Sale of Intellectual Property Rights & Income Tax

Apr 20, 2022 | IP Audit, IP Policy, IP Valuation, Monetization, Patent

Intellectual property rights (IPR) are elemental in modern-day business strategy. Technology transfer transactions provide income to several companies operating in countries all across the globe. These countries immensely benefit from the taxation of IP related transactions leading to the growth of their economies. Thus, to promote more of such ventures, willing countries pledge to follow international treaties such as the Trade-Related Aspects of Intellectual Property Rights (TRIPS), which contain several provisions to govern trade-related matters between countries in respect of IPR. Certain tax exemptions and deductions are also provided to native companies in other member states to provide an incentive to enhance their business income. In the Indian context, it has been observed that an efficient IP taxation regime and royalty policy would persuade creators to produce more original and artistic work and expand the number of technology or know-how transfers into the country.

The following article provides a basic understanding of how income derived from IPR transactions are taxed under the Income Tax regime in India.

Taxation Policy in India w.r.t. Intellectual Property Rights

The taxation structure in India provides that income from intellectual property rights (IPR) are segregated according to the nature of the transaction. If an individual authors a book, creates music or is the sole inventor of a medicinal cure, then in those situations, the Income Tax Act of 1956 (the ‘Act’) provides for certain tax deductions which will promote tax planning. Once the nature of the transaction is determined, it is easy to identify whether the amount paid is taxable or would be allowed as a deduction. The categories under which IP can be taxed are –

1. Deductions – In the pre-existing stage of an IP, the cost which is incurred on analysis, manufacturing, i.e., capital spent on research and development is treated as an expense and is to be deducted from the gross income received for the calculation of income tax.
2. Income – Income from an IPR either by assignment or licensing is treated as Capital gains or income received from royalties under the Income Tax Act, 1961.
3. Goods and Sales Tax – Tax on the sale of IP, transfer of IP, licensing of IP and assignment of IP are covered under the GST Act.

What is intellectual property according to tax law?

As per the definition of ‘capital asset’ in Section 2(14)[1], a capital asset has an all-embracing connotation except if it expressly excludes a certain item. It includes ‘property of any kind,’ which undoubtedly incorporates intellectual property. The Act does not define intellectual property as such but the difference between tangible and intangible assets is examined in Section 2(11)[2]. Intangible assets, as per the definition, include ‘know-how, patents, copyrights, trademarks, licenses, franchises or any other business or commercial rights of a similar nature.

Royalty

Section 9(1)(vi)[3] of the Income Tax Act elaborates the definition of royalty. Royalties are taxable as income or as a business expense. It is to be noted that regardless of the conditions mentioned in Section 9(1)(vi)[4], if the IP is located in India, then the consideration for its use or disposal will arise in India and will be taxed according to Section 5(2)[5] of the Income Tax Act. Income by way of royalty is taxable under the Income Tax Act for a resident except in respect of:

1. any right, property or information used or services utilized outside India or
2. To make or earn any income from any source outside India.

Royalty income is taxable for a non-resident in respect of –

1. any right, property or information used or services utilized in India or
2. To make or earn any income from any source in India.

If such income is payable due to an agreement made before the 1st day of April 1976, and the agreement is approved by the Central Government, such income cannot be taxed.

In CIT Vs. Koyo Seiko Co. Ltd [1999 233 ITR 421 AP] it was held that royalty excludes any consideration which would be chargeable under the head of ‘Capital Gains’ and is assessable to capital gains tax at the rates applicable. Thus, royalty is any consideration, including lump-sum amounts but excluding those which would be the income of the recipient chargeable under the head capital gains, for:

1. The transfer of all or any rights (including the granting of a licence) in respect of an invention, patent, secret formula or process, model, design, trademark or similar property;
2. The imparting of any information concerning the working of or the use of an invention, patent, secret formula or process, model, design, trademark or similar property;
3. The use of any invention, patent, secret formula or process, model, design, trademark or similar property;
4. The imparting of any information or the use or right to use concerning technical industrial, commercial or scientific knowledge, experience or skill; (but not including the amount referred to in Section 44BB[6].)
5. The transfer of all or any rights (including the granting of licence) in respect of any copyright, scientific, artistic or literary work including films or videotapes for use in connection with television or tapes for use in connection with radio broadcasting, but consideration for the sale, distribution or exhibition of cinematographer films.
6. The render in of any other service about the activities mentioned above.

Expenditure and Deductions

While determining tax liability, the aim and object of the expenditure should be kept in mind to decided whether it is a capital expenditure or revenue expenditure. A revenue expense is deductable from the chargeable income of a business, while the expenditure incurred on capital is not. The Supreme Court in the case of Assam Bengal Cement Companies Ltd. v. CIT [1955 SCR (1) 876], observed that if the expenditure is made for acquiring or bringing into existence an asset or advantage for the benefit of the business it is attributable to capital expenditure. On the other hand, if it is made for running the business or using it to produce profits, it is a revenue expenditure.

Section 32 (1)(ii) – Depreciation of an intellectual property asset as an expenditure [7].

Depreciation of an asset is considered to be a business expense and the section accounts for such depreciation of IP to be an expenditure for computation of Income Tax.

Section 35A – Expenditure on the acquisition of patents and copyrights [8]

1. When the consideration is paid in a lump sum, the depreciation over the acquired patent and copyrights shall be claimed over a period;
2. When the consideration is paid periodically, the depreciation can be claimed as an expenditure fully incurred for business.

Any expense undergone after 28th February 1966 but before 1st April 1998 on the acquisition of patent rights or copyright for a business committed actions will be allowed for each of the previous years on an amount equal to the appropriate fraction of the amount spread over fourteen years.

Section 35AB – An assessee who has paid any lump sum consideration to acquire any know-how for the use of his business, the expenditure for the same shall be deductable in six equal instalments for six years in the following manner [9]–

1. 1/6th of the amount paid shall be deducted while calculating the profits and gains of the business for the previous year;
2. the balance amount shall be deducted in equal portions for each immediately succeeding the previous five years.

Section 80 GGA – deduction in respect of certain donations for scientific research or rural development [10].

The research work for the development of intellectual property such as a  patent comes under the category of scientific research. Under present laws, expensed deductions and additional weighted deductions are permitted to everyone for research and developmental expenditure. For the tax years 2017-2018 to 2019-2020, the weighted deduction is limited to 150% after which it will be reduced to 100% of the expenditure.

Section 80 O – no deduction in respect of royalties from certain foreign enterprises [11]

1. 40% for the assessment year beginning on the 1st April 2001,
2. 30% for the assessment year beginning on the 1st April 2002,

• 20% for the assessment year beginning on the 1st April 2003,

1. 10% for the assessment year beginning on the 1st April 2004,
2. No deduction from 1st April 2005 onwards.

Section 80 QQA – Specific provision for copyright products [12]

A deduction of 25% shall be allowed from any income obtained by an author in the exercise of his profession on account of any lump sum consideration for the assignment or grant of right in the copyright of any of his works, except for the following –

1. Dictionary
2. Thesaurus
3. Encyclopedia,
4. Any book that has been added as a textbook in the curriculum by any university for the degree of graduate or postgraduate course of the university, or
5. Book which is written in any language specified in the 8th schedule of the constitution or any other language as the Central Government by notification in the official gazette specifies for the promotional need of the language.

Section 80QQB – deductions made in respect of royalty income of authors of certain books other than text-books [13]

Section 88 RRB – Specific provision for patented goods and services [14]

In some cases, the total income earned on a patent can be divided into royalty and additional income other than royalty. The income received as royalty is only eligible for tax deductions. When income is received as a royalty, the whole income or Rs. 3 lakhs (the lesser amount) shall be deducted. If a compulsory license is being granted for a patent, the terms and conditions of the license agreement shall decide the status of the income to allow deduction under this section which shall not exceed the amount of royalty.

Basic qualification criteria for an inventor under this section-

The individual must be an Indian resident.

• Original patent holders are only eligible to tax benefits.
• The patent under this section should be registered under the Patent Act of 1970, either on or after April 1, 2003.

Section 115BBF – concessional tax rate on the exploitation of patents [15]

10% concessional rate of taxation is applicable on royalty income from the exploitation of patents granted under the Patents Act, 1970. The following criteria must be satisfied –

1. The patentee should be an eligible Indian taxpayer,
2. The total income of the patentee must include income by way of royalty in respect of the patent developed and registered in India,

At least 75% of the expenditure is incurred in India for the invention, and

No other expenditure is allowed under the tax provisions if the concessional tax rate under this section is availed.

The benefit of Section 115BBF can be used in any year but the patentee is required to continue to avail of the benefit for the next 5 years. If the option is not exercised in any of the next 5 years, the benefit under the section for the next 5 years following such year in which option is not exercised, shall cease the exist.

Startups and SME’s

A Startup is an industry that has been in existence for not more than seven years and has a turnover not exceeding twenty-five crores whereas an SME is an enterprise with an investment of up to one crore in Plant and Machinery. A startup primarily focuses on the innovation and development of products and processes. Startup-India is an initiative of the government which intends to catalyze the startup culture in India to build a strong and inclusive ecosystem for innovation and entrepreneurship in the country and to provide IPR facilitation, better tax benefits and easier compliance procedures. The special tax exemptions to promote such startups are –

Section 80 IAC: Income tax exemption for recognized startups [16]

After getting recognition as a startup, this section provides that for any three consecutive years out of a block of 7 years (10 years for startups from the Bio-Technology Sector) from the date of its incorporation, tax exemptions can be availed. The eligibility criteria for the same is –

1. The entity should be a recognized startup,
2. Only private limited companies or limited liability partnerships are eligible,

• The startup should have been incorporated after the 1st of April 2016.

Section 56: Angel Tax [17]

After getting recognition, a startup may apply for Angel Tax Exemption. Eligibility Criteria for this section is –

1. The entity should be a DPIIT recognized startup
2. The aggregate amount of paid-up share capital and share premium of the startup after the proposed issue of shares, if any, does not exceed INR 25 Crore.

Other Benefits for Startups regarding IPR:

1. 1. Patent applications and facilitation helpline will be speedily available.
   2. The entire fees of the facilitators for any number of patents, trademarks or designs that a startup may file shall be taken up by the Central government and the cost of the statutory fees shall be paid by the startup.

Startups shall be provided with an 80% rebate in the filing of patents.

Government Scheme for MSMEs– Support for International Patent Protection in E&IT (SIP-EIT) Scheme

This scheme of the Government of India provides financial support to MSMEs and technology startups for international patent filing. The reimbursement limit provided in it has been set to a maximum of INR 15 lakhs per invention or 50% of the total charges incurred in filing and processing a patent application, (the lesser of the two). This scheme can be availed at any stage of international patent filing by the applicant. The reimbursement, however, will only apply to expenditures incurred from the date of acceptance of a complete application by DeiTY which has to be approved by a competent authority.

Conclusion

Today, several entities derive most of their income from their IP assets and thus enforce the importance of IP and the need for a more enabling taxing regimen. In India, the current economy is witnessing rapid growth in micro and small sector enterprises with great abilities to compete at a global level. Most of these enterprises do not protect their intellectual property due to several reasons such as lack of awareness, lack of funds, exhaustive procedures etc. and are not well equipped to take their businesses to the next level. Awareness of tax planning and a supplementing taxing regimen is the way forward to make a win-win situation for both the Government and the competing parties.

By: Aryashree Kunhambu, Shri Dharmasthala Manjunatheshwara Law College, Mangalore.

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Patent Assignment

Jul 24, 2011 | IP Audit, IP Policy, IP Valuation, Monetization, Patent

A patent assignment is an act by the patent owner in which the patent owner permanently transfers the patent’s exclusive rights to third party (Assignee). This transfer of rights is documented in the official patent record. In a patent assignment, the assignee must pay the assignor a consolidated amount and can collect profits from the patented invention subsequently. This qualifies as a consideration.

Patent licensing allows for the creation of value from innovation as well as the advancement of certain other strategic corporate objectives. Bilateral licensing transactions are the hallmark of the ‘traditional’ patent-licensing industry. It is moreover characterized by consequential transaction costs borne by the parties and information asymmetries that threaten to shrink the market over time. An exclusive license encompasses all of the patent’s rights licensee receives except the title. In this instance, the licensee enjoys the same rights as the patent owner, with the exception of the ability to transfer the patent to another individual or company. This restriction exists simply because even though the agreement allows the rights to be transferred; the patent owner retains ownership of the title.

The rights in lieu of the license agreement are predominately granted to the licensee and in accordance to the terms of the said agreement cannot be transferred further. Ergo, patent licensing is only for a limited term, when the license period ends, the owner reclaims his exclusive rights to his invention.

Professor David Teece asserted in an unconventional paper[1] that the ability to construct value from invention was dependent on interrelate assets like marketing, production, and after-sales assistance. Innovators frequently lack direct ownership or control over these assets, forcing them to license out the commercialization process.[2] Licensing can also be used to impact market demand and competitiveness. Patents are licensed out to restrict competitors from further conducting research and development.

This article states the various practices involving the re-assignment clarifying the ownership of the Patent Agreements.

Infringement Litigation

The patentee (licensor) has the sole right to sue for infringement under the Indian patent system.[3] The only statutory exceptions are the exclusive license and the licensee to whom a compulsory license has been granted.[4] A non-exclusive licensee is not allowed to sue for infringement in his or her own name.[5]

Preventing a third party from infringing on the patent, on the other hand, serves the interests of both the licensor and the licensee. Unlicensed usage by a third party will result in ULR fees being charged to the licensor. Similarly, the licensee will be concerned about an infringing competitor who has not been subjected to ULR payments, the expressions of the mutual interest. It may be however become problematic as the expenses of contesting the infringement are more than the patentee’s personal returns, (s)he may not be motivated to file the claim.

Patent buyouts

At least two instances during the early nineteenth century, when both patents and prizes were employed to encourage discovery, Governments integrated the patent and prize systems by purchasing patents. Patent buyouts are appealing because they provide the chance to eliminate monopolistic pricing distortions and duplicate research incentives while increasing rewards for innovative research. It’s crucial to investigate how they implemented the patent buyouts in practice.

Patents scarcely incentivize original research owing to the fact that potential inventors will not consider consumer surplus while deciding whether or not to pursue it. By purchasing the patent for Daguerreotype photography and releasing the technique in the public domain in 1839, the French government blended aspects of the patent system and direct government sponsorship of research. Daguerreotype photography was quickly embraced over the world after the patent was bought out, and it underwent significant technical advances. Patent buyouts like these have the capacity to eradicate monopolistic price distortions and inefficient reverse engineering incentives while further stimulating original research. Determining the price is a major difficulty for any patent buyout mechanism.

The government would propose to buy out patents at this private value times a fixed markup that would roughly cover the gap between the social and private value of inventions. Inventors could have the option of selling or preserving their patents. Government-purchased patents are usually released into the public domain.

However, in order to encourage auction participants to be honest about their appraisals, the government would select a few patents at random and sell them to the highest bidder. Encouragement of invention through such a process would necessitate greater discretion from government officials than the current patent system, but somewhat less discretion than that exercised by the National Institutes of Health.

Patents also restrict research by generating excessive motivation to produce alternatives for patented assets while providing too little incentive to develop complements. Firms can steal rents from existing patent holders by producing replacement inventions. The minimal information available implies that this issue could be intense. Mansfield, Schwartz, and Wagner (1981) discovered that 60 percent of patented discoveries were reproduced within four years, with the average imitation cost being two-thirds of the original cost of development. Potential complementary invention developers, conversely, will have insufficient incentive to create these inventions if they must first invest in developing supplementary inventions before negotiating license arrangements with original patent owners [Green and Scotchmer 1982]. Sometimes, due to asymmetric information, agreements between owners of complementary patents are not achieved, and inventions go underutilized.[6]

Grant Back

Many patent license agreements fail to address licensee improvements, allowing the licensee to file improvement patents of their own, potentially rendering the licensor’s technology obsolete or even preventing the licensor from commercializing its own product with the enhancements. By including “grant back” provisions in license agreements, a licensor can ensure that when licensing out patents covering its technology, any improvements by the licensee are granted back to the licensor. A licensor can ensure that when licensing out patents covering its technology, any enhancements made by the licensee are granted back to the licensor by incorporating “grant back” terms in license agreements.

Literature in relation to Employee-Employer Patent Ownership

By omitting to add a “deemed ownership” provision in the Patents Act of 1970, Indian policymakers missed the mark. Section 39 of the UK Patent Act, Section 132 of the Israeli Patent Act, and Section 6 of the Chinese Patent Act have all codified similar provisions. This deeming theory is founded on the “duty to invent” principle, which states that a person who has a duty to invent cannot have a patent registered in his name. This premise is based on the idea that if an employee has exploited the company’s facilities, technological know-how, or resources, the employer should not be barred from the benefits.

As a corollary, an employee who created the invention during his or her “course and scope of employment” is unable to get a patent in his or her own name. In Darius Rutton Kavasmanek v. Gharda Chemicals, the Bombay High Court was introduced this argument of “duty to invent.” The court, however, refused to evaluate the issue since it was an injunction appeal, and it could not opine on the merits of the case. In addition to the “duty to invent” argument, the “shop-right” principle, which originated in the United States, can be used to address the ownership problem. Regrettably, it has yet to be implemented in India. Even if there is no agreement for royalties, shop-right is a non-exclusive and non-transferable license with the employer to use the innovation without paying royalties. Even if the employee, who is the patent owner, sells his interest in the patent, the employer retains his shop-right in the patent under this doctrine.

When global firms are involved in Research and development activities and their inventors are Indian employees, the above-mentioned flaw in Indian patent law is very troublesome. According to Section 39 of the Patents Act, any resident of India who applies for a patent or causes an application for a patent to be filed in a country outside of India must first obtain authorization from the Controller of Patents.

For instance, a US corporation wishes to submit a patent in the US, but the inventors are Indian employees who live in the country. It might now be argued that the Indian employees, by their patent assignment agreement, have ‘caused’ the patent application to be filed in the United States, necessitating clearance from the Indian Controller of Patents. This is a significant impediment to the employer-company receiving a patent in a timely manner. Such unnecessary delay in an area as dynamic as intellectual property is likely to have an influence on the utilization of resident Indian personnel for invention. Incorporating such a provision that assigns patent ownership to the employer/company, on the other hand, will go a long way toward resolving such issues.

It’s worth noting that the United States Patent Act makes no mention of patent ownership between employers and employees. However, the courts have established a number of precedents that benefit employers“It is feared that if a corporation is denied the advantages of its success, it would cease to subsidize and experiments will go,” the court held in Goodyear Tyres and Rubber Company v. Miller  in the United States. In future judgements, Indian courts could take cognizance of this and set better precedents to potentially enable occlude loopholes in the patent law.

With India’s existing patent ownership framework, the employer bears the threat of not owning the invention despite making significant investments. Employers may be hesitant to invest in research possibilities as a result of this. An equivalent approach in India, as in the United States, the United Kingdom, and other nations, would undoubtedly aid in the resolution of patent ownership disputes between employers and employees.  If the invention was developed using the employer’s resources and during the course of employment, the employer should be given a say in the patent, even if there is no pre-assignment / assignment agreement for the same involving the abovementioned principles.

There clearly is a dilemma revolving the true ownership of the Patents developed under employment and the legal literature of various countries reflect the very same. The question of ownership, however, in India remains with the employer (with the assignment of intellectual property in the course of employment) development during an employment.

There is a certain exception which that outruns the private benefit and focuses on public good.

Compulsory License

Compulsory license occurs when the government grants authorization to any individual or organization to use, sell, or manufacture a patented design or product for the public good, regardless of the patent owner’s wishes. Compulsory licenses are commonly given in the pharmaceutical industry and in products that meet the standards set forth in Section 84 of the Patent Act 1970. On March 9, 2012, Natco Pharma Ltd. received the first compulsory license in India for making a generic version of Nexavar, a patented Bayer Corporation drug.

Compulsory licensing is provided under Chapter XVI of the Patents Act of 1970 as an essential precaution for defending the public interest. Any interested party can request compulsory license after three years if the invention is not fairly available to the general public. The central government has the authority to file an application with the controller, requesting that the controller endorse a patent with the ‘license of right’.

The provision of the central government was repealed by the amendment. Furthermore, required adjustments were made with regard to whether the public requirements were fulfilled, if the innovation is not manufactured in India or if the patentee refuses to accord a license, by removing a presumption that the public’s requirements are fulfilled based on local manufacture. The amendment also granted the controller the authority to issue a forced license in the event of a national emergency. There is also a provision that allows a third party to apply for a compulsory license even though the invention is not manufactured in India. This shift also allows the controller to revoke the compulsory license if the circumstances that led to it cease to exist.

In simple terms, the choice to assign or license is based on the most profitable commercialization route available to the patent holder. And, while making a decision, the advantages of receiving royalties or alternatively receiving a lump sum price, giving away title, or simply surrendering the rights to commercialize the invention in a certain location for a set length of time must always be evaluated against one another. Assignment may occasionally seem more beneficial than licensing.

Regardless of the fact that the law safeguards a patentee’s interests, the patent holder must prepare an appropriate assignment or license agreement to avoid any potential disputes regarding the ownership. Intellectual property rights have only recently come to the attention of the general public. Where industrial property is adequately protected, which in turn raises the country’s economy, a comprehensive understanding of intellectual property rights is vital. The entire legal infrastructure was furnished by the Government of India. Software, traditional knowledge, plant varieties, and geographical indications have all been accorded specific legal provisions. Among these provisions, certain remedies are only available to the owner of the intellectual property; hence the determination of ownership and proper re-assignment becomes vital.

Author: Vinita R. Gaud, Pravin Gandhi College of Law

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[1] David J. Teece, “Profiting from Technological Innovation : Implications for Integration, Collaboration, Licensing and Public Policy”, 15 Research Policy 285 (1986).

[2] Ibid. at 296.

[3] The Patents Act, S. 48 (1970)

[4] Id., S.110

[5] Pravin Anand, T. Saukshamaya & Aditya Gupta, India, in Patent Litigation : Jurisdictional Comparisons 201, 203 [Massimo Sterpi et al. (eds.), 2011]; Suchita Saigal, Parul Kumar & Aditya Verma, Licensing Intellectual Property Rights’ Use, in The Law of Business Contracts in India 92, 96 (Sairam Bhat edn., 2009).

[6] The Quarterly Journal of Economics , Nov., 1998, Vol. 113, No. 4 (Nov., 1998), pp. 1137-1167