How Do You Tax A Patent?

Introduction

A tax is a compulsory fee or financial charge levied by a government on an individual or an organization to raise revenue for public works.

According to Institute of Company Secretaries of India (ICSI) in their study module on IPR- Law and Practice for Professional Program, “the creation of human mind is protected by law with several measures and patent is one of them. Patent is a monopoly grant and it enables the inventor to control the output and within the limits set by demand, the price of the patented products.” Looking into this definition, it becomes evident that a patent is a legal right conferred on the inventor, allowing them to commercially exploit their invention and prevent others from making any unauthorized use of it.

Why Should Patents Be Taxed?

A granted patent enables the patent holder the right to restrict others from copying, manufacturing, selling or importing the patented innovation without their permission, This provides the patent holder opportunity to make good fortunes in the market by making commercial use of his invention.

In the meantime, the government needs tax contribution to continue its work. In the developing and less developed countries like India, tax revenue assumes a greater role to fulfil the welfare objectives and promote a better standard of living. One may also trace the redistribution of income and wealth in society as a basis for taxing the patent.

The Patent Taxation Regime in India

Generally speaking, taxes levied on inventions can be of two types. The first is the tax on income generated by the use of invention not patented. Such income/gain, generally, is taxed ordinarily according to the nature of the transaction.

For example: Mr. A, who has a partnership firm, in regular business of partnership, has invented a new production technique. Though, this invention was not patented, his partnership firm has allowed a U.S.A based producer to use this technique at the payment of certain fees. He pays this fees in dollars to this partnership firm registered in India. This particular income shall be taxed as an ordinary business/professional income received by the firm.

The second is any tax on the income/gains generated from use of patented invention. There are some special provisions for this.

Income earned from a patent is eligible for tax rebate, if the invention is patented under the Patents Act, 1970 as well as some other conditions. Section 115BBF (inserted with effect from 1^st day of April 2017) of the Income Tax Act, 1961, provides for a concessional tax rate of 10% on the income generated from royalties earned. Section 115BBF does not come into operation automatically- the patent holder has to opt for it. Such protection is applicable to all eligible assesses who are Indian residents and patent holders. To enjoy a tax rebate the patent must be developed and registered in India.

The total income of eligible taxpayers must include income by way of royalty, which is defined under Explanation (h) of the section. It states that royalty, in respect of the patent referred to under this section, is a consideration. It is an amount paid by a third party to an owner of a product or patent for the use of that product or patent. The terms of royalty payments are laid out in a licensing agreement. This can be in the form of sale or licensing of patent, but excludes income chargeable under capital gain and income derived from sale of products or processes in which the patent is used.

When Should You Make Use of Section 115BBF?

Section 115BBF has a few advantages. Once it has been put into practice, the royalty is first excluded from the taxable income of the assesse. Then this excluded royalty is taxed at a concessional rate of 10%. On the flip side, no other deductions can be made on the royalty income once Section 115BBF is put into place, and the section will be in effect for any royalty gains for the next 5 years.

In this case, it makes sense to use this provision when the sale and licensing of the patent is a primary or major source of income from the patent. Every assesse will need to of course consider the other incomes they have and weigh the benefit of subtracting the royalty gains from the net amount of earnings. All other options for deductions in respect to the patent must also be weighed before taking advantage of this provision.

What is the Advantage of this Provision?

This provision is based on the “Patent Box” regime initially developed in Ireland. It has been designed keeping in mind the industrial development of India. If a foreign company wants to claim concessional rate under this section then, it has to open its subsidiary in India and get the patent developed and registered in India. Another aim of the concessional taxation regime is to provide an additional incentive for companies to retain and commercialize existing patents and to develop new innovative patented products which in turn encourages companies to locate the high-value jobs associated with the development, manufacture and exploitation of patents in India.

Conclusion

A good taxation regime is fundamental fuel for boosting the research and development (R&D) and innovations. After tax reform in U.S.A there is spurge in innovation as evident from its ranking in Global Innovation Index 2021. India is also on the right track, as can be seen from the provisions discussed in this blog post. However, we still have a long way to go. Besides easing the tax regime on IPR, we also need to simplify compliance procedures and requirements. The structural bottlenecks has to be cured for making the tax regime on IPR more effective.

Author: Shubham Panwar, Legal Intern at PA Legal.

In case of any queries, kindly contact us here.