Licensing Companies And Intangibles

A Licensing Company is a type of offshore company that involves intangible property and the licensing of its use. It involves a variety of issues relating to country disparity. This use of the offshore situs usually is a result of a particular foreign situs imposing withholding tax upon royalty income and is not treaty accommodating. Also, one may find peculiar foreign situs rules that effect the disposition of industrial property rights.

Licensing Companies seek International Financial Centers that provide more reliable substantive judicial systems to protect intangible and substantive rights, as compared to a country situs of licensing use. Licensing Companies also provide flexibility. The flexibility lies in the contracting for rights to use in different foreign locations. The issues of Subpart F Income, source of income concepts, and arm’s length pricing of related parties are the focus of structural planning.

Intangible Transfers

Of particular importance to the use of Offshore Financial Centers is the treatment provided intangible property upon transfers that exit the United States. Intangible property for the purpose of Section 367, which governs exit taxation consequences, has its own definition. This is generally such intangible property as patent, invention, formula, process, design, pattern, know-how, copyright, literary, musical or artistic comp ositions, franchise, license and such other similar characterizations. In this regard there has been an additional development of the concept that what constitutes intangible property may be splintered so as to change its characterization.

Property for purposes of Section 367 is only deemed to be an intangible transfer if all substantial rights in the transferred intangible are granted exclusively and in perpetuity to a transferee. Thus what is determined to be property for statutory purposes can be altered by exclusive and non-exclusive contractual agreements as well as by establishing limiting durations of use.

What is perceived as property when appropriate state law impacts a transaction has become of particular importance. To date, these differences are occasioned by interpretations of substantive state law upon contract rights that are derived within the structuring of the licensing agreements. The point at which contract rights transmute to property and are included as intangible property for purposes of Section 367 has been the focus of several case interpretations. Quality draftsmanship of licensing agreements can alter the tax treatment and is an essential planning concept to be applied.

A transfer of intangible property by a United States person to a foreign corporation that is not a related person is treated as a taxable transaction and taxable at the time of transfer. Section 367 governs, but a separate subsection defines, intangible property. A United States transferor upon the transfer of an intangible to a related party is deemed to receive annual payments, which are contingent upon the productivity or use of the intangible property that is the subject of the transfer.

A United States transferor is required to include in gross income, annually over the useful life of the property, the amount that represents arms length charges for the use of the property. This arms length deemed payment shall be an amount that is an appropriate charge determined in accordance with the principles of Section 482 of the Code. This deemed receipt of gross income to the transferor is to be treated as foreign source income to the same extent that an actual royalty payment would be considered to be foreign sourced income.

The foreign source income characterization is a change from previous law that deemed it ordinary income from sources within the United States. This was a change occasioned by the Taxpayer Relief Act of 1997. The change now provides an opportunity to avail some relief to the taxpayer with respect to foreign tax credit limitation provided by formula.

The timing of the realization and recognition of gain of a transferor makes a distinction between related and unrelated transferees. A transfer that is made to a related person requires the consideration paid on transfer to a transferee be deemed a licensed payment. On the other hand, if a transfer is made to an unrelated person, gain must be recognized immediately. This same distinction is made with respect to subsequent disposition by corporate transferees.

Treating Transfers of Intangible Assets as a Sale

An alternative in financial planning and the transfer of intangible property is the ability to make an election to treat the transfer as a sale. A United States person may elect to treat a transfer of intangible property to a foreign corporation as a taxable event at the time of transfer. It is contingent upon certain conditions. The intangible property is required to be an operating intangible, or the transfer is legally required by the foreign government in which the transferee has been organized and is a condition of doing business in that country.

In the alternative, a United States person may transfer the intangible property to a foreign corporation within three months of its incorporation as a part of the original capitalization process. Immediately subsequent to this qualifying transfer, the United States person must own at least forty percent but less than sixty percent of the total voting power and the value of the stock of the transferee corporation. Additionally, as a condition of electing to recognize gain on the transfer, subsequent to the transfer a minimum of forty percent of the total voting power and total value of the stock on the transferee foreign corporation is required to be owned by a foreign person that is unrelated to the United States transferor.

The intangible property transferred in this recognition alternative is required to constitute a minimum of fifty percent of the fair market value of the property that is transferred to the foreign corporation. Such transferred intangible property must be used in the active conduct of a trade or business that is deemed to be outside of the United States. It cannot be used in connection with the manufacture or sale of products in or for the use of consumption in the United States in conducting a foreign situs trade or business.

Finally, with respect to the factors that are injected into the decision of whether to make an election to treat a transfer as a sale, an emphasis on the economic substance should be a governing consideration. The terms of a sale or license agreement which is made to a foreign corporation are required to be structured with economic reality to avoid the transaction being deemed a sham or lacking economic substance. A sale will be scrutinized in this regard not only with respect to the nominal terms of the agreement but also to the actual practice of the parties under that agreement.

In accordance with Circular 230 Disclosure

William Richards is a Sole Practitioner in Orlando, Florida, USA 32626. Attorney at Law, Legal Advisor. 1978 – Present

PUBLICATIONS: International Financial Centers, Adell Financial Series, AD Adell Publishing, Copyright 2012, 378 pages. The Handbook of Offshore Financial Centers, Adell Financial Series, AD Adell Publishing, Copyright 2004, 266 pages; Offshore Financial Centers and Tax Havens, Archives of Tulane Law Library, Tulane Law School, Tulane University, New Orleans, Louisiana, Copyright, 1996, 512 Pages.

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