A popular method for protecting and managing intellectual property (“IP”) assets — high valued assets, in particular — is to transfer them to a special company created for the purpose of creating, protecting, licensing, and monitoring, IP. Typically, a corporation may create a subsidiary to hold its IP, which it may license back to the parent and, perhaps, to third-party licensees.
Assuming that the holding company’s relationship with its parent is arms’ length and that it obeys all the appropriate corporate formalities, isolating the intellectual property protects the holding company from lawsuits against the parent, claims of the parent’s creditors, and the parent’s insolvency. It might also protect the IP from hostile takeovers of the parent company. Placing IP in a separate holding company may also provide an objective measure of its value, uncluttered by the operations of the parent. This may be of particular importance for obtaining financing and eventually selling the IP to a third party. From the income tax perspective, the Parent may deduct the royalties it pays to license the IP. Relieving itself of IP ownership may also reduce tax consequences based upon the parent’s net worth such as franchise taxes. Of equal importance is that the holding company subsidiary may not be liable for state income tax solely because it is a holding company. At the same time, the holding company is available to offer services to the parent as well as make loans and pay dividends.
Sound too good to be true? You may be right. States generally have an aversion to IP holding companies because they perform services but do not generate taxable income. Some states aggressively audit IP holding companies, hoping to “pierce the corporate veil” by proving that the holding company is the alter ego of its parent. Should the state require combined reporting for parent and sub as a result of an audit, it would eliminate the tax benefits of the arrangement altogether. North Carolina and some other states have enacted anti-passive investment company laws designed to eliminate the tax benefits of the intangible holding company. In recent years, IP holding companies have been challenged in Connecticut, Maryland, Massachusetts and New York. State legislative bodies in Connecticut, New York, Alabama, Mississippi, New Jersey, North Carolina, and Ohio have enacted so-called “Add Back” statutes. The Model Add Back statute provides that
For purposes of computing its net income under this chapter, a taxpayer shall add back otherwise deductible intangible expense directly or indirectly paid, accrued or incurred in connection with one or more direct or indirect transactions with one or more related members.
The bottom line is that if you believe that creating an IP holding company may be of benefit to your organization, you should be wary of the tax consequences, and plan to operate the holding company in accordance with state statutes to gain the expected benefits. Be sure to contact your tax professional as well as your lawyer to determine if having an IP holding company is right for your situation. Let us know if Lipton, Weinberger & Husick can help.
— Adam G. Garson, Esq.