Benefits of the Intellectual Property Holding Company
February 16, 2022
Many companies invest significant funds to develop products and services and the related intellectual property and to retain ownership of such assets. This intellectual property can be a critical element for the success and continued growth of the business. But many nosiness owners focus on the operations of the business and do not take advantage of the tax benefits and liability protection that may be afforded by use of an intellectual property holding company.
In the typical operations of a small or mid-sized business, for example, intellectual property is held in the primary business entity – meaning the same entity within which the business also operates. Such intellectual property rights include, for example, patents, copyrights, trade secrets and trademarks. Minimal tax deductions are taken for the intellectual property rights after development, and liability related to intellectual property rights remain within such entity.
The intellectual property holding company improves upon this situation. The intellectual property holding company is a separate entity created for the special purpose of holding and managing the intellectual property assets. The intellectual property is transferred and assigned to the holding company whether for cash, stock, or otherwise, usually via a tax-free exchange. The intellectual property is then maintained and managed by the holding company. When a company has multiple operating entities, the case for an intellectual property holding company only gets stronger.
One benefit results when the holding company licenses the intellectual property rights to the operating entity in exchange for a reasonable royalty fee. The operating entity then enjoys the benefit of deducting the royalty payments as a business expense of the operating entity, reducing the net income of the operating entity. This license can be exclusive to the operating entity with worldwide rights. In the alternative, the license can be non-excusive providing the option to license some rights to third parties for further royalties.
The key element in this approach is that the intellectual property holding company is formed in a State or jurisdiction with substantially low taxes. The intellectual property holding company receives the royalty payments which will then be taxed at a low level. In the United States, for example, the State of Delaware, among others, offers favorable tax treatment. Under its tax code, Delaware collects zero tax on income relating to intangible assets held by a holding company, such as patents, trademarks, and other intellectual property. Worldwide, several foreign countries also offer such favorable tax treatment.
Care must be taken so that ownership of certain intellectual property is maintained after transfer to the holding company. For example, the holding company will be the trademark owner but will not be directly using the trademarks in commerce, and accordingly the holding company must appropriately maintain the trademark registrations via claims of use by the related entity.
Another benefit results from the separation of the intellectual property from the operating entity. The holding company now provides a shield from liability for the intellectual property assets. If the operating entity suffers a financial disaster or is sued over product claims, the intellectual property assets will be shielded.
Another benefit is that the intellectual property holding company may help facilitate certain financing. The holding company holds the intellectual property, collects the royalties, and pays the lender.
In conclusion, as a business grows and becomes profitable, owners should consider whether setting up an intellectual property holding company is the right step for them. Tax benefits and liability protection can be achieved. However, specific laws in some states that are applicable to the operating entity must be examined to assess any limitations on the holding company tax advantages.
1 Vasilios Peros is founder and principal of Law Office of Vasilios Peros, P.C. He provides legal advisory and business advisory services to clients across various industries. His practice is focused primarily on business, technology and intellectual property law. He has been recognized as one of Greater Baltimore’s top attorneys, including SmartCEO’s 2016 Centers of Influence, 2015 CPA + ESQs, 2014 Power Players, and Legal Elite in 2011, 2010 and 2009. He can be reached at (410) 274-2053 and VPeros@PerosLaw.com.
2 This article is provided for informational purposes only and should not be construed as a legal opinion or legal advice. The reader should not rely on this article in making business, legal or other decisions on any matter without first consulting an attorney regarding any such decision or undertaking.