Make the most of your intellectual property
Please note that tax and commercial law are complex subject and you should not rely on this article without professional advice on the facts of your case.
Intellectual property (“IP”) is often overlooked when assessing the value of a business. In fact it often does not appear on companies’ balance sheets. This is because many businesses do not appreciate the value of the IP they have. Examples of the IP which most small and medium-sized businesses will have are know-how and commercial processes, websites and sometimes registered IP in the form of patents and trade marks. IP can be valuable but often they are not shown on the balance sheet.
Intellectual property, if exploited well, could become worth more than the company itself. Take Coca-Cola as an example, the brand is worth more than the value of all their bottling plants and sites worldwide.
Valuation of the Intellectual Property
Firstly, you should obtain a valuation of the IP you own. Whilst it can be difficult to assess, there are many companies, which specialise in valuing intangible assets such as IP who can assist you. It is advisable to have this done because the UK Revenue is unlikely to challenge the value of the IP if it has been assessed by professionals.
Once you have obtained a valuation, you can make a decision on your next move. Ultimately, any moves to protecting and exploiting the IP will incur you fees, whether it be legal or administrative. So you must ensure that the value of the IP justifies these costs.
Making the most of the intellectual property
One method of exploiting your IP is to transfer them to a company whose object is specifically to manage this kind of property. The role of this IP management company can involve licensing out the rights, enforcing protection of the rights, maintaining registration and policing infringements. This can be particularly helpful when the operating company is seeking to expand internationally, creating franchises etc. and this can also have added tax benefits. In order to authenticate such a transfer and avoid any challenges from the UK Revenue, any transfer of the rights should be for market value.
There are many commercial advantages to transferring the IP into a separate company, one of which is that income derived from leasing the rights out is kept separate from the operating company and taxed separately to the profit made from the sales or trades of the operating company. You are not restricted in your choice of jurisdictions where the IP company can be registered. Therefore, if the operating company is making substantial profits then this would reduce the tax liability by choosing a low or no tax jurisdiction.
By keeping the IP separate from the operating company, you will also have the option to retain the IP on the disposal of the business. You could then continue to benefit from IP, which you have worked hard to build, by leasing it to the original operating company, or other companies for a royalty fee. This could provide you with a healthy income.
Furthermore, having such a structure in place could also be attractive to offshore investors, which would add value to the potential sale price. Any offshore investors may also have the added benefit of not having any direct contact with a UK entity.
Protecting the intellectual property
There are other benefits to keeping the IP separate from the operating company. For instance if the operating company experiences financial difficulties, the IP is ring-fenced, not only outside the operating company but also outside the jurisdiction. Any unpaid debt will remain a liability for the operating company but not the IP company. Therefore, it would be possible to dissolve the operating company without affecting the value of the intellectual property rights. It would be prudent to consider a termination clause in any license agreement to provide for events such as liquidation.
The tax consequences
As mentioned above, keeping the IP in a low or no tax jurisdiction should reduce your UK tax liability. However, the transfer of the IP will have an initial increase in UK corporation tax because the disposal will result in a gain. It will be beneficial to consider moving the intellectual property offshore sooner rather than later whilst it is not worth a great deal so to avoid any large gains. Once the IP is offshore it can then be revalued in the light of its contribution to the operating company’
Following the transfer, the operating UK company will no longer own the IP and so it will need to be granted a licence to use the IP for which it will pay a royalty fee. The royalty payments should be deductible for UK corporation tax purposes for the operating company, thereby reducing the UK tax bill in future years. This is the key long term tax benefit. It will be necessary to carry out detailed assessments to determine whether such a transfer will be cost efficient. The costs of running the IP management company will also need to be considered when determining whether the transfer will be cost efficient.
It is vital that the operation of the IP company is commercially realistic because if the UK Revenue considers the entire operation is for the purpose of reducing UK corporation tax exposure i.e. amounts to tax evasion; they may disallow the deduction for the royalty payment.
Choosing the “right” jurisdiction
To ensure that the validity of the transfer is not challenged by UK Revenue, it will be better if the IP company is located in a country which has IP protection which is as good, if not better, than that in the UK. The more favourable the rules to the owner of IP, the more commercially beneficial the structure becomes.
It will be difficult to convince the UK revenue that the transfer is primarily for advancing the IP exploitation if the IP company was located in a country with little IP protection.
Similarly if the IP company has a genuine commercial reason to be in certain jurisdictions and it can be properly considered to be carrying on the management functions, then it should be helpful to locate the company in a country which has a lower corporation tax rate than the UK. In these circumstances, it will be unlikely that the UK revenue will challenge the commerciality of moving the IP offshore.
Examples of low tax jurisdictions are the BVI or Marshall Islands. However, whether a company could properly operate in such a location would be questionable. As such, the whole structure could be open to questioning by the UK Revenue. There would also be further tax considerations to bear in mind other than just corporation tax, notably withholding tax on the royalty payments out of the UK.
The ideal jurisdictions with low corporation tax (as well as the necessary protection) will be those which have a double tax treaty with the UK. The double tax treaty will generally provide for lower, or ideally no, withholding tax becoming due on royalty payments. There are several countries which can tick all these boxes.
Other points to consider
These structures may be viewed as aggressive tax planning by the UK Revenue. Consequently, there are a number of anti-avoidance provisions in UK legislation which seek to prevent tax advantages being gained by these types of transfers. It is essential to bear in mind that although there are potential advantages from a tax perspective, these are only likely to be an add-on to the commercial advantages which can be obtained from holding the IP in one management company.
You will need to carefully measure the benefits, both from a commercial and tax perspective, of moving the IP offshore. As mentioned above, there will be both initial and ongoing costs in running an IP company abroad. You will also need to consider the personnel abroad unless you are considering moving abroad to a lower taxing country.
If your lifestyle permits you to be flexible in terms of relocation then it should be possible to re-locate to a more favourable tax jurisdiction than the UK and take a tax-free salary from the company outside the UK tax net. This is provided you do not carry out any work in the UK. If you were concerned about leaving the operating company in the hands of another, then it is possible to have a supervisory role to allow you a degree of control over the operating company.
Solicitor and Chartered Tax Adviser