Navigating The Tax Implications Of Intellectual Property Rights Transactions

Taxation plays a crucial role in financing public expenditure and supporting a country’s economic growth. In recent years, Intellectual Property (IP) rights have been recognized as a valuable asset that can contribute significantly to a country’s economy. As a result, taxation laws have expanded their scope to include IP rights. The transfer of IP takes place through the means of either assignment or licensing and each with its own set of tax implications. A robust tax regime in relation to IP rights would reflect how the IP regime as a system would thrive in a nation.

Taxability of IP Rights

But before proceeding to the section on deductions and exemptions, let us understand how IP rights, being intangible property, can be taxed. To be taxable, the nature of IP must be defined. Then it becomes easy to decide the deductions, exemptions, depreciation, and other allied provisions. As such, the GST law recognizes IPR as a “good,” but a license to use the same is considered a “service.” At the same time, the permanent transfer of IPR is “good”, and the temporary transfer of the right to use IPR is recognized as a “service”. Various judicial pronouncements, such as Commissioner of Sales Tax v. Duke & Sons (P) Ltd. ((1999) 112 STC 370 (Bom)), A.V. Meiyyappan v. Commissioner (AIR 1969 Mad 284), etc., also recognize patents, copyright, trademarks, and technical know-how as “goods”. It should be noted that GST is only applicable on the transfer of IP rights for temporary use in exchange for a consideration, not on the sale of IP because the owner no longer owns the sold IP rights.

Provisions of IP taxation under the Income Tax Act, 1961

Several Sections deal with the taxation of IP rights under the Income Tax Act, of 1961, such as Sections 32(1) (ii), 35A, 35AB, 80 GGA, 80-O, 80OQA, 80QQB, 80RRB, etc. The Act treats IP as a depreciable asset for the computation of income. 

Section 9(1)(vi) of the Act defines royalty and says that income by way of royalty is taxable. About the transfer of IP, if it is made for a lump sum consideration once and for all, then it falls under the category of capital gains and is taxable.

However, the following are certain exemptions to the above provision wherein royalties are not taxable:

Firstly, the royalty payable in respect of any right, property, or information used or services utilized by a person outside India to carry on business or profession or for any purpose of making or earning income from any source outside India.

Secondly, royalty is a lump sum consideration for any transfer outside India or imparting of information outside India in respect of any data, documentation, drawing, or specification relating to any patent, invention, model, design, secret formula or process, trademark or similar property if it is payable under an agreement made before 1st April 1976 and the same is approved by the Central Government.

Thirdly, a lump sum payment of income through royalty by a resident for the transfer of all rights, including granting of a license in respect of computer software supplied by a non-resident manufacturer, is approved under the policy on Computer Software Export, Software Development, and Training, 1986 of the Government of India.

Fourthly, in respect of patents and copyrights, section 35A of the Income Tax Act, 1961, deals with expenditure on the acquisition of both patents and copyrights. The purchaser is entitled to claim depreciation if they are bought for a lump sum consideration with an enduring benefit. Additionally, deductions are permitted for each of the previous years in an amount equal to the relevant fraction of the total amount divided over 14 years for expenses incurred on the acquisition of patents and copyrights for businesses after 1966 and after 1998. Also, in the case of amalgamation, if the amalgamating company sells or transfers the rights to the amalgamated company being an Indian company, then, in that case, deductions do not apply to the amalgamating company.

Further, by section 35AB, if the assessee acquired know-how for his business in a previous year for which a lump sum consideration was given, one-sixth of the amount so paid shall be deducted in determining the profits and gains of the business for that previous year. The remainder of the amount will be deducted in equal installments over the next five years. In other words, the expense will be deducted in six equal installments over six years.

Income from Copyrights

Deductions on Income from Copyrights is dealt with under Section 80QQA of the Income Tax Act, 1961. It provides that in cases where an author is an individual resident in India, a deduction of 25% is allowed on the income derived by the author in the exercise of his profession in the previous year relevant to the assessment year beginning on April 1, 1980, or to any one of the nine assessment years following the assessment year, or any one of the four assessment years following the assessment year.

However, it is to be noted that no deductions are available in textbooks namely- dictionaries, thesaurus, or encyclopedias. It is also not allowed in books that are prescribed or recommended as a textbook, or included in the curriculum of degree or post-graduate courses.

Royalty on Patents

According to Section 80RRB, on royalties in respect of patents registered on or after the 1st day of April 2003, where the assessee is an individual resident in India, deductions are allowed of an amount equal to the whole of such income or three lakh rupees. In the case of compulsory licensing, the income by way of royalty for deduction shall not exceed the amount of royalty specified under the terms and conditions of the license settled by the Controller under the Patents Act, 1970. Furthermore, section 115BBF provides for a concessional rate of taxation of 10% on royalty income from the exploitation of patents granted under the Patents Act, 1970. To be eligible for this, the eligible taxpayer must be an Indian resident and at least 75% of the expenditure must be incurred in India, provided no other concessional tax rate would be allowed if the same is sought under section 115BBF. Whereas section 80O says that no deductions are to be allowed to income from patents in respect of the assessment year beginning on the 1st day of April 2005, and for the subsequent years.

Intellectual property (IP) holders may benefit from tax-related advantages and deductions that can help reduce their tax liability. These tax provisions may include tax credits, deductions, and other incentives that can be used to offset the costs associated with developing, acquiring, and maintaining IP. To make the most cost-effective use of IP, IP holders need to analyze and understand the various tax provisions that are available to them. This can involve a thorough review of the tax code, consultation with tax experts, and careful planning to ensure that the IP is being utilized in a manner that maximizes tax benefits.

By taking advantage of these tax provisions and carefully managing their IP assets, IP holders can reduce their tax burden and improve their overall financial performance.

Vedant Pujari, Partner

Shashank Raj, Senior Associate

Ritika Reddy, Senior Associate