Skattenytt nr 11 2003 s. 776

Tax Treatment of Intangible Assets

1 Introduction

One of the issues which calls out for simplification is the tax treatment of intangible assets. It is a topic which is bizarrely arcane. Experts get lost in it and judges regularly disagree on how to treat it, particularly for tax purposes. Large amounts of money are involved in its valuation. This article discusses in brief the taxation of these important assets in India, a developing country and the US, one of the top industrialized nations of the world. The term ’intangible assets’ is neither defined in the Indian Income Tax Act (IT Act) nor in the US Internal Revenue Code (Code). Only examples such as ’good will’, ’patent rights’ and others are given. The word ’intangible’ is derived from the Latin word ’tangere’ meaning to touch. Intangible assets are wholly ethereal. They cannot be felt and they do not wear out in any physical sense, but they nevertheless have value.

2 Indian Law

In India, the IT Act allows amortization of only three intangible assets, namely,

  1. patent rights or copyrights, and

  2. Know-how, and

  3. Telecom License Fees.

It does not allow amortization of goodwill and many other intangible assets as allowed in the US Code. The provisions in the Indian law may be noted first briefly.

(i) Patents or Copyrights: Section 35A of IT Act.

When a taxpayer incurs any expenditure of a capital nature on the acquisition of patent rights or copyrights, used for the purposes of the business, the said capital expenditure shall be allowed under the IT Act as a deduction in 14 equal installments, beginning with the previous year in which such expenditure is incurred. Where such expenditure is incurred before the commencement of the business the period of 14 previous years shall be reckoned from the previous year beginning with the previous year in which the business is commenced.

The amortization period in the IT Act is 14 years, when the expenditure on acquisition of the patent rights or copyrights is treated as capital expenditure. In that event the claim will have to be decided on merits by the general principles of determination of the nature of an expenditure, discussed in this article later. If the expenditure is found to be appropriately of a revenue nature, it will be deductible in one year, that is, the year in which it is incurred.

(ii) Know-how: Sec. 35AB of the IT Act.

Where a taxpayer has paid in any previous year any lump sum consideration for acquiring know-how for business purposes, the amount so paid shall be deducted under the IT Act in computing the profits and gains of the business, in the following manner:

  1. Where the know-how is indigenously developed in a laboratory, owned of financed by the government, or a laboratory owned by a public sector company, a university established by law or declared by law to be a university, or an institution recognised by the prescribed authority: (Authority as prescribed in rule 5A of IT Rules, 1962 and is the Secretary, Department of Scientific and Industrial Research, Government of India, New Delhi) the deduction shall be allowed in three equal installments beginning with the previous year in which the lump sum payment is made and the two immediately succeeding previous years.

  2. Where the know-how is not indigenously developed as mentioned in (i) above, the deduction shall be allowed in six equal installments beginning with the previous year in which the lump sum payment is made and five immediately succeeding previous years.

For the purposes of above provisions, ’know-how’ means any industrial information or technique likely to assist in the manufacture or processing of goods or in the working of a mine, oil well or other resources of mineral deposits, including the searching for, discovery or testing of deposits, or the winning of access to the deposits.

(iii) Telecom License Fees: Section 35 ABB of the IT Act.

Inorder to give fillip to the telecom sector, in addition to a tax holiday, the Finance Act 1997 inserts a new section 35ABB in the IT Act. The section provides that any capital expenditure incurred and actually paid by an assessee on the acquisition of any right to operate telecom services by obtaining licence will be allowed as a deduction in equal instalments over the period for which the licence remains in force.

It further provides that where the licence is transferred and proceeds of the transfer are less than the expenditure remaining unallowed, a deduction equal to the expenditure remaining unallowed as reduced by the proceeds of transfer, shall be allowed in the previous year in which the licence has been transferred. It also provides that if the licence is transferred and proceeds of the transfer exceed the amount of expenditure remaining unallowed, the excess amount shall be chargeable to tax as profits and gains of business in the previous year in which the licence has been transferred. It also provides for amortisation of unallowed expenses in a case where a part of the licence is transferred. The restrictive provisions of this section shall not apply in relation to a transfer in a scheme of amalgamation whereby the licence is transferred by the amalgamating company to the amalgamated company, the latter being an Indian company.

(iv) Non-lump sum payments

The specific provisions: of the IT Act, narrated in the paragraph on ’know-how’ above, cover only lump sum payments for acquisition of know-how. Where the payment is by installments or any mode other than lump sum, a question arises whether the payment is of a revenue nature and is deductible in the year of payment or is not deductible, being of a capital nature. For the determination of such questions, it is often necessary to refer to principles laid down by courts.

The dispute regarding and admissibility of either the whole or part of a payment for know-how under a foreign collaboration agreement ultimately boils down to the question whether it is a capital expenditure or a revenue disbursement? The leading authority for determination of this question, which has held the field since 1926, is Viscount Cave’s celebrated dictum in an English case: British Insulated and Helsby Cables Ltd v. Atherton 10 Tax cases 155, (1926) Appeal cases 285. The learned Lord has observed as follows:

’When an expenditure is made, not only for once and for all but with a view to bringing into existence as asset or an advantage for the enduring benefit of the trade, there is very good reason for treating such an expenditure as properly attributable not to revenue but to capital’.

Each payment for ’know-how’ under a foreign collaboration agreement is therefore, examined with the touch stone of the ’enduring benefit’ test. If the payment brings into existence as asset or advantage of enduring benefit it is capital in nature and is not admissible as revenue expenditure. The outcome of the enduring benefit test often depends on the drafting of the agreement in each individual case.

3 Drafting of Agreements

The drafting of clauses of an agreement setting out the terms and conditions of collaboration is very important and should be done with great care and expert advice. Unfortunately, sometimes the collaboration agreements are not properly worded. Generally, a foreign collaborator does not give up the technical know-how absolutely, he merely grants a license to use it. Still in some cases, the clauses of the agreement give an impression that there is an outright sale of know-how. The case of Triveni Engineering Works: [Triveni Engineering Works Ltd v. Commissioner of Income Tax (CIT) (1982) 136 Income Tax Reports (ITR) 340 (Delhi High Court)] offers a good example.

An Indian company, Triveni Engineering works Ltd., was set up to manufacture steam turbines. It did not posses the technical know-how or the expertise for this purpose. The technology was obtained from Brotherhoods Ltd. of the United Kingdom in the form of drawings, designs and know-how. Clause 2 of the agreement mentioned that Brotherhoods would ’sell outright’ to Triveni the technical know-how in respect of steam turbines. According to Clause 3, technical information designs and drawings which were provided to Triveni would be its ’absolute property’. In view of these words in the agreement and the fact that the expenditure was of an initial nature in as much as the Indian company had obtained the know-how for starting its business, the Income Tax Officer had disallowed the payment as capital expenditure. When the case came up before the Delhi High Court, the ruling of the High Court was in favour of the company.

After examining the clauses of the agreement in their totality, the High Court agreed with the taxpayer that on a cursory reading, the agreement gave the impression that technical know-how was sold absolutely, a careful and closer study of the agreement as a whole made it clear that despite the use of the words ’agree to sell outright to Triveni’ the agreement, in substance was more in the nature of a licensing agreement. The high Court held that the technical know-how fees were admissible as revenue expenditure in computing the taxable income of Triveni. This specific case underscores the importance of the drafting of clauses. If the agreement had been better drafted, considerable litigation costs and time would have been saved.

4 Court Assistance

Even in the case of well drafted agreements disputes arise about the interpretation of the terms of the agreement. The Supreme Court of India has enunciated the principles for interpretation of collaboration agreements in the leading case of Ciba: [CIT v. Ciba of India Ltd (1966) 69 ITR 692 (SC)]. According to this decision, it must be questioned whether the agreement merely gives the right to the assessee to draw upon the technical knowledge of the collaborator for a limited period for the purpose of carrying on its business of manufacture by making the technical knowledge available? Or does the collaborator gives up the asset of its business as a result of which the assessee acquires as asset or advantage of enduring nature for the benefit of its business? The Supreme Court analysed the agreement and noted the following important facts:

  1. The object of the agreement between Ciba of India Ltd., as Indian subsidiary of Ciba Ltd. Of Basle, Switzerland, was to obtain the benefit of technical assistance from the Swiss company for running the business of the Indian company.

  2. The license was for a period of five years. It could be terminated in certain circumstances even before the expiry of that period.

  3. The license was granted to the assessee subject to rights actually granted or which may be granted after the date of the agreement to other persons.

  4. The assessee was expressly prohibited from divulging confidential information to third parties without the consent of the Swiss company.

  5. There was no transfer of the fruits of research once and for all. The Swiss company, which was continuously carrying on research, had agreed to make it available to the assessee.

  6. For the right to receive scientific and technical assistance the assessee had agreed to make contributions of 5 percent, 3 percent and 2 percent respectively, of the net sale price of the products sold by the assessee towards: (a) technical consultancy and technical service rendered and research work done, (b) cost of raw material user for experimental work, and (c) royalties on trademarks used by the assessee. These stipulated payments were recurrent, dependent upon sales and only for the period of the agreement.

On the basis of the above facts, the Supreme Court held that it could not be said that the Swiss company had parted with the technical knowledge absolutely in favour of the assessee. The facts clearly established that the secret processes were not sold by the Swiss company to the assessee. Accordingly, the Supreme Court decided that the contribution made by the assessee to the Swiss company was allowable under Section 10(2) (xv) of the 1922 Act, corresponding to Section 37 of the IT Act in the year in which it was incurred.

5 General Approach of Courts

The case law noted in the foregoing paragraph is only selective. It is not exhaustive. There are many cases on this topic. However, starting from the earliest and coming to the latest decision one broad uniform pattern which clearly emerges is that courts are more or less unanimous in their thinking that technical know-how fees for manufacturing processes supplied by way of drawings, designs, information or otherwise are allowable as revenue expenditure. The different arguments advanced by the Tax Authorities for having them treated as capital outlay have not been accepted by the courts.

Capital gains on self generated intangible assets

By virtue of specific provisions: (Sec. 45 of IT Act) in the IT Act, capital gains arising on the transfer of a capital asset is subjected to income tax. The IT Act: (Sec. 48 of IT Act) lays down the method of computing capital gains. The cost of acquisition and expenditure relating to the transfer, are deducted from the full value of consideration to arrive at the capital gains. ’Capital asset’ is defined: (Sec. 2(14) of IT Act) as including all kinds of property except a few specified ones such as stock-in-trade of a business or personal effects.

In a number of cases, the courts have decided that, in case of self -generated assets like goodwill or where the cost of an asset to an assessee is nil, no tax on capital gains consequent to the transfer of such assets could be charged. They have interpreted that, only if an asset did cost something to the assessee in terms of money, the provisions: [Sec. 45(1) of IT Act] relating to the levy of tax on capital gains would apply. A transaction to which these provisions cannot be applied has been held to be one never intended to be the subject of the charge. The courts have further interpreted that the intent of levying capital gains tax depends on the nature and character of the asset, that it is an asset which possesses the inherent quality of being available on expenditure of money to a person seeking to acquire it. The courts: {The leading case on the subject is the Supreme Court’s decision in the case of {CIT v. B. C. Srinivas Setty (1981) 128 ITR 294 (SC)} have held that none of the provisions pertaining to the heading ’capital gains’ suggests that ’capital assets’ include as asset in the acquisition of which no cost at all can be conceived.

In order to overcome the judicial interpretation, it has provided in Section 55(2)(a) of the IT Act that the cost of acquisition in the case of self-generated goodwill will be taken to be nil. For the purpose of bringing the capital gain arising from transfer of any of the following assets, in the acquisition of which assesee has not incurred any expenditure. The cost of acquisition of some more intangible assets as nil was added by subsequent amendments. Thus, the total list of all the intangible assets in section 55(2)(a) are:

  1. goodwill of a business

  2. trade mark or brand name associated with a business

  3. right to manufacture, produce are process any article or thing

  4. right to carry on any business

  5. tenancy rights,

  6. stage carriage permits

  7. loom hours.

  8. trading or clearing rights of a recognised stock exchange acquired by a shareholder for equity share under a scheme of demutualisation or corporatisation.

On the sale of all these assets the full sale value is treated as capital gains.

6 Comparative Legislation

It will be useful to compare the taxation of intangible assets in India with taxation in an advance country. For the sake of brevity comparition with only one country, namely the United States of America, should be sufficient.

7 U.S. law

In the United States of American, the law on tax deduction for the cost of purchased intangible assets like patents, copyrights and goodwill covers a much larger area as compared to similar legislation in India. It presents some specific new concepts which deserve attention.

The US law: [Sec 167(a) of US Internal Revenue Code (IRC)] allowes as depreciation (amortisation is a form of depreciation) deduction, a reasonable allowance for the exhaustion and wear and tear (i) of property used in trade or business, or (ii) of property held for the production of income. Under the US Treasury Regulation: [Treasury Regulation Sec.1–167(a)–3] the depreciation deduction for an intangible asset which is less susceptible to obvious signs of exhaustion and wear and tear, is allowed only if the life of the intangible asset is known to be limited from experience or other factors and can be estimated with reasonable accuracy. The Regulation does not define intangible assets, but gives two examples of intangible assets, namely, patents and copyrights.

’Goodwill’ is not defined by the law. Some definitions of ’goodwill’, like ’continued patronage’ can be culled from the plethord of case law on the subject. Theoretically, existence of goodwill continues as long as the related business continues: (Metropolitan Laundry Company’s case [52-1-US Tax cases (USTC) 9136)]. Under the above Regulation no depreciation for ’goodwill’ was allowed under the prior law, since it lacks an ascertainable useable life.

Relying on the provision that no depreciation is admissible on ’goodwill’, the Internal Revenue Service (IRS) always took the position, that some assets inseparable in the eye of the law from goodwill, and were thus not eligible for depreciation or amortisation. This view gave rise to lot of litigation. This long-argued position was again reiterated by the IRS in a paper: (”Consumer Issues Paper’ dated 8 June 1992 on Consumer based intangibles).

8 Landmark decision

The IRS position was challenged in a case decided by the US Supreme Court in the case of the Newark Morning Ledger Company,: (Newark Morning Ledger Co. V. United States 93-1 USTC 50-228; Law Week 4313-4323). In its epoch-making decision the US Supreme Court ruled that a taxpayer that proves that its purchased intangible assets have both an ascertainable value and a limited useful life, the duration of which can be ascertained with reasonable accuracy, may amortise these assets over that useful life. The intangible asset in question in this case was called ’paid subscribers’ and was valued at $68.7 million. It was a list of identified newspaper subscribers who had intimated, in writing, to purchase a newspaper if it was delivered at the specified place. Newark Morning had purchased this list from the previous owner of the newspaper along with the newspaper and other assets. The sum of $68.7 million was the taxpayer’s estimate of future profits to be derived from identified subscribers. The IRS disallowed the taxpayer’s claim of amortization of the sum of $68.7 million on the ground that the concept of ’paid subscribers’ was indistinguishable from ’goodwill’. The Supreme Court held that the taxpayer was able to prove the value of the intangible asset and also the fact that it had a limited life. It observed that such an asset was entitled to amortization over its useful life regardless of how much it resembled ’goodwill’.

This far reaching Newark Morning Ledger decision of came just at the time when the Budget Bill: (The US Omnibus Budget Reconciliation Bill, 1993) was before the US Congress. Realising that the new ruling will open floodgates of contests claiming amortisation on new intangible assets and asking for shorter and shorter periods for the duration of their useful life, the administration moved to codify the law on the subject to impart a degree of certainty and simplicity. Keeping in view the impact of the Supreme Court ruling, the legislature even included purchased goodwill for the purposes of allowing amortization.

9 New Law

The US Omnibus Budget Reconciliation Act 1993 (Budget Act), enacted on 10 August 1993 inserted a new Section 197 in the Code. It allows taxpayers to amortize many intangible assets including goodwill and going concern value over 15-year period. The new section is effective and mandatory for intangible assets acquire after the date of enactment of the Budget Act, namely, 10 August 1993. A taxpayer is permitted to elect to apply the new provisions to intangible assets acquired after 25 July 1991. The election is allowed only once and can be revoked only with IRS consent.

A Section 197 asset includes such intangibles as goodwill, going concern value, workforce in place, business books and records, patents, copyrights, formulae, processes, designs, patterns know-how and formats, customer-based intangibles, suplier based intangibles, covenants not to compete, franchises and trademarks or trade names. The inclusion of such assets as goodwill and going concern value is especially noteworthy since those assets were not depreciable under prior law.

10 Amortizable Intangibles

An ’amortizable, Section 197 intangible’ is any Section 197 intangible acquired after 10 August 1993 and held in connection with the conduct of a trade or business. At the election of the taxpayer, assets acquired after 25 July 1991 may also qualify as amortizable Section 197 intangibles, or certain intangibles acquired after the date of enactment may remain subject to the pre-1993 Act law.

Subject to a number of important exceptions, Section 197 of the IRC applies regardless of whether the intangible is acquired as part of a trade or business or not. Section 197 intangibles, or certain intangibles acquired after the date of enactment may remain subject to the pre-1993 Act law.

Subject to a number of imortant exceptions, Section 197 of the IRC applies regardless of whether the intangible is acquired as part of a trade or business or not. Section 197 intangibles include:

  • goodwill and going concern value,

  • workforce in place,

  • information base,

  • know-how,

  • customer-based intangibles,

  • supplier-based intangibles,

  • franchises, trademarks and trade names,

  • insurance policy expirations,

  • bank deposit base.

Section 197 intangibles also include any other item that is similar to workforce in place, information base, know-how, customer-based intangibles or supplier-based intangibles.

11 Asset Treated As Amortizable

Some assets are treated as Section 197 intangibles only if acquired in connection with the acquisition of a business. These consist of:

  • computer software,

  • films, sound recordings, videotapes and books,

  • copyrights and patents,

  • rights to receive tangible property or services,

  • interests in patents and copyrights,

  • mortgage servicing rights secured by residential real property,

  • contract rights for less than 15 years or fixed in amount.

12 Asset Not Treated As Amortizable

Some assets are never treated as Section 197 intangibles regardless of how they are acquired. These consist of:

  • interests in corporations, partnerships, trusts and estates,

  • computer software that is readily available for purchase by the general public,

  • futures, foreign currency contracts and national principal contracts,

  • land,

  • lease of tangible property,

  • debt instruments,

  • sports franchises,

  • tax-free transaction (Iodopco)costs,

  • accounts receivable,

  • self-created intangibles. Amortizable Section 197 intangibles generally do not include self-created intangibles,

  • losses generally disallowed on disposition of Section 197 intangibles. New Code Section 197 bears any loss deduction on the disposition, worthlessness or abandonment of a Section 197 intangible if:

    1. any other Section 197 intangible was acquired in the same transaction, and

    2. the taxpayer still retains any of the other Section 197 intangibles so acquired. The amount of any loss barred under this rule is reallocated to be retained.

It is not possible in this short article to elaborately discuss all the items of assets listed in paragraphs 13 to 15 above. Only some important selected items are taken up for detailed consideration. This would be sufficient to covey the basic approach of the new US legislation.

13 Goodwill and Going Conern Value

The pre-1993 law barring amortization for goodwill and going concern value has produced an enormous amount of litigation. The IRS has generally taken the position that any amount paid for intangibles in the acquisition of a business relates to non-amortizable goodwill or going concern value while the taxpayer has attempted to show that amortizable intangibles such as customer lists have a value apart from goodwill or going concern value and a limited useful life. The new Section 197 of the IRC eliminates this IRS-taxpayer conflict by providing that the costs of purchased goodwill and going concern value are Section 197 intangibles and are thus amortizable over the same 15-year period applicable to other Section 197 intangibles. Self-created (as distinguished from purchased or acquired goodwill or going concern value) are generally not subject to a 15-years amortization.

For this purpose, goodwill is the value of a trade or business that is attributable to the expectancy of continued customer patronage, whether due to the name of trade or business, the reputation of a trade or business, or any other factor.

Going concern value is the additional element of value of a trade or business that attches to property by reason of its existence as an integral part of a going concern. Going concern value includes the value that is attributable to the ability of a trade or business to continue to function and generate income without interruption nowithstanding a change in ownership.

14 Insurance Policy Expirations

Among the assets acquired in the purchase of an insurance agency business are policy expirations and similar records, such as ’dailies’ records of essential details of each policy including the renewal date of health, accident, fire, casualty and similar insurance sold by the agency.

Under the earlier law, the depreviation or amortization of these items depended on whether the taxpayer established that the assets (1) had an ascertainable value separate and distinct from goodwill, and (2) had a limited useful life whose duration could be ascertained with reasonable accuracy. For example, in the case of Valler Insurance: [US Tax Reports (USTR) 1675-016(15)] a district court found a five year life for fire, casualty and automobile insurance expirations based on industry statistics and the taxpayer’s own experience.

15 Customer-based Intangibles

Section 197 intangibles include any customer-based intangible. Customer-based intangibles are the composition of market, market share, and any other value resulting from the future provision of goods or services out of relationships with customers (contractual or otherwise) in the ordinary course of business. For example, the portion of the purchase price of an acquired trade or business that is attributable to the existence of customer-base, circulation-base, undeveloped market or market growth, insurance in force, investment management contracts, or other relationships with customers that involve the future provision of goods or services, is to be amortized over the 15-year period.

16 Supplier-based Intangibles

A taxpayer who acquired the assets of a business will often acquire rights under contracts that were made by the seller of the business with third parties. For example, the buyer may step into the shoes of the seller with respect to a supply contract that grants the buyer more favourable terms than the buyer could obtain on his own with respect to the subject matter of the contract. Under prior law, the portion of the purchase price of an acquired business assigned to a favourable contract may be amortized if the buyer establishes that (1) the contract has a limited useful life, the duration of which can be established with reasonable accuracy, and (2) the contract has an ascertainable value that is separate and distinct from goodwill. For example, the Tax Court held in the Ithaca Industries case: (USTR 1675-022 (65)) that the cost of acquiring contracts that allowed the taxpayer to purchase raw materials (yarn) at a price below market could be amortized over the useful lives of the contracts.

Supplier-based intangibles are the value resulting from the future acquisitions of goods or services out of relationships (contractual or otherwise) in the ordinary course of business with suppliers of goods or services to be used or sold by the taxpayer. For example, the portion of the purchase price of an acquired business attributable to a favourable relationship with persons who provide distribution services such as, favourable shelf or display space at a retail outlet, the existence of a favourable credit rating, or the existence of favourable suply contracts, is generally to be amortized over the 15-year period.

17 Computer Software

Under pre-1993 law the tax treatment of computer software depended on how it was acquired by the purchaser. If there is a composite bill for computer software and computer hardware without separate identification of the charge of the software, then the buyer had to treat the entire amount of the cost including that of the software as the cost of the hardware to be depreciated over the useful life of the computer hardware. If the charge for the computer software was separately stated, it could be amortized over five years or any shorter useful life the taxpayer could establish: (USTR 1674-033).

Under the new Section 197 of the IRC, with certain exceptions, computer software is eligible for amortization over a 15-year period. However, computer software that is readily available for purchase by the general public is expressly excluded from being categorized as amortizable.

The term ’computer software’ includes may incidental or anxillery rights that (i) are used only in connection with the software. On the other hand, the term ’computer software’ does not include any data base unless the data base is in the public domain and is insidental to the operation of otherwise qualifying computer software. A dictionary feature used to spell-check a word processing programme is not treated as a database.

If a depreciation deduction is allowed with respect to any computer software that is not a ’Section 197 intangible’, the amount of deduction is computed using the straight line method and a useful life of 36 months.

Where the main purpose of acquisition is to obtain computer software, the taxpayer may be well advised to buy just the software and not the seller’s entire business. When the software is purchased alone in a ’free-standing’ transaction it no longer remains a ’Section 197 intangible’ and becomes entitled to be written off in 36 months instead of the longer amortization period of 15 years.

18 Residual Methods of Allocation

Under pre-1993 law, the purchase price of a business must generally be allocated by the ’residuary method’ prescribed under the Internal Revenue Code Regulations. According to this method, all assets of an acquired trade or business are to be divided into four classes:

  1. Class I assets, which include cash and cash equivalents,

  2. Class II assets, which include certificate of deposit, government securities,

  3. Class III assets, which include generally all furniture, fixtures, land, buildings, equipment, other tangible property, accounts receivable, coverants not to compete and intangible assets other than goodwill and going concern value and

  4. Class IV assets which include intangible assets in the nature of goodwill or going concern value.

The purchase price of an acquired trade or business is first allocated to Class I, II, and III. To the extent that the purchase price exceeds the value of the assets in the first three classes, the excess was allocated to goodwill or going concern value which was non-amortizable under the previous law.

The new law generally provides no rules for allocating the amount attributable to Section 197 intangibles among the particular intangibles that comprise that class. This is not necessary as the amortization period is 15 years for all such intangibles.

The concept of the residuary method will become somewhat clear by studying a numerical illustration.

A company on 1 January 2002 buys all the assets of a sole proprietory business for $2,000,000. These assets consist of:


Cash in bank and hand


Government securities


Land, building, furniture & fixtures


Value of assets


Purchase Price


Excess of purchase price over value of assets

(2000,0000 – 1400,000)


Under the residual method as amended by the 1993 Act, $600,000 the excess of the purchase price over the value of assets must be allocated to Section 197 intangibles comprising know-how, software and goodwill. The value of these intangibles, namely, $600,000 will be amortized over the 15-year period beginning from 1 January 2002 and ending 31 December 2017. In this example, it is not necessary to determine the separate value for the three intangible assets. Under the previous law, the taxpayer had to prove a separate value and useful life for each specific intangible asset.

19 Self-Created Intangibles

Under pre-1993 law some costs that are paid or incurred to create, maintain or enhance the value of intangible assets may be deducted as ordinary and necessary business expenses for the year in which the costs are incurred. Some examples are advertisings expenses, research and experimental costs and expenses incurred to train employees. These expenses create intangible assets which also yield income in future years. These self-created intangible assets are different from purchased intangible assets. The costs incurred to develop or maintain self-created assets are deductible in the year in which they are incurred, the cost of intangible assets, purchased or acquired at the time of acquisition of a business are amortizable if they fall under the category of ’Section 197 intangibles’ or intangibles deemed as ’Section 197 intangibles’. Section 197 exempts self-created intangibles from the new 15-year amortization provision. These self-creeated intangibles continue to remain subject to the pre-1993 law. The answer to the question whether costs incurred to develop or maintain self-created assets are deductible or not is governed by the old law and not by the new Section 197.

20 The Indopco Case

The US Supreme Court has held in the case of Indopco Inc.: (US Supreme Court 1039, USSC 50–113) that legal investment advisory fees insurred in a friendly acquisition do not qualify for deduction as ordinary trade or business expenses. The Court ruled that these acquisition expenses produced significant benefits extending beyond the current tax year. The taxpayer’s argument that these expenses were not capital cost since they did not create a separate and identifiable asset was not accepted. It is to be noted here that thye Indopco case involved the deductibility of self-created assets while the Newark Morning Ledger case involved the deductibility of purchased intangibles.

21 Valuation of Intangibles

It was stated at NewDelhi by Prof Lynn M. Martin, of the University of Central England Business School at a recent workshop jointly organised by the Indian Institute of Foreign Trade (IIFT) and the Institute of Chartered Accountants of India (ICAI) on ”valuation of intangibles in technology intensive industries”, that the time is now ripe for reassessment of intangibles such as proprietary lists, beneficial contracts, patents and applications for patents, copyrights, trademarks, brand names, subscriptions and service contracts franchise pacts, software and goodwill in present day knowledge economy.

Delivering the keynote address, Prof Martin said ”for most firms, intangibles represnt investment in things which were not concrete but which might well result in real benefits for years to come. There were difficulties in valuation of such items. There were doubts even whether they should appear in the balance sheet at all,” he added.

He further said, accounting standards do not just affect company accounts. Firms would make business-decisions based upon how these would affect their published financial statements. Thus, accounting standards directly affect levels of investment and hence regional and national economies, he said, adding that decisions which circumscribe current investment in intangibles might impact severely on future profitability.

In his remarks, the Secretary, Ministry of Small Scale Industries, Mr S.K. Tuteja, said the concept of intangibles was not alien to India as it was part and parcel of day-to-day work ethics while conducting any kind of business activity, the best example being goodwill. Stating that the human capital involved in today’s knowledge economy was an important component of this intangible, Mr Tuteja said that there was need to devise an appropriate methodology to value this concept and asset. In mergers and acquisitions, intangibles had come to play a vital role, he said underlining the need to value properly and precisely the intangibles involved in the small-scale sector as it contributes immensely to the growth of GDP.

Earlier, welcoming the participants, the IIFT Director-General Mr Prabir Sengupta, said the advancement of new technology, application of computer software and related technologies and other knowledge intensive activities appeared to have warranted detailed research on valuation methods for intangibles.

The ICAI Secretary, Dr Ashok Halida, said the value of human capital and role of technology were contributing significantly to the growth of the economy, which form definitely an important part of the intangibles in technology-driven industries: (The Hindu Business Line, Delhi Edition dated 10 March 2003).

22 Epilogue

The Newark Morning Ledger case and the new Section 197 of the IRC has significant financial and industry implications. Taxpayers in the US considering business acquisition strategies realized that the value of their customer-based intangible has increased. Just one day after the Newark Morning Ledger decision, stock prices of several companies with sizable intangible assets went up on the stock exchange: (The Wall Street Journal, 21 April 1993 at p.A. A-3). The new Section 197 of the IRC has not only partly accepted the Newark Morning Ledger decision but has made the law certain, simple and uniform. Taxpayers would now avoid the litigation costs associated with court proceedings to defend claims to amortization and useful life of intangible assets. Though there are many gainers under the new law, there are some losers also. Many intangibles acquired in connection with the acquisition of business such as movies, computer software, insurance policy expirations, bank deposit bases, and convenants not to compete, which have been held to be subject to the pre-1993 Act recovery period of less than 15-years are mandatorily subject to a 15 year amortization under the new law.

The price a buyer will pay for a business is to some extent affected by the tax treatment he expects to be accorded with respect to the purchased assets. The fact that the buyer of an asset can recover its cost through amortization deductions makes the asset worth more to him than if it were non-amortizable.

Conversely, if the recovery period for an asset is made longer, its value to the buyer is reduced.

In India, and other developing countries, specific tax treatment is provided only for a small number of intangible assets like ’patent rights’, ’know-how’ and telecom license fees. These countries and India should broaden the list of intangible assets for the purposes of amortization. This is necessary as most of them are now globalizing their economy. They can benefit from the US experience.

Har Govind

Har Govind Msc.BL. currently practices as an Advocate and Business and Tax Consultant in India. His former functions include, Chief Commissioner of Income Tax Delhi, Member Income Tax Appellate Tribunal, Competent Authority for Forfeiture of Smugglers’ Properties and Director Investigation Monopolies and Restrictive Trade Practices Commission.

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År 2019 2020 2021
Prisbasbelopp 46 500 47 300 47 600
Förhöjt pbb. 47 400 48 300 48 600
Inkomstbasbelopp 64 400 66 800 68 200
Utdelning fåmansföretag
År 2019 2020 2021
Schablonbelopp 171 875 177 100 183 700


År 2019 2020 2021
Räntesats 0,51 0,50 0,50


År 2016-07-01 2019-07-01 - 
Räntesats -0,5 0,0
Ränta på skattekontot
Period 2013-2016 2017 -
Intäkt 0,5625 0
Kostnad Låg 1,25 1,25
Kostnad Hög 16,25 16,25
Inkomstår 2019 2020 2021
Positiv 6,51 6,50 6,50
Negativ 1,51 1,50 1,50
År 2019 2020 2021
31 maj 0,05 -0,01 0,28
30 nov -0,09 -0,10  


Inkomstår 2019 2020 2021
Egen bil 18,50 18,50 18,50
Förmånsbil, diesel 6,50 6,50 6,50
Förmånsbil, bensin 9,50 9,50 9,50
År 2019 2020 2021
Frukost, lunch och middag 245 245 250
Lunch eller middag 98 98 100
Frukost 49 49 50
Skattefria gåvor
År 2019 2020 2021
Julgåva 450 450 500
Jubileumsgåva 1 350 1 350 1 500
Minnesgåva 15 000 15 000 15 000


År 2019 2020 2021
Skattesats 21,4% 21,4% 20,6%
År 2019 2020 2021

25 %

25 % 25 %
Livsmedel, krog m.m. 12 % 12 % 12 %
Persontransport, böcker m.m. 6 % 6 % 6 %
Födda -1937 1938 - 1954 1955 -
Arb. avgifter 0 % 10,21% 31,42%
Egenavgifter 0 % 10,21% 28,97%


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