Royalty-free license for intellectual property: tax implications.

This brief note provides information on the taxation of transactions involving the transfer of the right to use intellectual property (“IP”) where a license is issued on a royalty-free basis.

Commonly, IP lawyers do not deal with taxes and tax specialists do not deal with IP. My colleagues at 3i and I decided to fix the situation, thanks, of course, to our client, who posed the question to us – what tax implications arise for a Kazakhstan company that has been granted with a royalty-free license for IP by a foreign counterparty.

This article comprises the brief answer to the question (for those who cannot devote more than one minute to reading), as well as a more in-depth analysis of the legislation of the Republic of Kazakhstan for those who are interested in this topic.

As I like, we will divide this topic into two articles. Here is the legislation. We will publish a separate article on the judicial practice. A little teaser on the enforcement is at the end of this note.H

• The civil law of the Republic of Kazakhstan allows for the execution of a license agreement for the transfer of rights to IP for free. A provision for the gratuitous transfer of IP rights should be included in a license agreement. Otherwise, the license will be considered a paid one.

• The operation of transferring IP rights free of charge is subject to taxation. This operation should be considered from the point of view of both the CIT and the VAT.

• VAT: IP rights are expected to be transferred free of charge. In this regard, no VAT arises in such transaction. In our situation, this is the VAT for a non-resident payable by the RK resident (if the resident is registered for VAT).

• CIT: the licensee may have an obligation to pay CIT. The object of taxation is property received free of charge. The obligation to pay CIT will arise if the property is valued above KZT 0.

• If the licensee is granted with the right to use IP free of charge, we recommend engaging appraisers to evaluate the right received under the license.

• The IP licensor can maintain its practice of issuing royalty-free licenses, and the licensee will discharge its tax obligation in Kazakhstan.

Now with references to the law.

The value of any property received by a taxpayer free of charge is its income, as provided for by Article 238.1 of the Tax Code of the Republic of Kazakhstan.

Under Article 115 of the Civil Code of the Republic of Kazakhstan, property means, inter alia, the results of intellectual activities and the means of individualization, as well as property rights.

Rights obtained under a license to use IP are validly classified as property rights.

The right to IP consists of two categories of rights: moral rights and property rights.

There are IP items for which only property rights arise and no personal non-property rights arise. Such items include phonograms, trademarks and a number of others.

Property rights are the subject of civil circulation and can be transferred under a license. Personal non-property rights are not the subject of civil circulation and are not transferred under a license.

Accordingly, rights obtained under an IP license should be classified as property rights.

Thus, the licensee may become liable to pay CIT. The object of taxation is the property right granted on a free-of-charge basis.

The amount of income received in the form of gratuitous property shall be determined based on its market value, pursuant to Article 238 of the RK Tax Code.

To determine the market value, property should be appraised in accordance with the RK laws on valuation activities.

Thus, the base for paying CIT will be the value of the property reflected in accounting records, based on the appraisal.

We understand that appraisers may conclude that the property right to use IP has a value of KZT 0. The appraisal may depend on the conditions of the license.

The obligation to pay CIT will arise if the taxable object is assessed by specialists at more than 0 tenge.

Article 238.2 of the RK Tax Code provides that income received in the form of IP rights is recognized in a tax period in which such right was granted. From the accounting standpoint, the issue of paying CIT arises if a license agreement is executed for several years. According to the above rule (our interpretation of the rule), CIT must be paid once in a tax period in which the right is received (in accordance with the license). We understand that the appraisers will also take into account the term of the license agreement to determine the value of the gratuitously received property right. Therefore, the entire cost may be included in taxable income within one tax period.

Services provided by a non-resident on a reimbursable basis, the place of sale of which is recognized to be the Republic of Kazakhstan, when they are purchased by a VAT payer, constitute the turnover of such payer for the purchase of works or services from a non-resident. Such turnover, pursuant to Article 373.2 of the RK Tax Code, is subject to VAT.

The granting of IP rights should be treated as turnover on the provision of services. Therefore, VAT is payable on the sales amount. In this case, the right to use the IP is supposed to be sold free of charge, so the licensee does not have any obligation to pay VAT.

As a small teaser for a future note on the law enforcement practice, we note as follows. We have not located any Kazakhstan judicial practice (colleagues, if you have participated in such cases, please share). But we found the Russian judicial practice on claims of organizations against tax authorities to cancel decisions on additional tax assessments on the IP rights granted for free. The Russian judicial practice is favorable for taxpayers. The arguments that Russian arbitral tribunals use when canceling acts of tax authorities may be used in the Republic of Kazakhstan, but only partially. Most of the findings made by the courts in the Russian Federation are not applicable to our Kazakhstan realities due to some differences in the classification of objects of civil turnover, that are included in the company’s income for the CIT purposes. We will make a separate article about this.