June 9th, 2009
A Tax-Saving Strategy for Trademarks &
Customer-Based Intangible Transfers
Edward E. Pratesi CPA/ABV, ASA, CVA
Managing Director
Brentmore Valuation Advisors, LLC
Monetizing certain intangible assets such as trademarks, trade names and other customer-based assets has been a rather straightforward affair - either contract for an outright sale of the property or arrange an out-bound license. The taxation of the transfer, however, has been the subject of constant litigation between the IRS and taxpayers. Generally speaking, if the transfer is a license, the income received is taxable as ordinary income. Alternatively, if the transfer is deemed to be a sale, the sale proceeds received would be taxed at capital gains rates.
An alternative tax treatment or tax deferral is available for certain classes of assets under Code Section 1031 that provides that no gain or loss is recognized for like kind exchanges of certain qualifying assets. The tax basis of the assets exchanged remains the same in each holder's hands, except if cash is exchanged in the transfer. The exchange must meet certain conditions in order to qualify for the deferred tax treatment, most important of which is the need for each property to "like kind." Unfortunately, prior to a recent IRS pronouncement, tax-free exchanges of trademarks, trade names and other customer-based intangibles were ineligible for this tax-deferred treatment.
Without a long discussion of the historical treatment of the sale and/or licensing of these "customer-based intangibles," the IRS as recently as 2006 and 2007 had indicated that trademarks and trade names of a business entity could not be valued and separated from the "goodwill" or going concern value of a business. And, under the Internal Revenue Code the goodwill or going concern value of a business can not be considered to be a "like kind" asset for purposes of an exchange for the goodwill or going concern value of another business, thus positioning trademarks and other customer-based intangibles as ineligible property for exchange treatment.
On February 12, 2009 the IRS issued an advisory memo concluding that if certain intangible assets, such as trademarks, trade names, mastheads and other customer-based intangibles (subscriber lists, insurance expirations, patients or clients, for example) can be separately described and valued apart from goodwill, then these assets can be eligible for tax-free exchange treatment under Code Section 1031.
It is important to note, however, that the exchange must be of "like kind" property. Under regulations set forth by the Service prior to this advisory memo, like kind properties must meet a two-pronged test to be a like kind exchange - the nature of the rights being transferred and the nature of the underlying property to which the intangible asset relates must be like kind. Thus, for example, an exchange of a patent for a trademark would not meet the two-pronged test under the existing rules. In order to gauge the impact of this memo we will separate the assets covered into two asset categories - "Registered Property - Trademarks & Service Marks" and "Customer-Based Intangibles:"
Registered Property - Trademarks & Service Marks
- The impact of this change can be significant for certain corporations and other entities holding portfolios of registered trademarks and/or service marks as well for holders of under-utilized or unused property. Aggregators of registered intellectual property may find it beneficial to exchange trademarks and/or service marks with other aggregators or with other entities to avoid immediate taxation. This can be particularly important where one or more of the parties has a very low tax basis in the intellectual properties
- The ability to utilize the tax-free exchange provisions of the Code presents an alternative to the typical monetization avenues - selling to an aggregator, selling at auction or using an IP consultant to sell or market the property. It does, however, appear that the use of an IP consultant or IP investment bank may be necessary in order to find the appropriate channel for marketing the property.
Customer-Based Intangibles
For customer-based intangibles the options are interesting as well, as the potential for exchanges of customer lists, subscriber lists and other customer-based property becomes apparent.
- A property & casualty agency, for example, can bundle a segment of customers or markets to trade with another agency.
- Aggregators of domain names and sites, for example, may be able to find an ability to use exchange treatment to their advantage, especially where the cost basis is low.
- Again, as above, under-utilized or unused customer-based intangibles may also represent an exit strategy.
- Arguably, financial institutions that are seeking to minimize a presence, for example, in a particular geographic area or a type of customer can look to trade a portfolio of customers for a like kind portfolio of customers in a different geographical area or having a slightly different customer profile.
In the past the Service has construed the definition of like kind very narrowly for both tangible personal property and intangible personal property much more so than the standard applied to Real Estate exchanges. With this recent pronouncement it will be interesting to follow future developments of the like kind test.
Edward Pratesi is the Managing Director of Brentmore Valuation Advisors, LLC, an intellectual property and technology-based valuation firm based in Farmington, CT.
