Capital or revenue?
The decision confirms that the treatment of receipts from IP assets is not significantly different to that of receipts from other assets; where there is a significant reduction in value of an asset as a result of a transaction, that transaction is likely to be viewed as a capital transaction and any receipt will be a capital receipt. In this case, the grant of a 5 year licence over the IP asset was held to constitute a significant reduction in value of that IP asset.
The capital/revenue distinction is less important for companies without capital losses as the tax rate is the same – it matters more to individuals, who pay different rates of tax on capital and revenue receipts.
One useful point that arises from the judgement is the confirmation that, simply because a payment arrangement is not typical for that type of transaction, it does not necessarily affect the tax treatment – HMRC had argued that trademark licensing arrangements are usually based on periodic payments, not a lump sum, and that the lump sum here simply relieved the subsidiaries of having to pay periodic payments. As such, they argued that the lump sum should be regarded as revenue. The judgment noted that this was not how the transaction was structured – the lump sum was not based on royalties, or any use of the IP assets, and the fact that this was atypical was not "of much significance".
Creating IP - licences and other implications
The tax rules for company IP assets depend on whether the asset was created or acquired before or on/after 1 April 2002 – the rules for post-1 April 2002 assets are more generous and so there are rules to stop related parties getting benefits by transferring IP assets between themselves. Basically, you can't turn a pre-1 April 2002 asset into a post-1 April 2002 asset by transferring it from one related party to another.
Unfortunately, the related parties rules don't really take licences into accounts – in this case, the parties tried to create post-1 April 2002 assets by creating licences from the trademarks. Licences are qualifying IP assets within the tax rules.
The judgement accepts that the licences of the trademarks were created after 1 April 2002 but finds that, in this case, there was no expenditure on the creation of the licences after 1 April 2002. The only expenditure in respect of the licences was on their acquisition. If there's no expenditure on creation of an IP asset after 1-April 2002 then it's not a post-1 April 2002 asset, under the tax rules. Even if it's actually created after that date.
As a result, the judgement finds that the licences can't fall within the corporate intangible tax rules because they are acquired from a related party – for the acquirer to get beneficial tax treatment, the IP asset must have been a post-1 April 2002 asset for the related party.
There was no discussion as to creation expenditure in respect of the licences and particularly the legal fees and the management time that are usually involved in the creation of the licenses. It seems unlikely that the licences sprang fully formed from the licensees and the licensor's only involvement was signature – particularly as it's clear from the background facts in the judgement that the licensor's directors were involved in discussions on the matter.
If time and legal fees incurred in creating licences don't count as post-1 April 2002 creation expenditure then there could be an argument that time spent by an author in creating a copyright work equally doesn't count as expenditure on creating an IP asset as copyright can be created without more identifiable expenditure. It's unlikely that HMRC would take the point, but it's arguably a logical conclusion from the judgement.
The decision was fairly clearly signalled by the point (in para 250-251) that there must be some limitation on licences counting as IP assets, otherwise all that would be needed to get around the related party rules would be to licence a pre-1 April 2002 asset, rather than transfer it. It's a pity that the judgement has to be a bit contorted in trying to get to this point – it's a point that should be properly dealt with in legislation.
It should be noted that the decision doesn't affect licences acquired from third parties – all that's required in such cases is that expenditure on acquiring the licence is incurred on/after 1 April 2002: the pre/post-1 April 2002 status of the licence with respect to the licensor doesn't matter.
There's a section in the IP tax rules for companies that effectively denies beneficial treatment if one of the main purposes of a transaction is to get a tax benefit (a mini-general anti abuse rule). The judgement findings here aren't specifically related to IP tax – they have wider implications for other mini-GAARs and the main GAAR that's anticipated in 2013. In particular, the judgement found that:
- it could take the tax adviser's intentions into account in deciding whether a tax advantage was a main purpose, as the taxpayer company directors didn't fully understand the structure
- it could compare the transaction to a hypothetical transaction that achieved the commercial objectives more effectively
It's unlikely that there will be an appeal given that the defeat was on a basic point of IP law, so the IP tax points will stand as obiter dicta for the time being – the main points to note are:
- get the IP law right!
- make sure the taxpayer understands the structure
- trying to get around the rules will probably not be favourably looked upon by the Tribunal