Thayne Forbes, of Intangible Business, and Rajesh Sharma, of Smith & Williamson, believe taxpayers can benefit from placing intangibles in SPV structures

Special purpose vehicle (SPV) is often considered a series of dirty words. The assumption being that something devious is going on to hide a potential liability. But this simply is not the case. All financial instruments are exposed to misuse so of course SPVs are no exception, but they can be used for legitimate business advantage, especially regarding intangible assets.

There are also tax benefits to be gained if SPVs are used appropriately. The UK foreign profits consultation continues, but it is unlikely any changes will be introduced in the short term. As a result, there should be a window of opportunity for the transfer of intangibles to defer UK taxation on such profits. Inevitably, consideration needs to be given to the location where the intellectual property (IP) is to be transferred to, in other words, the anti-avoidance provisions that could apply to the income derived from the intangibles. Therefore, the reorganisation of any business IP should focus on the commercial and fiscal aspects.

Moving IP into a separate company could increase shareholder value in a number of ways. It can ring-fence assets so they are no longer vulnerable to other business risks. It tidies up ownership of the intangible assets, ensuring they are owned properly, looked after and given the attention they deserve as highly valuable business assets. It draws together all the legal and commercial activities required to manage IP. Another key commercial benefit is it focuses management attention on the asset as business divisions or fellow subsidiaries will need to pay for its use at arm's-length rates.

Intangible assets that can be transferred
Although the legal forms of IP must be considered, a useful starting point is the definition given by the International Financial Reporting Standards for use in business combinations, IAS 38 intangible assets. To distinguish an intangible asset from goodwill, the standard claims it must be both identifiable and separable:

An asset meets the criteria the definition of an intangible asset when it:

• is separable, meaning it is capable of being separated or divided from the entity and sold, transferred, licensed, rented or exchanged, either individually or together with a related contract, asset or liability; or
• arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights and obligations.

The following types of intangible assets could therefore be considered: brand names; mastheads and publishing titles; computer software; licences and franchises, copyrights, patents and other industrial property rights, service and operating rights; recipes, formulae, models, designs and prototypes; and intangible assets under development. To this list can also be added contracts and databases which, together with the previous list, is a pretty comprehensive inventory of items found in most businesses.

All of these assets can be suitable for transfer to a SPV. The more significant and reliable the cash flows generated by the asset the more suitable they are. Brand names, for instance, are often suitable as they are frequently the most valuable asset.

The process of transferring IP
There are six main stages for placing IP in SPVs:

1. Identification: The assets being considered for placement in an SPV need to be identified and defined. In some instances it may be necessary to bundle certain assets together to strengthen the IP. For example, for a pharmaceutical company it could be best to bundle a drug's patent, brand name and distribution contracts together in an SPV as the value is dependent largely on all three components over time. A musician could include the copyright for their back catalogue as well as their performance name. A magazine would need its masthead, brand name and customer lists. Marmite would need its recipe, brand name and design for its iconic bottle design.

2. Valuation: Once the intangible assets have been isolated their value can be quantified by an independent valuation expert. This would generally be done using a combination of the three accepted methodologies. The income approach drives the valuation and calculates the net present value of future cash flows attributable to the brand, usually using the relief-from-royalty approach. The market approach (which adjusts comparable transactions for parity) and the cost approach (which considers the cost of creating and recreating the asset) are used in support of the income approach.

3. Location for the SPV: Tax planning for the location of the SPV to hold the IP should concentrate on maximising the after tax profits for any business. The main factors to consider in choosing the location are:
• Tax treatment of the net income derived from the intangibles;
• Double tax treaty provisions between the parties; and
• Potential anti-avoidance provisions present in the jurisdiction regarding conditions surrounding the beneficial owner of IP.

4. Legal due diligence: The legal due diligence of a transfer would usually concentrate on the written contract between the royalty payer and receiver and the documentation for the licensing arrangements in place, and the technical attributes of the IP being transferred. In particular, consideration has to be given to:
• Setting up of arrangements for the transfer of the assets ensuring that their legal title is intact and can be adequately protected;
• Setting up formal licensing contracts between the relevant parties; and
• Setting up arrangements for the ownership for any improvements or modifications to the intangibles.
Many European jurisdictions have introduced tax incentives for some type of intangibles so as to make these locations attractive to multinationals.

5. Transfer of intellectual property: The transfer of IP should take into account the anti-avoidance provisions which are in place in most jurisdictions for the transfer of the ownership and development of the IP. For example in Luxembourg, provisions exist to deny the benefits of partial exemption (broadly 80% exemption for net IP income) for IP transferred from associated companies broadly defined as companies having a common shareholding in the company invoking the benefit of the regime. In addition, the transfer of IP should be at an arm's-length basis.

6. Management and issues after the transfer of intellectual property: There are many aspects to the management of IP once the transfer to the relevant SPV has taken place. Monitoring of IP rights should take place to ensure that there is continuing alignment of these rights to the business process on which the IP is based. Care should also be taken to monitor changes to the existing IP and to stop anyone else using such rights. Significant management time should be spent in this area.
From a tax perspective, the tax residence of the SPV should be maintained in the juridisction to which it has been transferred. This would require that the central management and control of the SPV is located in the jurisdiction in which it is situated. Where work is carried out by associates to maintain or develop the IP compensation for such services should take place at arm's-length rates.

Benefits
There are a number of commercial, management and tax benefits to be gained by placing intangible assets in SPVs. With the intangible assets ring-fenced they can be properly managed. Managing IP requires a number of different activities such as trade mark, patent and domain name registrations, watching services and rights enforcement. With all the IP held in one company this becomes much easier and more effective.

The process of transferring intangible assets can also expose areas of vulnerability. It ensures all appropriate ownership rights are in place and any gaps are filled. Having all the IP in one separate company is a clean way of operating and gives a good impression internally and externally during any subsequent sale negotiations relating to the business. The process of transferring intangible assets to a separate company is similar to the process used to securitise assets. The intangible assets could therefore be used as part of the collateral to invite outside investment.

Once an intangible asset, say a brand, is in a SPV it is then licensed back at a market rate to those who use it, either the original owners or a third party. This means that where previously the original company was using the brand for free, it now pays for its use through royalty payments. This enables management to monitor the strength of the brand by product, sector and territory. It also helps expose weak management and reward those whose brand contributions are significant and growing.

From a tax perspective, the SPV would normally be located in a low tax jurisdiction or a jurisdiction which offers tax incentives for the profits generated from intangibles.

However, the potential ease with which intangibles can move from location to location has meant that the pricing of any cross-border transactions in this area has always been of fundamental importance. Increasingly, this is also becoming the area of focus for many tax authorities in transfer pricing investigations, especially where complex supply chains are involved. Accordingly, a taxpayer should consider the following before implementing any IP strategy:

• The transfer of any intangible to an SPV is likely to result in a tax charge based on its market value;
• The licence fees for the right to use the intangible should be at arm's-length rates. Otherwise it is likely that the authorities may deny tax relief on the proportion of the compensation that is considered to be excessive;
• The SPV may be subject to the controlled foreign company legislation in the parent company location and this may erode potential tax benefits;
• The SPV should be the beneficial owner of the intangibles. However, many tax treaties include provisions for the limitation of treaty benefits where the recipient is not the beneficial owner of the IP; and
• Any work done by associated companies on the research or development to enhance the intangible or protect and maintain the IP should be priced at arm's-length rates.

Example 1
Let's take XYZ, the global fashion brand, for example. It sells its ranges of male and female fashion garments through the wholesale channel. Its retail division consists of licensed and owned stores and concessions through which XYZ branded goods are sold. It also licenses its brand for products such as fragrances, watches, footwear, eyewear, childrenswear, lingerie and branded mobile phones. It operates in the UK, Europe, US, Middle East, Asia and Australasia through these different channels.

As the brand is owned in the UK the existing royalty income of £5.3 million ($8.9million) from retail and product licences comes to the UK and is subject to the standard rate of tax, 28%. If, after a restructuring, the XYZ income stream could be treated as due in Luxembourg rather than the UK, the tax rate on that income stream could be as low as 5.9% instead of 28%, resulting in a 30% increase in after-tax return before capital costs compared to a UK location.

Careful planning is a must
Clearly, SPVs are an attractive form of vehicle for businesses to consider both from a commercial and tax perspective. In an increasingly global environment, IP rights can be transferred to suitable jurisdictions through the use of SPVs.

However any business strategy involving the use of SPVs has to also take into account the various commercial and tax issues associated with their use. Careful planning around these points is therefore a must for any business and advice should be sought on the overall intellectual property strategy before any structure is set in place. With careful planning and management of such intellectual property, the use of SPVs should bring advantages to businesses.