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 –
- 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.
- 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.
- 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:
- any right, property or information used or services utilized outside India or
- To make or earn any income from any source outside India.
Royalty income is taxable for a non-resident in respect of –
- any right, property or information used or services utilized in India or
- 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:
- 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;
- 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;
- The use of any invention, patent, secret formula or process, model, design, trademark or similar property;
- 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].)
- 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.
- 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]
- When the consideration is paid in a lump sum, the depreciation over the acquired patent and copyrights shall be claimed over a period;
- 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]–
- 1/6th of the amount paid shall be deducted while calculating the profits and gains of the business for the previous year;
- 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]
- 40% for the assessment year beginning on the 1st April 2001,
- 30% for the assessment year beginning on the 1st April 2002,
- 20% for the assessment year beginning on the 1st April 2003,
- 10% for the assessment year beginning on the 1st April 2004,
- 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 –
- Dictionary
- Thesaurus
- Encyclopedia,
- 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
- 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 –
- The patentee should be an eligible Indian taxpayer,
- 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 –
- The entity should be a recognized startup,
- 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 –
- The entity should be a DPIIT recognized startup
- 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:
-
- Patent applications and facilitation helpline will be speedily available.
- 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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