TAX ASPECTS OF TECHNOLOGY TRANSACTIONS

Transcription

1 TAX ASPECTS OF TECHNOLOGY TRANSACTIONS Roger Royse Royse Law Firm, PC 2600 El Camino Real, Suite 110 Palo Alto, CA Skype: roger.royse IRS Circular 230 Disclosure: To ensure compliance with the requirements imposed by the IRS, we inform you that any tax advice contained in this communication, including any attachment to this communication, is not intended or written 1 penalties under the Internal Revenue to be used, and cannot be used, by any taxpayer for the purpose of (1) avoiding BAYTL February 2, 2011

2 TAX OBJECTIVES Exploit Rate Differentials Defer, Defer, Defer (Then Die) Avoidance (Exemption or Non recognition) 2

3 OVERVIEW 1. Technology Transfers 2. Entity Formation 2. R&D Partnerships 3. IP Holding Companies 4. Foreign Structures 5. Litigation Recoveries 6. New Developments 3

4 SALE vs. LICENSE (15% vs. 35%) Sale: All Substantial Rights Capital gains No Personal holding company income Section 197 Amortization License: No transfer of All Substantial Rights Ordinary income Ordinary deduction 4

5 INCORPORATION / FORMATION ISSUES Technology Services StartUp Company Cash 5

6 SECTIONS 721 AND % or 35% vs. 0% Non-recognition requires a transfer of property IRS requires transfer of All Substantial Rights Case law is more lenient: United States v. Stafford, 727 F.2d 1043 (11th Cir. 1984) contribution of letter of intent held to be property E.I. DuPont de Nemours v. United States, 471 F.2d 1211 (Ct. Cl. 1973) grant of non-exclusive patent rights 6

7 ALL SUBSTANTIAL RIGHTS Inventor Company Buyer Company Transfer of All Substantial Rights? Generally, no, if: Use of the patent limited geographically within the country of issuance Time period of less than the remaining life of the patent Limited to specific trades or industries Rights that are less than all the rights covered by the patent (prior transfers) Limit on further sublicensing Grant of less than all the claims or inventions covered by the patent Retention of a right to terminate the transfer at will or on condition subsequent 7

8 CAPITAL GAIN UNDER SECTION 1235 Allows patent holder to obtain long-term capital gains treatment regardless of holding period, the method of payment, and the status of the inventor as a professional; could potentially apply to trade secrets or other patentable know-how Requirements Available to holders meaning either the individual who (1) created the patent or (2) acquired an interest therein prior to reduction to practice; look-through for LLC ownership Must transfer all substantial rights Patent means a patent granted under domestic law, or any foreign patent granting rights generally similar to those under a United States patent; not necessary that patent or application be filed Not available in (1) transfers8 to related parties (25%

9 TAX ISSUES STARTUP, INC. Code Section 83 Option Grant Sale for Partially Recourse Note Stock Grant Code Sections 351/721 Stock/Capital for Property License In 9

10 LLC PROFITS INTEREST Under Rev. Proc , the receipt of a profits interest is generally not a taxable event for the partner or the partnership. A member has a capital interest if he or she has a share of unrealized appreciation in the partnership's assets. In Rev. Proc , the IRS stated that it would not tax the employee or the partnership on grant of a non-vested profits interest. 10

11 PARTNERSHIP EQUITY TRANSFERS FOR SERVICES Proposed Regulations published May 24, 2005 Rev. Proc and Rev. Proc Will Be Obsoleted Section 83 Applies to Profits Interest Section 83(b) Election Required for Unvested Profits Interest Partnership Deduction in Year of Employee s Income Inclusion Partnership Recognizes No Income on Capital Shift Safe Harbor Election Forfeiture Allocations Required Effective When Finalized 11

12 TRADEMARKS Acquisition Costs Expenses to develop trademark must be capitalized No depreciable life Section 195 (startup costs) does not apply Section year amortization Contingent or periodic payments deductible Income from Disposition Receipt of amounts contingent on productivity, use or disposition are noncapital Retention of any significant power, right or continuing interest (quality control) results in ordinary income 12

13 COPYRIGHT Costs Revenues Most copyright costs must be capitalized (no current deduction) Subject to depreciation 195 Startup expenses Inventory costs Software may be depreciated over 36 months Capital Asset does not include copyright held by person whose personal efforts created it or to whom it was assigned in a carryover basis transaction Personal efforts of corporation? Inventory Software as franchise 13

14 PATENTS Deduction of R&D Expenses under 174 Section 41 Credits Capitalize and Amortize 1235 Capital Gains Available to Holders Inventor Obtained an interest in the invention before reduction to practice 14

15 TRADE SECRETS AND KNOW HOW Section 1235 applies to potentially patentable trade secrets Treatment as Property Transfer of all substantial rights No retained rights to use 15 15

16 SOFTWARE: PATENT OR COPYRIGHT Copyright Patent Not Capital Asset in hands of Creator One year capital gains holding period Sale by Holder qualifies for capital gain transaction 1235 instant capital gains 16

17 SOFTWARE Right to copy Transfer of copyright right Transfer other than sale or royalty right to copy Sale or rent Produced for Services purchaser 17

18 PERSONAL HOLDING COMPANY INCOME Personal Holding Company More than 50% owned by 5 or fewer individuals 60% of adjusted ordinary gross income is PHCI If PHCI exceeds 25% of gross income, corporate level tax on excess net passive income S election can terminate if excess passive income for 3 consecutive years Personal Holding Company Income Includes patent royalties Copyright royalties are excluded from PHCI if they are more than half of gross income and the company has little other PHCI Exception for active computer software royalties Subchapter S passive income for S corps with former C corporation E&P 15% penalty tax for undistributed PHCI 18

19 BUSTED 351 Shareholders Inventor Patent OldCo, Inc. OldCo wants Inventor s patent for restricted stock Inventor wants OldCo Stock Can t do a 351 because of 80% requirement 19

20 TAX FREE REORGANIZATION StartUp LLC Merger INCORPORATED 20 Acquiring Corporation

21 TAX ISSUES STARTUP, INC. Shareholders Inventor OldCo Stock OldCo, Inc. Stock Patent Merger NewCo, Inc. Step Transaction - sale Continuity of Business 21

22 WITHHOLDING 30% on US Source royalties Lower Treaty Rates Characterization of payment Fees or Royalty Software Regulations 22

23 Regulations Computer programs Sales Licenses Leases Services Know-how 23

24 367(d) SUPER-ROYALTY Section 351 does not apply to transfers of Intangible Property to foreign corporation Transfer of IP treated as sale for contingent payments Commensurate with income from the IP US Parent IP Transfer Stock IP Holding Co. 24

25 TRANSFER PRICING Under Code section 482, the IRS can re-allocate income among "controlled" entities to properly reflect income. The prices charged between related parties ( transfer prices ) are required to be arm's length prices. Substantial penalties for understatements of US tax due to transfer pricing adjustments 20% or 40% of the underpaid taxes, depending on the size of the understatement. Penalty may be avoided if taxpayer has adequate documentation supporting its transfer prices (i.e. a transfer price study) 25

26 COST SHARING US Company Split ownership of Intangibles Share costs and exploitation rights No Intercompany Royalty Buy In Payment Can migrate intangibles to Low tax country Ownership Of Intangibles Foreign Operations Company Current Problems: Nonexclusive Technology reverts on termination Capital Technology Distribution Network 26

27 EFFECTIVELY CONNECTED INCOME Foreign corporations are taxable on income that is effectively connected with a US trade or business Income attributable to a US office or other fixed place of business A U.S. trade or business can be carried on through an agent A foreign corporation's "independent" agent will not constitute a US office but a dependant agent might. The office of a dependant agent is disregarded unless the agent has and regularly exercises the authority to conclude contracts in the name of the foreign company or has a stock of goods belonging to the foreign company from which orders are regularly filled on behalf of the foreign company. 27 Foreign Corporation US PE

28 SUBPART F US shareholder of CFC is taxed directly on pro rata share of CFC's Subpart F income. Foreign corporation is CFC if more than 50% of its stock, by vote or value, is held by U.S. shareholders at any time during the year. 28

29 PASSIVE FOREIGN INVESTMENT COMPANIES (PFIC) Income Test: 75% of gross income is passive Asset Test: 50% of assets produce passive income Interest charge on "excess distributions" from PFICs QEF Election 29

30 SUBPART F - EXAMPLE Subpart F income includes royalties, except royalties derived in the active conduct of a trade or business if received from a person who is not a related person. US Co 100% Tax Haven Company Technology Ownership 100% Royalty License Base Company Manufacturing and Sales Cash or Property Ownership 30

31 FOREIGN BASE COMPANY SALES INCOME Subpart F income includes Income from sales of goods when CFC purchases goods and either sells them to, or buys them from, a related party Same country exception US Co 100% Tax Haven Company Sales 100% Base Company Manufacturing Sales Cash or Property Ownership 31

32 BRANCH RULE Subpart F Income includes sales income if a related person is the seller or buyer Exception for income from sales of goods manufactured or produced by the CFC Manufacturing branches treated as separate corporations if located outside the country of incorporation, and the effective rate of tax on non-branch income is less than the lesser of (i) 90% of rate of country of manufacturing, or (ii) a rate 5 percentage points below country of manufacture rate. US Co 100% Tax Haven Company Sales Branch 32 Manufacturing Branch

33 CONTRACT MANUFACTURER STRUCTURE Founder Optionees Preferred Shareholder Ashland Oil v. CIR Vetco Inc. v. CIR US Sales US Co Rev. Rul Contract Manufacturer is not a branch 100% Local Distributors Cash or Property Ownership Products Contract R&D Service Fees Tax Haven Company Are activities of contract manufacturer attributed to tax haven company? Service Fees Contract Manufacturing Technology Ownership 33 [PRC] Manufacturer

34 INTERNATIONAL E-COMMERCE OPERATIONS US Company Cost Sharing License International Holding Company Deemed Sale Customer Fees/Sales Royalties Server Company License/Royalty Commission/Fees 34 Local Country Company

35 SALES TAX R&D Contracts nontaxable under true object of the contract test Navistar v. SBE sale of drawings and manuals were taxable Transfer via Remote Telecommunication Custom made software: Reg. 1502(f) (2) Publishers Exemption: Reg. 1502(f)(1) (B) 35

36 STATE TAX ISSUES California Parent Employees Admin, legal and commercial Registrations, enforcement R&D, commercialization IP Transfer License Back Nevada IP Holding Co. Services Income 36

37 ASSOCIATED PATENTEES CHARACTER CONVERTER R&D Partnershi p Sale of Patent Contingent Payments Developer Corporatio n ssociated Patentees, Inc.: current deduction for payments based o atent s use or production 37

38 R&D PARTNERSHIPS LDL Research & Development II, Ltd. Partnership had no real prospect of exploiting technology Developer relied on to conduct technology business Only possibility that partnership would ever act Kantor v. CIR Partnership must have realistic possibility of entering its own business Prospect of entering business must be shown at time of expenditure Option to acquire exclusive rights for nominal sum Lack of Capability to enter business Scoggins v. CIR Developer had significant cost option to acquire IP Partnership was capable of developing business if developer did not 38

39 R&D PARTNERSHIPS SCOGGINS PARTNERSHIP Investors Inventor Partnershi p or LLC Sharehold ers Non-Exclusive License Option to Buy Tax Advantaged Structure R&D Deductions Capital Gain Treatment Bankruptcy Remote Partnership Liability Protection 39 Operating Corporatio n

40 IP HOLDING COMPANY STRUCTURES Optionees US Sales Founder US Compan y Products FOREIG N COMPA NY HOLDS IP Contract R&D Service Fees 100% Local Distributors Preferred Shareholder Tax Haven Company w/ Technology 40 Service Fees Contract Manufacturing [PRC] Manufacturer

41 IP HOLDING COMPANY STRUCTURES US Company US Sales Local Distributors Contract R&D Product sales Technology License 100% 100% Tax Haven Products Local Sales Service Fees DOMEST IC COMPA NY HOLDS IP Manufacturer 41 Contract Manufacturing (or License)

42 Litigation Recoveries Payor deduction vs. capitalized Recipient ordinary vs. cap gains vs. capital recovery Origin of the Claim Test State Tax issues related to venue 42

43 CLIENT PARTNERSHIP WITH ATTORNEY Inventor Attorney Infringement Claims Legal Services Patent Infringement LLC Litigation Proceeds Defendan t Generally, legal expense deduction limited by (1) 2% floor on AGI, (2) alternative minimum tax and (3) itemized deduction phase out Structuring the relationship as a client-attorney partnership may eliminate the client s tax on the portion paid to the attorney; in a partnership, the client s gross income will not include legal expenses Can be useful in prosecution of patent infringement 43 claims

44 CLIENT PARTNERSHIP WITH ATTORNEY Partnership Formalities An Agreement; Conduct of the parties in execution of its provisions; Statements of the parties; Testimony of disinterested persons; Relationship of the parties; Respective abilities and capital contributions of the parties; Actual control of income and purposes for which it is used; and Other facts showing the true intent of the parties (file partnership return). Other Issues Federal tax law determines existence of partnership (not State) State rules of professional conduct (conflicts, partnership with non-attorney) Control of the case 44

45 Section 409A Issue Section 409A Issue IP transfer distinguished from services agreement Boulez v. Comr., 83 T.C. 584 (1984). Ownership rights are essential in a transfer of IP. 45

46 NEW DEVELOPMENTS 2010 Small Business Jobs Act September 27, 2010, President Obama signed into law the Small Business Jobs Act of The Act doubled the Section 179 immediate deduction for certain new property placed in service during 2010 and The Act provides for 50% bonus depreciation on new MACRS property with a recovery period of 20 years or less (and certain computer software) placed into service in The Act increased the capital gain exclusion to 100% on the sale of qualified small business stock acquired between Sept. 27 and the end of

47 NEW DEVELOPMENTS 2010 Tax Extender Bill December 17, 2010, President Obama signed into law the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 The Act reduced the Section 179 immediate deduction for certain new property placed in service during 2012 and subsequent years. The Act provides for 100% bonus depreciation on new MACRS property with a recovery period of 20 years or less (and certain computer software) placed into service in the end of 2010 and through 2011, which rate goes back down to 50% for The Act extended the capital gain exclusion to 100% on the sale of qualified small business stock acquired during The Act extended the Research Credit through

48 NEW DEVELOPMENTS IRS Uncertain Tax Positions December 17, 2010, the IRS released final regulations (T.D. 9510) that allow the IRS to require that certain taxpayers file a schedule disclosing uncertain tax positions with their tax returns. The filing requirement will apply to taxpayers based on their asset values, as follows: 2010 larger taxpayers (assets in excess of $100 M); 2012 medium taxpayers (assets in excess of $50 MM); 2014 smaller taxpayers (assets in excess of $10 MM). The IRS disclosure requirement is similar to the disclosure requirement under Financial Accounting Standards (FIN 48). Disclosures will be detailed, and will contain (i) ranking of size of uncertain positions, (ii) the Code 48

49 NEW DEVELOPMENTS Codification of Economic Substance Doctrine Codified as a part of the Health Care and Education Reconciliation Act (P.L ), signed March 30, Immediately effective. Clarifies doctrine s requirements that (1) the transaction changes in a meaningful way (apart from Federal income tax effects) the taxpayer's economic position, and (2) the taxpayer has a substantial purpose (apart from Federal income tax effects) for entering into such transaction. Not meant to change circumstances in which doctrine is applied. 49

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