PORTFOLIO

Intellectual Property: Acquisition, Development and Ownership (Portfolio 557)

Be a trusted advisor to your clients with Bloomberg BNA Tax Portfolios. In this portfolio, Premier tax experts describe the rules governing U.S. federal income tax treatment of the costs of developing, acquiring and owning patents, copyrights, know-how and trade secrets (referred to generically as “know-how”), and trademarks and trade names, along with a fifth type of intellectual property, computer software, that can be protected as all or a combination of a patent, know-how and copyright. 

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DESCRIPTION

The Intellectual Property: Acquisition, Development and Ownership, No. 557-2nd portfolio describes the rules governing U.S. federal income tax treatment of the costs of developing, acquiring and owning patents, copyrights, know-how and trade secrets (referred to generically as “know-how”), and trademarks and trade names, along with a fifth type of intellectual property, computer software, that can be protected as all or a combination of a patent, know-how and copyright.

The first section of this portfolio contains a description of the foregoing types of intellectual property, including the basis on which each enjoys protection under applicable non-tax law. The second section of the portfolio considers the taxation of technological research and development expenditures, which enjoy special treatment under the Code. The third and final section of the portfolio begins with a description of the statutory framework for the taxation of other development costs as well as acquisition and ownership costs and then considers how this framework applies to each of the foregoing types of intellectual property. Among the sections of the Code discussed in detail in this portfolio are §§41 (relating to the research credit), 162 (relating to deduction of ordinary and necessary business expenses), 165 (relating to abandonment and worthlessness losses), 167 (relating to depreciation), 174 (relating to research and development expenditures), 183 (relating to hobby losses), 197 (relating to amortization) , 212 (relating to deduction of expenses incurred in for-profit activities), 263 (relating to capitalization), 263A (relating to capitalization of certain inventory costs), and 1253 (relating to trademark and trade name payments).


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AUTHORS

Bloomberg BNA Portfolios are written by leading tax professionals who set the standard as leaders in their fields. The Intellectual Property: Acquisition, Development and Ownership portfolio was authored by the following attorneys.

 

HARSHA REDDY, ESQ.

 

Harsha Reddy is a partner in the law firm's Tax practice and is located in the New York office. He represents U.S. and foreign business entities and individuals in the U.S. federal income tax aspects of international transactions; buyers and sellers in asset and stock purchases and sales; individuals and business entities in tax-free mergers and divestitures; corporations in business restructurings; domestic and foreign issuers and underwriters in offerings of various securities; domestic and foreign lenders and borrowers in various types of financings; and businesses in the tax aspects of project finance.

 

He is the author of the treatises “Intellectual Property: Acquisition, Development and Ownership” and “Intellectual Property: Exploitation and Disposition” in the Bloomberg BNA Tax Management Portfolio series.

 

He is also a co-author of the treatise, “Stock Purchases Taxed as Asset Acquisitions - 338,” in the Bloomberg BNA Tax Management Portfolio series.

 

Credentials / B.A., Yale University (1993, magna cum laude, distinction in Economics, Phi Beta Kappa); J.D., Harvard Law School (1996, cum laude); co-author of 788 T.M., Stock Purchases Treated as Asset Acquisitions — Section 338; member of the Tax Management U.S. Advisory Board.


TABLE OF CONTENTS

Detailed Analysis

I. Introduction

A. Overview

B. Capital Gain Treatment to Licensor

II. Research and Experimental Expenditures

A. General

B. Section 174 Deductions

1. What Expenses Qualify

2. In Connection with a Taxpayer's Trade or Business

3. Costs of Research Performed by Others

4. Recapturing Deductions

5. The Election to Expense or Amortize

6. Reasonableness Requirement

C. Amortization Under § 197

1. General

2. Patents and Know–How as § 197 Intangibles

D. Section 41 Credit

E. Passive Loss Limitations Under § 469

III. Patents

A. Overview

B. Substantive U.S. Patent Law

1. The Patent Grant

a. The Patent Application

b. The Issued Patent

2. Reduction to Practice

3. Assignments and Licenses

C. Types of Licenses

D. Professional Inventors

E. Qualifying Under Section 1235

1. Overview

a. Background

b. Section 1235 and Loss Recognition

c. Formalities

d. Exclusivity of Section 1235

2. Definition of a Patent

a. General

b. Options

3. Definition of Transfer

a. Payments to an Employee

(1) General

(2) Shop Rights

b. Successive Transfers

c. Gift, Inheritance, or Devise

4. All Substantial Rights

a. General

b. Transfers that are Limited in Scope

(1) Geographical Limitations

(2) Limits on Duration

(3) Field of Use Fragmentation

(4) All Claims and Inventions

c. Right to Defend Against or to Sue for Infringement

d. Rights Which May Be Substantial

e. Rights Which Are Not Considered Substantial

f. Prior Transfers

g. Right to Terminate

(1) At Will

(2) On Condition Subsequent

h. Retention of a Right to Use

5. Undivided Interests

6. Definition of a Holder

a. General

b. Individuals

(1) Creator of Property

(2) Partners as Inventors

(3) LLC Member as Holder

(4) Trust Beneficiary as Holder

c. Fiduciaries and Personal Representative

d. Financial Backers

e. Related Parties

7. Payments to a Holder

a. Treatment of a Holder

b. Treatment of the Payor

(1) Overview

(2) Payments Outside Section 197

(3) Payments Under Section 197

c. Interest

8. Depreciation of Patent Applications

F. Sales and Exchanges Qualifying Outside Section 1235

1. Section 1221

2. Section 1231

3. Professional Inventors

4. Holding Period

5. What Must Be Transferred

a. Make, Use and Vend

b. Geographical and Field of Use Limitations

c. Duration Limitations

d. Right to Sue for Infringement

e. Prior Transfers

f. Retention of a Right to Make, Use or Vend

6. Undivided Interests

7. Payments

a. Treatment of Payee

b. Interest

c. Payments for Infringement

d. Transfers of Multiple Assets and/or Services

e. Treatment of Payor

(1) Overview

(2) Payments Outside Section 197

(3) Payments Under Section 197

8. Depreciation of Patent Applications

IV. Know–How

A. Definition of Know–How

1. The IRS Position

2. Court Interpretations

3. Payments for Services

4. Unpatented Technology and Computer Software As Trade Secrets

B. Licenses of Know–How

1. Licenses Not Constituting Sales or Exchanges

2. Transfers by Employees

3. Transfers Constituting Sales or Exchanges

a. Capital Asset Status

b. Holding Period

c. What Must Be Transferred

d. Undivided Interests

C. Payments for Know–How

1. Payments for Licenses Not Constituting a Sale

2. Payments for Transfers Constituting a Sale

a. Payee's Treatment

b. Payor's Treatment

(1) Overview

(2) Application of Section 174

(3) Payments Outside Section 197

(4) Payments Under Section 197

V. Foreign Related Transfers

A. Overview

B. Outbound Transactions

1. Non–Sales or Exchanges

a. Personal Holding Companies

b. Foreign Personal Holding Companies Under Prior Law

(1) Controlled Foreign Corporations

(2) Former § 551

2. Sales or Exchanges

a. Controlled Foreign Corporations

b. Section 367(d)

c. Former § 1491

d. Section 1249

C. Inbound Transactions

1. Non–Sales or Exchanges

2. Taxation of Sales or Exchanges

D. Section 482

E. Section 936

VI. Ancillary Considerations

A. Installment Sales - Section 453

B. Imputed Interest - Sections 483 and 1274

C. Gain from the Sale of Depreciable Property Between Certain Related Taxpayers - § 1239

D. Sales or Exchanges to Controlled Partnerships - § 707(b)

E. Assignment of Income Problems

F. Size of Retained Royalty Interest on Sales for Contingent Payments

G. Personal Holding Company Issues - Section 541

1. General

2. Computer Software Payments

H. Certain Computer Software Company Stock

I. Alternative Minimum Tax

J. Charitable Contribution Issues


WORKING PAPERS

Working Papers

Table of Worksheets

Other Resources

Worksheet 1 Assignment of Patent and Assignment of Application.

Worksheet 2 Patent License Checklist.

Worksheet 3 Report of the Senate Committee on Finance to Accompany H.R. 8300 (Internal Revenue Code of 1954), S. Rep. No. 1622, 83d Cong., 2d Sess., 438–441 (1954).

Worksheet 4 Conference Committee Report to Accompany H.R. 3838, (the Tax Reform Act of 1986) , H.R. Rep. No. 841, 99th Cong., 2d Sess., II–68–76 (1986)

Bibliography