Article by Gwen Souter and Kirsty Cunningham. Gwen Souter is Director of Tax and Kirsty Cunningham is a Tax Manager at Maclay Murray and Spens. This article appeared in the October 2002 issue of Tax Adviser. The Managing Director of a large company may well consider intellectual property its most important asset. . This is increasingly the case as a result of growth in technology companies and the increasing importance of brand names. However, until the changes in Finance Act 2002 (FA 2002) the tax treatment of intangible assets, including intellectual property, varied significantly depending upon the nature of the asset. Patents were eligible for capital allowances which gave rise to an income deduction. Copyrights obtained an income deduction. Trademarks and goodwill attracted capital treatment.
The previous legislation developed in a haphazard fashion over many years. It was complex and ripe for reform. As part of its aim to modernise the tax system, the government started a consultation process in March 1998 on the reform of the tax treatment of intangible assets. Several discussion documents followed with the process finally completed by the inclusion of new legislation in the FA 2002.
The new legislation unifies the tax treatment of intangible fixed assets and is contained in FA 2002, Sch. 29, 30.
The legislation applies to companies only and, in broad terms, it provides that a company’s gains in respect of intangible fixed assets are chargeable to corporation tax as income and its losses obtain tax relief.
What is an intangible asset?
Schedule 29 provides that an intangible asset shall have the same meaning as it has for accounting purposes. This continues the trend in recent years of moving towards an accounts based approach in calculating taxable profits and losses.
The accounting standard which deals specifically with intangible assets is financial reporting standard (FRS) 10 Goodwill and Intangible Assets. It defines intangible assets as non-financial fixed assets that do not have physical substance, but are identifiable and are controlled by the entity through custody and legal rights. The standard provides that purchased goodwill and intangible assets should be capitalised as assets and amortised over a period not exceeding twenty years. This is subject to certain very limited exceptions.
In addition to the adoption of the accounting definition of intangible assets, the legislation also states that references to an intangible asset shall include intellectual property. It further states that intellectual property shall include any patent, trademark, registered design, copyright or design right, ‘know-how’ or licences. Goodwill is specifically brought within the new rules, although this was not the government’s intention at the outset of the consultation process. It should be noted that relief can only be obtained for purchased goodwill. So called ‘consolidation goodwill’ does not qualify for relief, even if it is pushed down to the subsidiary company level.
Certain assets are specifically excluded from the legislation. These include intangible fixed assets that represent a right in relation to land or tangible moveable property, oil licences, shares in a company, rights under a trust, the interest of a partner in a partnership and assets used for non-commercial purposes.
Debits in respect of intangible fixed assets
The legislation provides that debits relating to intangible assets must be brought into account for the purposes of corporation tax. These debits can take the form of:
- expenditure on an intangible fixed asset that is written off as it is incurred; or
- the write down of an intangible fixed asset on an accounting basis; or
- the write down of an intangible fixed asset on a fixed rate basis; or
- the reversal of a previous accounting gain in respect of an intangible fixed asset.
A company may decide not to capitalise its expenditure on an intangible fixed asset and instead to write it off to the profit and loss account in the period that it is incurred. This will give rise to a tax debit under the new rules. If a company does capitalise its expenditure on an intangible fixed asset and amortises that cost over a fixed number of years then the amortisation cost will be allowable for tax purposes. This is a major change from the previous rules which did not allow a deduction for amortisation costs. If the expenditure is capitalised, but not amortised, the company may elect to write down the expenditure at a fixed rate of four per cent.
This means that the tax treatment of the expenditure on the intangible fixed asset should be the same as the accounting treatment. However, this is founded on the expectation that the company will prepare accounts in accordance with generally accepted accounting practice (GAAP). If they do not, the provisions of the schedule will apply as if they had drawn up such accounts.
If the asset giving rise to a debit is held for the purposes of a trade then the debit is treated as an expense of the trade. If debits arise which are classed as ‘non-trading debits’ the company may make a claim to set the loss against the company’s total profits for that period.
Credits in respect of intangible assets
As is the case with debits, the legislation provides that credits relating to intangible assets must be brought into account for the purposes of corporation tax. These credits can take the form of:
- Receipts in respect of intangible fixed assets that are recognised in the profit and loss account as they accrue
- Revaluation of an intangible fixed asset
- Credits recognised for accounting purposes in respect of negative goodwill
- The reversal of previous accounting debits in respect of an intangible fixed asset.
Financial Reporting Standard 10 allows a revaluation of intangible assets in limited circumstances. If an intangible asset has a readily ascertainable market value, it may be revalued to that market value. The credit arising on the revaluation must be brought into account for tax purposes.
If an acquisition made by a company gives rise to negative goodwill, this must be recognised on the company’s balance sheet. Where the associated gain is recognised through the profit and loss account, the credit must be brought into account for tax purposes.
If the asset giving rise to a credit is held for the purposes of a trade then the credit is treated as a receipt of the trade for tax purposes. If ‘non-trading credits’ arise, these will be chargeable to tax under Sch. D, Case VI.
Realisation of intangible fixed assets
An asset is realised whenever it ceases to be recognised in the company’s balance sheet or if there is a reduction in the value of the asset. The realisation of an asset will give rise to either a debit or credit which will be deductible or taxable as outlined below.
If the proceeds of realisation exceed the tax written down value of the asset, then the excess will be chargeable to corporation tax. If the proceeds of realisation are less than the tax written down value, then the amount of the shortfall will be a debit for tax purposes. If there are no proceeds of realisation then the tax written down value will be a debit for tax purposes.
The tax written down value of an asset is defined as the tax cost of the asset less any debits and plus any credits relating to that particular asset.
Despite the fact that any profit on the realisation of an intangible fixed asset will now be taxed as income, not capital, the new legislation provides a roll over relief. If a company disposes of an ‘old asset’ and reinvests the proceeds in ‘new assets’, the company may claim to roll over an element of the proceeds received for the ‘old asset’ against the cost of the ‘new asset’.
The proceeds of the ‘old asset’ must exceed its original cost before a claim can be made i.e. a profit must be made on the realisation of the asset. The ‘old’ and ‘new’ assets must be chargeable intangible assets and the expenditure on the ‘new’ assets must be capitalised for accounting purposes.
The time limit for the acquisition of ‘new’ assets is identical to that under the old roll over provisions in Taxation of Chargeable Gains Act 1992, (TCGA 1992), s. 152(3). A new investment must be made within the period commencing twelve months before and three years after the ‘old’ assets are disposed of.
Relief can be claimed for the amount by which the proceeds of the ‘old asset’ exceed its original cost providing that the qualifying expenditure on the ‘new asset’ is in excess of the proceeds of the old asset.
The effect of the relief is to reduce the proceeds attributable to the sale of the ‘old asset’ and reduce the expenditure on the ‘new asset’ by the amount of relief claimed.
Groups of companies
The legislation contains special provisions which apply to groups of companies. The definition of a group within Sch. 29 is very similar to the definition used for capital gains tax (CGT) purposes.
A group of companies is defined for the purposes of the new legislation as: a company (the principal company of the group) and that company’s 75 per cent subsidiaries as well as the 75 per cent subsidiaries of those subsidiaries.
The group cannot include a member which is not an effective 51 per cent subsidiary of the principal company. A company cannot be a member of more than one group and the group can include non-United Kingdom (UK) resident companies
If an intangible asset is transferred from one member of a group to another member of the same group and the asset will be a chargeable intangible asset for both companies, the transfer is tax-neutral that is the recipient inherits the asset at its tax written down value.
However, a degrouping charge similar to that applied under TCGA 1992, s. 179 will apply if the transferee company leaves the group within six years of the transfer. That company is treated as if it had sold and immediately reacquired the asset at its market value at the date of transfer. It is possible to elect that this charge accrues to a company that remains within the group that the company has just left. The company that is treated as bearing the charge as a result of the election must be UK resident or carrying on a trade in the UK through a branch or agency.
Special provisions for roll over relief apply to groups. If one member of the group disposes of a chargeable intangible asset, roll over relief may be claimed if the new investment is made by another company in the same group. The companies are treated as if they were the same person.
Commencement date and transitional provisions
The new legislation is effective from 1 April 2002 and there are transitional provisions to ensure that it is implemented smoothly.
The new rules will apply to intangible assets acquired or created after 1 April 2002. Assets owned at that date will still be subject to the old regime. However, if the company sells an asset after 1 April 2002, which it owned at 1 April 2002, then roll over relief may be claimed under the new regime. There are anti-avoidance provisions aimed at preventing abuse of the new rules including the conversion of old intangible assets into new intangible assets which can then benefit from the reliefs.
The new rules for intangible assets were introduced following a lengthy consultation process. When combined with the abolition of stamp duty on intellectual property and goodwill and the removal of the requirement for UK companies to deduct basic rate tax from royalty payments made to other UK companies, they support the government’s aim of creating a more straightforward tax framework for companies. They are, therefore, welcomed.
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October 2002 by