Integrating the IP of New Technologies: Global Tax and IP Risks
Many companies depend on the acquisition of IP-protected technologies through either internal R&D or M&A transactions. In either case, the company must integrate the relevant IP so that it can use the technologies to sell new products, conduct new research, or enter into new licensing agreements with third parties.
This process—known as IP integration—typically requires an intercompany licensing structure that poses two major risks. First, an intercompany licensing structure can create an increased tax risk, particularly if it involves cross-border licenses. In such cases, the taxing authorities may claim that the licensing structure effectively transferred the IP to an affiliate in a high-tax jurisdiction, even though the affiliate does not hold legal title to the IP. Tax authorities also routinely assert that the IP assigned or licensed in intercompany transactions was under- or over-valued, resulting costly, high-stakes disputes and potential assessments.
Second, a poorly drafted licensing structure can compromise a company’s ability to enforce its newly acquired IP. For example, in some cases, a company may adopt a licensing scheme that prevents it from obtaining an injunction or recovering lost profits in US litigation against infringing competitors. This is particularly true if the company designs and implements the structure based solely on tax considerations.
These risks underscore the importance of assessing—and mitigating—the tax and IP issues arising from a proposed intercompany licensing structure before acquiring new technologies through R&D or M&A deals.
1. IP Integration: The Need for Intercompany IP Licensing Structures
To properly integrate the IP for new technologies, an acquiring company must implement an intercompany licensing structure that conveys the IP to the proper affiliates.1 The first step in this process is determining which affiliate will own the IP, and what kinds of licenses will be given to other affiliates.
These issues will usually depend on the nature and purpose of the IP. For example, if the IP relates to a new research platform, the company may want to license the IP to an R&D affiliate so that it can use the platform to generate new products and new IP:
Intercompany Licensing Structure for Newly Acquired R&D IP:
On the other hand, if the IP relates to technologies that can immediately be used to make new products, the acquiring company may want to give its manufacturing affiliates the right to make the products, while sublicensing the right to sell the products to distributors in different jurisdictions:
Intercompany Licensing Structure for IP Relating to Marketed Products
These kinds of licensing structures are essential to enable the entire corporate organization to use, enforce, and sublicense the newly acquired IP. Yet, while critically important, they also pose risks of their own.
2. The Tax Risks Arising From Intercompany Licensing Structures
An intercompany IP licensing structure can create a significant tax liability, particularly if it involves affiliates in different jurisdictions and thus raises cross-border transfer pricing issues. Indeed, in recent years, the tax authorities in a growing number of jurisdictions have claimed that a post-merger licensing structure effectively transferred the IP out of the jurisdiction—thus triggering a so-called “exit” tax—even when the acquired entity remained the legal owner of the IP. 2
For example, in one recent case, an Israeli court upheld the imposition of an exit tax on a US company that developed the IP of a newly acquired Israeli subsidiary through a broad license. The court stressed that the license (1) gave the US parent an unrestricted right to use the IP, while reserving no rights for the Israeli subsidiary; (2) designated the US parent as the owner of any new intangibles developed with the licensed IP; and (3) was executed nearly two years after the license’s intended effective dates. Based on these and other facts, the court concluded that the Israeli subsidiary effectively transferred the ownership of the IP to the US parent, even though the subsidiary continued to be its legal owner and to collect royalties under the license.
In reaching this conclusion, the court relied on a familiar distinction in tax law between the legal owner of IP and its economic owner. 3 Under this distinction, the corporate entity assuming the greatest risk and cost in developing and using any intangible asset is deemed its economic owner—and thus subject to the greatest tax liability based on ownership and allocated income. To make this determination, many jurisdictions rely on the so-called “DEMPE” factors developed by the Organization of Economic Cooperation and Development—i.e., development, enhancement, maintenance, protection and exploitation. 4 Based on these factors, a revenue authority may determine that a corporate parent “transferred” the IP of a newly acquired subsidiary to a foreign jurisdiction when it licensed the IP to an affiliate located in that jurisdiction.
Another material risk relates to the valuation of IP assigned or licensed between affiliates following its acquisition. Tax authorities frequently assert that IP assigned or licensed between related parties is substantially undervalued relative to the “arm’s length price” that would have been paid by unrelated parties under similar circumstances. Such valuation challenges can result in a significant increase in taxable gain or royalty income, even if the company was diligent in conducting its initial valuation. Indeed, the US Internal Revenue Service recently issued guidance encouraging auditors to aggressively challenge initial valuations of IP assigned or licensed between related parties based on profits later actually realized from the IP’s exploitation, while limiting potential defenses.5 Moreover, tax authorities in the jurisdiction of the assignee or licensee may take the opposite position that the IP was over-valued, resulting in the loss of deductions for IP amortization or royalty payments and double taxation of the same income already taxed in the transferor’s jurisdiction.
In light of these considerations, a company acquiring IP-protected technologies—either through R&D or through acquisitions—should assess the tax risks arising from its proposed intercompany licensing structure before actually acquiring the technologies. Such an assessment may reveal ways in which the structure can be revised to reduce the tax risks. 5
3. The IP Risks Arising From Intercompany IP Licensing Structures.
An intercompany licensing structure is essential not only to convey the appropriate rights to the proper affiliates, but also to enforce such rights against third-party infringers. The nature of the necessary licenses will depend on the nature of the underlying IP.
a. Patents
In the case of patent-protected products, a key goal of the licensing structure should be granting exclusive patent rights to affiliates that are actually selling the products. This goal arises from the requirements of standing for patent enforcement actions against third-party infringers. In the U.S. and other jurisdictions, an affiliate lacks standing to join such an action unless it owns the patent or is an exclusive licensee. 6 Consequently, if the “selling” affiliate is a non-exclusive licensee (as is often the case in tax-driven structures), it will have no standing to join the lawsuit. 7
This point is important because a company generally cannot recover lost profits or obtain an injunction if the affiliate selling the patented product has no standing to join the lawsuit. 8 To be sure, the patent-owning affiliate can still bring an infringement action (because it owns the patent), but it cannot recover lost profits unless it actually sells the patented products. For this reason, the post-closing licensing structure must vest the US selling affiliates with an exclusive patent license to sell the patented product.
b. Trade Secrets
If the newly acquired IP includes trade secrets, the licensing structure must take several steps to ensure that the trade secrets can be protected and enforced. With respect to standing, only the “owner” of a trade secret can bring a civil action under the Defend Trade Secrets Act, but any party with lawful possession can bring a common law action for misappropriation. 9 Consequently, the acquiring company must decide what entity will be the owner of the new trade secrets and what entities will be the licensees.
Furthermore, to ensure enforceability, the trade secret licenses must also impose on the licensees specific obligations to protect the confidentiality of those trade secrets, including restricting employee access and use of such information. 10
c. Trademarks and Copyrights
If the new IP includes trademarks or copyrights, the licensing structure will need to identify what entity will be the registered owner of the marks or copyrights, and what entities will be licensees. For purposes of enforcement, the registered owner in each jurisdiction will generally have standing to enforce the mark or copyright in that jurisdiction, and, in the United States, an exclusive trademark licensee may also have standing, depending on the rights granted by the underlying license. As with any trademark license, the intra-corporate licensing structure should address quality control provisions to guard the value and validity of the licensed trademark.
4. Employment Agreements.
A final stage in the IP integration process deals with employment agreements that are put in place, which should contain sufficient provisions to (1) protect the confidentiality of the company’s proprietary information, and (2) ensure that any innovations developed by the employee are properly assigned to the company.
To achieve an effective assignment, the employment agreement must affirmatively recite that the employee “hereby assigns” all future innovations to a designated corporate affiliate. With this language, the assignment will automatically take place as a matter of law at the moment the employee conceives the invention.11 On the other hand, if the agreement merely reflects a “promise to assign,” it will not be sufficient to effect the assignment.12
In addition, the agreement should expressly identify the specific affiliate to which the future innovations will be assigned. In many cases, the employment agreement identifies the assignee as the “Company,” a defined term that includes the parent and all of its subsidiaries. However, in such a case, the future innovations will then be assigned—at the moment of conception—to every affiliate in the corporate organization, making each of them a co-owner of the invention:
Such a result could be problematic, particularly if the parent later sells or spins off an affiliate that co-owns the invention.13 If this occurs, the now-independent affiliate will be able to use the invention for its own purposes, and the innovator company will lose control of what could be a critical business asset.
Finally, in the case of multi-jurisdictional companies, one other factor warrants serious attention: The laws governing employee rights to innovations differ widely across jurisdictions. It is therefore critical that any revisions of employment agreements take into account such cross-border differences in governing law.
5. Mitigating the Risks Arising from Intercompany IP Licensing Structures
In light of the tax and IP risks arising from IP integration, a company should assess and mitigate those risks before acquiring IP-protected technologies. Such an assessment may reveal ways in which the proposed licensing structure can be revised to reduce the tax and IP risks. At a minimum, the pre-closing assessment should include the following steps:
- For each of the separate categories of IP (patents, trade secrets, trademarks and copyrights), determine which affiliate will be the legal owner of that IP and which affiliates will be the licensees;
- Determine the jurisdictional scope of each of the proposed licenses;
- Determine which of the proposed licenses will be exclusive and which will be non-exclusive;
- Identify what specific DEMPE functions will be performed by which affiliates and determine impact on existing transfer pricing model;
- Determine if any of the potential tax risks can be reduced by designating different affiliates to perform any of the DEMPE functions (consistent with the company’s business objectives);
- Determine what impact the above analysis has on the costs of the transaction;
- Confirm that the proposed licenses will contain provisions sufficient to protect the enforceability of each of the separate categories of IP; and
- Ensure that the relevant employment agreements adequately protect the IP relating to the new technologies.
In this way, the company can mitigate the tax and IP risks of IP integration, while assessing more accurately the costs of the transaction.
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The global tax and IP risks arising from an intercompany IP licensing structure shows why such structures should be carefully assessed before acquiring new technologies. At a minimum, such an assessment should (1) determine the affiliates proposed to be the owners and licensees of the specific categories of IP; (2) identify the nature of each of the proposed licenses; and (3) identify the DEMPE functions proposed to be performed by affiliates in specific jurisdictions. Only in this way can the company adequately manage the tax and IP risks, while and more accurately projecting the costs of the transaction.
1 See J. Ferguson, “Intercompany IP Licensing Structures: Tax and IP Issues,” 44 The Licensing Journal 1 (February 2024).
2 L. Vella, “Companies, Governments Clash Over Who Owns Intellectual Property,” Bloomberg Law (August 2024).
6 Ferguson, supra note 1; Mars, Inc. v. Coin Acceptors, Inc., 527 F.3d 1359, 1367 (Fed. Cir. 2008).
8 Ferguson, supra note 1; Poly-America, LP v. GSE Lining Technology, Inc., 383 F.3d 1303 1311(Fed. Cir. 2004).
10 Insulet Corp. v. EOFlow, Co., Ltd., 104 F.4th 873, 880 (Fed. Cir. 2024)
11 See, e.g., Abraxis Bioscience, Inc. v. Navinta, LLC, 625 F.3d 1359 (Fed. Cir. 2010).
13 See, e.g., Janssen Biotech, Inc. v. Celltrion, Case No. 1:17-cv-11008 (D. Mass.) (Oct. 31, 2017).
