfer Pricing Provisions under Section 92A-92F