28 Aug 2015

Patent transfer

27 February 2013

An inventor personally owns a patent that is licensed to his company, which exploits it. To mitigate personal tax liabilities, it has been suggested the patent be owned by a company

We have been asked to incorporate an inventor’s business. He has registered a patent in his personal name, after several years of research and development by his trading company, of which he is the 100% shareholder.

His trading company has the exclusive worldwide right to exploit his patent and pays our client an annual sum for this benefit. This is exposing our client to very high income tax charges.

Our client has a number of new ideas which may result in new patents, so he has asked us to incorporate his patent business to avoid even higher income tax charges as new ones are developed.

Our client’s trading company is owned by a non-trading holding company (Holdco). Our client wishes to create a new subsidiary (under the holding company) which will ring fence his patent business and reduce his income tax exposure.

He wishes to do this by gifting his patent to Newco, using the TGCA 1992, s 165 gift provisions.

We believe that, to avoid a tax charge under ITTOIA 2005, s 587 (which would tax our client as receiving an income gain rather than a capital gain on the disposal of the patent to Newco), our client must receive nil consideration on the disposal of his patent business to Newco.

Because our client indirectly owns Newco (the recipient of the patent) by virtue of owning the shares in the non-trading holding company, will our client be deemed to receive consideration on the incorporation?

Also, if s 587 does not apply, will HMRC accept a TCGA 1992, s 165 election on the basis that our client is not disposing of an investment (the patent) but is disposing of a trade (the patent business)?

Basically, we need to know whether we can complete the transfer of this patent, which is potentially worth £1m, to Newco without any tax cost?

Query 18,146 – Baffled Boffin

Reply from Archimedes

The first point of difficulty may be the inventor’s ownership of the patent in the first place. It appears that the company (of which the inventor was presumably a director) has incurred expenditure on developing the invention.

On the face of it, it would seem that it would have been the company and not the individual who had the right to register the patent (see HMRC’s Capital Gains Manual at CG68290).

Allowing the inventor to do so personally does not appear to be a commercial way to proceed and there must be a risk either that the company would be denied tax relief for the costs or that some measure of taxable benefit may be assessable on the inventor.

That aside, what are the consequences should the inventor now gift the rights to a new company? It would be a disposal for capital gains tax purposes and market value would be substituted.

Normally the costs of developing the invention would be deductible as the base cost of the asset but in the present case it appears that the costs were borne by the company so the inventor has no base cost.

Although what is being disposed of is not itself a trade, it seems on the facts that it is an asset which is being used for the purposes of a trade carried on by the inventor’s personal company.

In this case, holdover relief under TCGA 1992, s 165 should be available on the gift, whether to the existing company or to a new company.

The fact that the inventor indirectly owns the donee company does not mean that he would be treated as receiving consideration for the disposal, either for capital gains tax or ITTOIA 2005, s 587 purposes.

In summary, injecting the rights into a company should not be problematical: the real problem may arise from what has happened in the past.

Reply from Kitt Girl, Tax Insight LLP

Unless the corporation tax intangible asset regime applies, the taxation of any capital sum received from the sale of patent rights is taxed as income, rather than a chargeable gain (ITTOIA 2005, s 587 refers). The tax charge depends upon whether the recipient is UK resident or non-resident.

A UK resident is normally taxed on one-sixth of the amount received for each of the six chargeable periods that begin with the chargeable period in which the capital sum was received.

Alternatively, a seller can elect to have the whole of the capital sum taxed in the chargeable period in which it was received.

This election is made under the usual self-assessment time limits for individuals but where, unusually, a company needs to elect, and is not within the 2002 corporate intangibles regime, then the time limit is two years from the end of the chargeable period in which the sum is received.

Baffled Boffin is right to raise the possibility of relief under TCGA 1992, s 162 or s 165. The availability of entrepreneurs’ relief is potentially limited unless the client is carrying on a trade in inventions et al and is holding the patent as a business asset.

It would seem that the facts are that this is not the case and TCGA 1992, s 169(L) would be in play, the patent being his personal “asset” and preventing that relief.

Going back to the hypothetical possibility of gift or incorporation relief, and taking the latter first, s 165 prescribes that business assets need to be both:

used for the purposes of the company’s trade, [profession or vocation]; and
chargeable assets are all assets except those where no chargeable gain could arise on their disposal.

Given the special “income deeming” rules of s 587, it would seem that the relief would be blocked because the character of the disposal is income in nature, preventing access to both entrepreneurs’ relief or gift/holdover reliefs.

The legislation is clearly taxing income rather than a chargeable gain as income, so precluding these key business reliefs: “Income tax is charged on profits from sales of the whole or part of any patent rights” (s 587(1).

Even if s 162 relief were feasible, Boffin would, of course, need to demonstrate the transfer of “all assets”, with the possible exception of cash, upon the incorporation of the old business.

If the company pays or intends to pay or award shares for the assets, the transfer will not have been wholly for shares.

There is the final unhappy danger that under the disguised remuneration rules, etc any share award in Holdco may have employment-related securities issues.

What can be done? The incorporation of any business requires a careful appreciation of the assets to be transferred, identifying both their intrinsic nature and open market value.

Baffled Boffin may well find it useful to take a dissective approach to the valuation of the assets actually being sold.

Is it perhaps the case that, bound up in the sale of the patent stream and related intellectual property, there is in fact a disposal of a separate asset such as Boffin’s inherent goodwill.

This might reflect his special expertise, longevity or reputation in the particular field of technology or advances for which the patent was registered.

What is the open market value of the patent as distinct from the “deal value”?

It may have a reduced value if, say, it was first registered in a field where radically improved and possibly more efficient applications are now freely available.

For example, the value of patents on the first mobile telephone handset probably do not compare with the figures recently debated by the Apple and Samsung patent/know-how litigants.

It is also hoped that, because the R&D regulations concerning the vesting of intellectual property (IP) were only relaxed in April 2009, the trading company has made any claim to research and development tax relief appropriately.

Despite these hurdles, the incorporation is hopefully well timed and possibly preferable to a limited liability partnership vehicle. Companies may, from 1 April 2013, opt into the new “patent box” regime.

This means they can elect to tax trading profits/sale proceeds from patents and qualifying IP at a lower than standard rate of corporation tax.

After five years of phasing-in, the lower patent box rate will be 10%. The further simplification of registering in one territory rather than separately in the UK and EU may also be helpful.

Reply from Steve Kesby

Baffled Boffin has possibly overlooked one other alternative; that the inventor may be exercising a profession or vocation of inventing, assessable under ITTOIA 2005, Part 2.

It does seem to be rather analogous to a professional author, earning income from the “fruits of their brain”, and in respect of whom a receipt from the disposal of the entirety of their copyright in a work is generally considered to be a revenue receipt.

The position of a professional author and this treatment as a revenue receipt is dealt with in HMRC’s Business Income Manual at BIM35725 to BIM35735.

Relevant cases supporting HMRC’s assertions are:

  • Billam v Griffith 23 TC 757
  • Glasson v Rougier 26 TC 86
  • Howson v Monsell 31 TC 529
  • Mackenzie v Arnold 33 TC 363
  • Wain’s Executors v Cameron 67 TC 324

In the case of authors, the only contrary authorities seem to be Beare v Carter 23 TC 353 (which concerned a single work) and Nethersole v Withers 28 TC 501 (which had rather unique facts).

There is, though, case law suggesting that the position does differ for inventors. In CIR v Sangster 12 TC 208 an inventor was not considered to be earning profits from a trade or business in the context of the excess profits duty charged by F(No2)A 1915.

Kirke v Good 36 TC 509 (an income tax case) followed this position that an inventor was not carrying on a profession.

However, Sangster was held not to be carrying on a business, because only one of his 400 inventions had ever previously been sold (some 25 years previously) or otherwise developed to be a source of income.

Kirke was a somewhat vexatious litigant (essentially arguing, for a second time, that receipts of his inventions simply weren’t taxable) and the General Commissioners’ application of the decision in Sangster was not considered by the High Court, who were more concerned with the overriding principle that the receipts should not escape taxation.

If it were to be established that the disposal of the intellectual property arises out of the exercise of a profession or vocation, and that any amount to be brought into account as a receipt is taxable as income, then the next issue to consider is what amount should be so brought into account, where the intellectual property concerned is gifted.

Returning to the author analogy, this issue was considered in Mason v Innes 44 TC 326, where the then Inland Revenue argued that the copyright works were essentially an author’s stock, to which the market value principle from Sharkey v Wernher 36 TC 275 applied when the author gifted his copyright in a work to his father.

The Court of Appeal rejected the argument, likening the position to that of barrister acting pro bono who would bring no receipt into account.

Similarly, there would not seem to be anything within UK GAAP to require a market value receipt to be brought into account.

The principle in Sharkey v Wernher has now been given statutory effect in ITTOIA 2005, Part 2, Ch 11A, which excludes services.

However, if it was argued to be a cessation, a market value receipt would need to be brought into account under Part 2 Ch 12 (which includes services) and no election could be made under ITTOIA 2005, s 178 because the company will not be acquiring the patents as stock or work in progress, but rather as an intangible asset.

Alternatively, as Baffled Boffin suggests, there may be no profession or vocation and any proceeds (or deemed proceeds) will then be taxable as income by virtue of s 587.

In either case, it is significant that the company acquires the patents as intangible assets.

Where the patents arose after 31 March 2002, they will be new intangibles within the scope of the corporate intangibles regime in CTA 2009, Part 8.

There is then a deeming provision in CTA 2009, s 845 that essentially says that where an intangible asset is transferred to a company from a related (read connected) party it is treated as transferred at market value for all purposes of the Taxes Acts, including ITTOIA 2005, s 587 and Part 2.

However, to the extent that the patents arose before 1 April 2002, they will be old intangibles within the scope of TCGA 1992.

If they do not also arise on the cessation of an inventing profession or vocation, then any actual consideration received will be taxable either under ITTOIA 2005, s 587 or as a receipt of a continuing profession or vocation.

Any excess of market value over the actual consideration will be taxable as a capital gain, by virtue of TCGA 1992, s 17 and s 18 (with any amount charged to income tax being excluded by TCGA 1992, s 37).

The company’s acquisition will similarly be at market value and an election under TCGA 1992, s 165 will be possible, to the extent of the inventor’s chargeable gain; but only in these particular circumstances.

CTA 2009, s 845 would seem not to apply if the patents are transferred to a partnership (or LLP) of which a company is a member, notwithstanding the provisions in CTA 2009, Part 17.

The issue of a profession or vocation ceasing might also be addressed using a partnership vehicle. A corporate partner in a partnership can also benefit from the patent box regime or, alternatively, the company could be granted exclusive development rights over the patents.

Reply from Andy Wells, AVN Venus Tax LLP

I suggest Baffled Boffin stops to question whether this is the right approach for his client and, if so, retains a record of the reasons, covering the possible risks.

A few years ago I was involved as an expert in a negligence action against a firm of accountants that had facilitated the incorporation of a valuable patent.

The taxpayer had come to regret the decision when contemplating the sale of the rights.

The lawyers were attuned to the opportunity for some redress against the person who had advised it. It was demonstrable that the tax paid over the “corporate life” of the patent was substantially more than it might have been under a different structure.

It is impossible to say what is the right thing to do, but Baffled Boffin might be well advised to cover his position if apparent short-term income tax savings are all that is driving this.

One could envisage circumstances in which someone with a patent held in a company and generating income might prefer it to be held differently.

I’m not saying it is wrong per se, merely that it might prove to be. There will always be someone to say “why did you do it that way?” which may be followed by the thought of “is there a case for legal action?”

It is often said that hindsight is a wonderful thing.

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