Royalty or intangible asset - how to protect yourself from additional charges from the tax side?
We often deal with tax disputes concerning the assignment of royalties to the expenses of the taxpayer - fees for the use of intellectual property. Taxpayers state that payments for the use of intellectual property objects do not fall under the definition of “royalty”, which is contained in subparagraph 14.1.229 of paragraph 14.1 of Article 14 of the Tax Code of Ukraine (hereinafter - the TC of Ukraine), which means that it is impossible to attribute such payments to the taxpayer’s expenses. And as a consequence, the report on the tax inspectorate of the taxpayer contains an overestimation of the negative value of the object of taxation on income tax.
Such situation may be familiar to the owners of IT-companies, which pay royalties for the use of software. In this case, due diligence and, in the case of an existing problem, a quick reaction can help avoid additional charges, and therefore additional costs.
Let’s consider examples from our lawyer’s practice and ways out of the situation.
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The core of the case: The position of the tax authorities regarding royalties.
The Client, an IT-company, got the right to use the object of intellectual property (software) under the non-exclusive license, in order to use such a program in the process of providing information services to other users.
In the opinion of tax authorities, the amount of remuneration for the use of intellectual property is not a royalty, but should be capitalized and included in the value of intangible assets created by the company. That is, the company, which received the right to use the intellectual property object, in the understanding of the controlling authority, is the final consumer of such “benefit”, and therefore royalties are not royalties, and cannot be attributed to expenses.
Is this approach correct?
This approach is refuted by the fact that the right to use an intellectual property object does not mean the acquisition of such an object in ownership and therefore the company has every chance to defend its interests in court.
Thus, the right to use a work (and a computer program is exactly a work) and the right to allow the use of the work are property rights to intellectual property, and the powers on them are specified by law (Article 440 of the Civil Code of Ukraine, Article 15 of the Law of Ukraine “On Copyright and Related Rights”).
In the case of the IT-company, it gets non-exclusive rights to allow the use of intellectual property rights and the right to use them (software) solely for the purpose of granting this right to end users.
The company did not get any ownership rights to the software, the company received property rights to intellectual property, namely:
- the right to use the work;
- the exclusive right to allow the use of the work by end users.
That is, a condition for determining the nature of payment for the receipt of a certain intellectual property object is the existence of the relevant rights to such object:
- Copyright to the software - belongs to a person who developed the software or a person who received property rights in whole or in part under a license agreement;
- Ownership rights to the tangible object in which the program is embodied (a copy of the program, recreated on a disk or other media) - belongs to the end user.
Thus, payments for the use of copyright to computer programs, rather than payments for the use of computer programs, are recognized by the tax laws of Ukraine as royalty.
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Legal advice on preventing the situation with additional accrual for an intangible asset
Since in this case the IT-company obtained the right to use intellectual property - that is, it was not the end user of the software - the fee under the license agreement was a royalty, within the meaning of subparagraph 14.1.225. of paragraph 14.1. of Article 14 of the Code.
Therefore, in order to avoid additional charges from regulatory authorities, we recommend you the following:
- The licence agreement should clearly stipulate which intellectual property rights will be obtained as a result of the agreement.
- The licence agreement shall set out in as much detail as possible the amount and procedure for payment of royalties.
- Get individual tax advice on the practical application of the provisions of tax law, which, by virtue of the prescriptions of Articles 52, 53 of the Tax Code of Ukraine, releases the taxpayer from financial liability.
If you want to get information about tax optimization of your business activity or advice on certain taxation issues, don’t hesitate to call us. We will find the best solution for you.