Tax law

New rules mean tax deductions for some

Taxation of intellectual property, goodwill and other intangible assets for companies

The 2002 Finance Bill will contain detailed provisions dealing with the taxation of intangible assets, bringing their tax treatment into line with their accounting treatment for the purposes of corporation tax only and changing their basic tax treatment from capital to revenue.

Here, the focus is on acquisition of intangible assets, reinvestment relief and group treatment under the new regime.

Under these new rules, companies acquiring intellectual property, goodwill and other intangible assets (such as copyrights, trademarks, know how, domain names and customer lists) on or after 1 April 2002, will be able to claim an immediate tax deduction, broadly in accordance with the accounting treatment of those assets.

Other expenditure by a company on intangible assets, such as research on developing intellectual property, will also be deductible for tax purposes.

(Note, however, that some expenditure may still be capital, and so non-deductible, even though it is written off to revenue in the accounts.) Sales of intangibles will be taken into account in calculating taxable income, but gains may be deferred under reinvestment relief.

An alternative regime, most likely to be relevant for assets with an indefinite economic life, allows companies to elect for tax relief at a fixed, annual rate of 4% of cost on a straight-line basis.

In the case of assets with an indefinite economic life, making such an election will reflect the fact that such assets, unlike items such as goodwill, are not generally amortised in company accounts.

These changes may cause purchasers of intangible assets to delay their purchase until after 1 April, to enjoy the benefits of the new regime.

Currently, there is no immediate tax relief available for expenditure incurred on intangible assets (although relief may be available for research and development expenditure and capital allowances can sometimes be available).

The draft legislation also includes a new reinvestment relief modelled on rollover relief.

Reinvestment relief will allow the deferral of profits on realisation of intangible assets, to the extent that the proceeds of a disposal of those assets are reinvested in replacement assets, which are within the rollover relief code.

The base cost of the replacement assets will be reduced by the amount of the deferred gain, and the usual time limits for rollover relief apply, namely the expenditure on the replacement asset must be incurred between one year before and three years after the disposal of the original asset.

A company may also rollover a profit on the disposal of intangible assets into the acquisition of a company, where the newly acquired company has assets already attracting relief under the new intangibles regime.

The relief will be available where a 75% interest in such a company is acquired and takes the form of an adjustment to the relief being claimed by the newly acquired company; the profit will be deducted from the written down values of the intangible assets owned by the subsidiary at the time of the acquisition.

Broadly, intra-group transactions should be on a tax-neutral basis under the new regime.

The definition of a group is the same as for capital gains purposes.

Intra-group transfers will be on a no gain/no loss basis along the same lines as transfers of capital assets.

However, where intra-group transfers take place other than at book value, special rules apply.

There will be a degrouping charge similar to that for other capital assets.

Where intangible assets have been transferred on a no gain/no loss basis between group companies and the transferee company leaves the group within six years, still owning those assets, a charge will arise.

The intangibles degrouping charge will fall on the degrouping company, but the draft legislation provides for a member of the retained group to elect jointly with the degrouping company for a retained company to meet the charge.

It also contains provisions for any unpaid degrouping charge to be assessed on other members of the retained group.

Generally, this should allow a vendor to ensure that the degrouping charge arises in a member of the retained group.

In addition, the degrouping charge may be deferred by the reinvestment relief mentioned previously.

Now that stamp duty is no longer a concern with transfers of intellectual property (but it is still payable for the acquisition of goodwill generally), an asset acquisition (rather than a share acquisition) looks particularly attractive for a prospective corporate purchaser of intangible assets.

In addition to the benign stamp duty position, the purchaser should be entitled to tax relief on the acquisition cost of the assets.

However, a vendor will still want to sell shares for the traditional reasons (such as avoiding the double tax charges arising that could otherwise arise on an asset sale, for example, the tax on capital gains or capital allowances balancing charges that may arise in the company followed by further tax charges when the profits are actually distributed to shareholders) and also, from 1 April 2002, to benefit from the substantial shareholdings exemption, if available (see [2002] Gazette, 21 February, 33).

In carrying out its due diligence, a purchaser of a company should be aware of the danger that the company it is acquiring may not only be liable for its own degrouping charges but also for the degrouping charges of any companies formerly in its group.

This may cause a target company to have tax liabilities disproportionate to its size.

Tax warranties and the tax deed should be drafted to cover this possibility and to ensure that there is no obligation on the target to enter into any election to take over the degrouping charge of any other company in the retained group.