New Tax Regime for Intellectual Property and Intangible Assets

The current tax system relating to Intellectual Property (IP) is highly complex. Some IP assets are subject to capital gains rules, whilst others are taxed as income items.

On 1 April 2002, a comprehensive new tax regime is expected to come into place, constituting a major simplification in this area. It should also result in many companies paying less tax. The regime will only apply to companies and aims to align the tax treatment of intangible assets more closely to the existing accounting treatment.

Tax relief will broadly be available for expenditure on the creation, acquisition, enhancement and maintenance of most intangible assets and goodwill. With limited exceptions, the tax relief will match the writeoff for that expenditure in companies' accounts. Receipts for the use of intangible assets (including royalties) and on their disposal will also follow the accounts and be taxed as income.

The new regime will apply to expenditure incurred on and disposal proceeds relating to assets acquired or created after 1 April 2002. Receipts for the use of intangible assets received after that date will also be covered by the new regime, whether or not they relate to assets acquired or created after that date.

Other aspects of the proposals include:

• the ability to elect for a straight line rate of depreciation of 4% a year, even where accounting rules do not allow any depreciation,
• allowing the surrender of excess relief between group companies,
• a new relief allowing profits on the disposal of intangible assets to be reinvested into new intangibles (or, in limited circumstances, into shares in companies) and
• tax neutral status where intangibles are transferred between group companies (but with a related degrouping charge).

Further Details

SCOPE:

The new rules apply to "intangible assets" as that phrase is understood for accounting purposes (see especially FRS10), e.g. goodwill and intellectual property. Intellectual property is defined broadly to include:

• patents,
• trademarks,
• registered designs,
• copyright,
• design rights and
• plant breeders' rights.

Intellectual property also includes any licence in respect of those rights, and any information or technique not specifically covered above but having industrial, commercial or economic value.

Some intangible assets are specifically excluded, e.g.:

• rights arising out of land,
• financial assets, including money debts, financial instruments and insurance contracts/ policies,
• rights in companies/partnerships/trusts, e.g. shares and
• assets not held for a business or commercial purpose.

NEW TAX TREATMENT:

The draft legislation uses the terms credits and debits to describe gains/profits and losses on intangible assets. Broadly, credits and debits on intangible assets are to be treated for tax purposes as income matters, not capital. This will apply to intangible assets previously taxed under rules for capital gains, e.g. goodwill.

Credits cover:

1. profits on the disposal of an intangible asset,
2. revenue from exploiting the intangible asset and
3. in limited circumstances the revaluation of an intangible asset.

Debits cover:

1. expenditure written off as it is incurred (i.e. expenditure on assets not included in the balance sheet which is written off to the profit and loss account as it is incurred) and
2. expenditure on assets included in the balance sheet, amortised over a period of years in line with the accounts, or upon election, on a 4% p.a. fixed rate basis (this is useful for assets of "indefinite economic life" which cannot be amortised in the accounts).

Any excess of debits over credits will be available for relief against other profits of the company or for surrender as group relief in the usual way.

ROLLOVER RELIEF ON RE-INVESTMENT:

When an intangible asset is disposed of, the resulting taxable credit can be deferred by rolling over the credit into expenditure on other intangible assets. The rules for this rollover relief are largely taken from the existing capital gains provisions for rollover relief on reinvestment into business assets (Sections 152-159 - Taxation of Chargeable Gains Act 1992). Some points to note on the application of these rules to intangible assets:

• The intangible asset being disposed of and the new one being acquired must fall within the categories of intangible assets covered by this new legislation.
• The expenditure on the new asset must be incurred in a period extending from 12 months before the disposal of the old asset to three years after.
• Rollover relief will be possible within a group of companies (as defined above).
• For part disposals to qualify, they must be genuine disposals rather than the ordinary exploitation of the asset in question.
• A credit can also be rolled over into the acquisition of at least 75% of the shares in a company that has intangible assets already attracting relief under the new rules.
• This rollover relief will be available for all disposals after 1 April 2002, whenever the asset was acquired or created.

GROUPS OF COMPANIES:

Where intangible assets are transferred between members of a group, this will be on a tax neutral basis. There will be no credit/debit for the group companies involved, and the acquiring company will inherit the tax position of the disposing company in relation to the asset. A de-grouping charge will occur in the acquiring company if within six years of such a transfer, the group relationship between the acquiring and disposing companies is broken.

Group is defined in the same way as for capital gains, i.e. broadly a 75% shareholding between parent and direct subsidiary, with an effective 51% indirect shareholding relationship between the group parent and any indirect subsidiaries.

The de-grouping charge will be capable of allocation, upon election, to another group company.

ANTI-AVOIDANCE:

Rules will prevent the artificial reduction of asset values, for instance in order to accelerate amortisation deductions, or to depress taxable proceeds on a disposal to a related party.

There will be an exit charge which will apply where a company with intangible assets changes its tax residence, so that the assets no longer remain within the charge to UK corporation tax.

It will not be possible to bring an asset within the new rules by acquiring it from a related party.

HOW WE CAN HELP?

Wragge & Co's Corporate Tax Team, with ten experienced legal experts, is a national leader. The team has expertise in many areas including the tax aspects of the licensing and transfer of intangible assets, cross-border transactions and group restructuring.

Our Intellectual Property Group is the third largest IP team in the UK. With dedicated specialist teams in Birmingham and London, we offer strength in depth in the areas of biotechnology/pharmaceuticals, brands/trade marks, Internet policing, media and franchising.

This briefing note contains information of general interest about current legal issues, but does not give legal advice. For more information about the topic covered in this note, please contact one of the specialists below.

Corporate Tax

Andrew Noble or tel: +44(0)121 685 2945 Kevin Lowe or tel: +44(0)121 685 2779

Intellectual Property

Gordon Harris or tel: +44(0)121 265 2200

January 2002