Taxation – Patent tax out of date

Every year we hear the cry for tax simplification and every year the system gets more complicated. Case law is cumulative, and statute law becomes ever more extensive as business itself becomes more complex.

The Inland Revenue is consulting on the current system in the context of ‘Innovating for the Future: Investing in Research and Development’, and an obvious consideration is the taxation of intellectual property.

The current rules for patents and know-how bring in capital receipts as income to counter avoidance which pre-dated the taxation of capital gains. The rules relating to trademark licensing and assignment are non-existent, no doubt because trafficking in trademarks used to be prohibited. In the computer age, the distinction between what is patentable and what is copyright, or what is merely protected under the laws of confidentiality or passing off, hardly seems to justify differences in the taxation treatment.

The withholding tax provisions relating to royalties are a joke, as they apply to UK patents. The Netherlands seems to work perfectly well without levying a withholding tax on royalties. Would it be the end of life as we know it if the UK were to do likewise?

We have, after all, complex anti-avoidance provisions recently reinforced, relating to offshore trusts and companies, transfer pricing and controlled foreign companies, to prevent non-commercial exploitation.

Legislation for investment

To encourage investment into UK companies, quoted Eurobond interest is payable gross, and the government has given up levying withholding tax on foreign investment in gilt-edged securities. Perhaps we should take this one step further and forego withholding tax on those areas of intellectual property to which it now applies.

If it was argued that the only way to lower withholding taxes in other countries under double taxation agreements would be to grant dispensation from the tax ourselves, we could legislate to enable withholding taxes to be applied on royalties paid to areas where a double tax treaty reduction is not given.

The UK does not levy a withholding tax on the importation of goods and services including management consultancy, so it is difficult to follow the logic of such a tax on the importation of intellectual property.

So can we look afresh at the taxation of intellectual property and try to make it simpler and more logical?

Most transactions involving such property relate to business activities, and it would not seem unreasonable to include all income from the disposal of any intellectual property rights as trading income, and to allow a deduction for expenditure on intellectual property as a trading expense.

Commercial life variance

Statements of accounting practice these days are mandatory and the expenditure would be written off under the fundamental principle of matching against the income which it generates. This is surely an acceptable method of profit calculation for tax purposes. Capital allowance is singularly ill-suited to intellectual property, as the commercial life of the asset acquired may be vastly different from its theoretical life.

Although a patent may have a fixed life of 20 years, it is often effectively protected by means of supplementary patents long after the initial patent has expired. Conversely, copyright may, in theory, extend to 70 years after the death of the author, but the commercial life of a pop song may be measured in weeks if not days.

Where expenditure on development is incurred, but no income has arisen, it would either be written off as part of the profits of a larger trade, carried forward or set against other profits under group-relief provisions.

Can we actually encourage innovation by an innovative approach to the taxation of intellectual property income? Who knows, if such proposals were written in newspeak we might even be able to understand both the applicable law and the taxation concepts, which would indeed be innovative.

Nigel Eastaway of TaxServe is chairman of the technical committee of the Chartered Institute of Taxation

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