Intellectual property assets, including patents, trademarks, designs, copyright, and trade secrets, are some of the most valuable business assets that a company can have in its possession.
Many software and product companies, whether through licensing or commercialization of intellectual property products and services, are being built predominantly upon their intellectual property. Moreover, intellectual property plays a fundamental role in companies’ investment decisions. Intellectual property can be used as collateral to obtain financing, for valuation purposes in an equity offering, and can be the impetus for a merger or acquisition.
This article focuses on:
- The use of intellectual property holding companies.
- How intellectual property holding companies can be used to protect a company’s intellectual property assets.
- The benefits of using intellectual property holding companies in your business.
- The practical considerations for leveraging an intellectual property holding company in your company’s overarching organizational structure.
What is an Intellectual Property Holding Company?
An intellectual property holding company is a special purpose business entity, often a corporation or a limited liability company, whose sole purpose is the management and holding of a business’s intellectual property assets. These assets can include patents, trademarks, designs, copyright, and trade secrets. Intellectual property holding companies are used to separate a company’s intellectual property from its operations in order to insulate intellectual property from claims against the operating entities and to facilitate centralized management of a company’s IP assets.
How do Holding Companies Work?
An intellectual property holding company is a special type of corporate entity whose sole purpose is to own intellectual property assets, including patents, trademarks, copyrights, and trade secrets, and manage such items.
An intellectual property holding company is established when an affiliate company assigns its intellectual property assets in exchange for monetary consideration, or for stock or membership interest in a newly formed intellectual property holding company. Depending on the particular configuration, this exchange may be deemed a tax-free transaction between the intellectual property holding company and the affiliate company. Along with the exchange of consideration for IP assets, the newly formed intellectual property holding company will typically provide the affiliate company assigning the IP assets with a license to such IP. Such License-Back Agreement contemplates fees or royalties due to the IP holding company, and crucial termination and assignment terms that sever the licensing relationship as necessary to protect the IP from the operating company’s creditors. Depending on the nature of the intellectual property, the intellectual property holding company may also license certain IP assets (or components thereof) to third parties for concurrent use, or to exercise in particular industries or use-cases.
Relocating IP to Tax Advantageous Jurisdictions
Intellectual property holding companies have been historically created in states or foreign jurisdictions with favorable tax laws. The selection of a tax friendly jurisdiction for the intellectual property holding company will result in an overall reduction in the amount of overall taxes paid via the business enterprise. When fees or royalty payments are made to an intellectual property holding company, pursuant to the terms of a license agreement, the payments are considered as an expense to the parent company and therefore not included in the net taxable income of the parent company.
When selecting a place of incorporation/organization for the subsidiary company it becomes paramount to choose a location that excludes, from taxable income, any fee or royalty income derived pursuant to a licensing agreement.
In the US, states have been looking at different methods to increase their state’s overall tax revenue and thereby have enacted different types of reporting requirements aimed at intellectual property holding companies such as mandatory combined reporting requirements (requiring companies to file a single comprehensive tax return for all of their subsidiaries when they calculate their taxes) as well as addback statutes (requiring companies to add back any tax deductions taken for royalties paid to their intellectual property holding companies. While some states have been cracking down on the use of intellectual property holding companies as a means of reducing tax liabilities, Delaware has retained favorable tax laws for intellectual property holding companies transacting business in their state.
Should you or your company need assistance navigating through complex and uniquely challenging issues surrounding the implementation of intellectual property holding companies please feel free to reach out to David Pierce, JD, MBA at Founders Legal or Amit Patel, JD, LLM.
David Pierce, JD, MBA is a former tech sales leader who now devotes his legal practice towards building out legal infrastructure and facilitating deals for his technology clients.
Amit Patel, a business transactional attorney, began his career with a Big 4 accounting firm and now leverages his experience in formulating tax-advantageous strategies for clients.