CAPITAL GAINS TAX ON INTANGIBLE ASSETS
You cannot touch me, but I can touch you.
I can’t hear you, but you can hear me.
I can't follow you, but you can follow me.
Intangibles are a source of intrigue – and often, they turn out to be far more valuable than tangible objects. Before this discussion takes a philosophical (or maybe even theological) turn, let’s manoeuvre it gently to the field of tax law. The monetary value associated with intangibles has often driven revenue authorities across the world to fight for taxing right over income arising from copyrights, brand-names, technical information, franchisee rights, and so on. These incomes could be in the nature of consideration for the right to use certain intangibles (characterized as royalties) or they may result from outright transfer/alienation of an intangible itself. This article shall primarily be concerned with the latter stream of income.
Under the Indian income tax law, i.e., the Income-tax Act, 1961 (‘ITA’), any income from ‘transfer’ of a ‘capital asset’ is taxable under the head ‘Capital Gains’. Both these expressions – ‘transfer’ and ‘capital asset’ – are defined under the ITA, and have been subject to significant litigation, judicial interpretation, and legislative amendments.
When does an intangible qualify as a ‘capital asset’?
Section 2(14) of the ITA defines ‘capital asset’ to mean ‘property of any kind held by an assessee, whether or not connected with his business / profession’. This definition has been held by several courts to be of wide amplitude to include every conceivable right or interest that a person may hold. As a result, different kinds of intangible rights have been held by courts, to qualify as capital assets.
While the ITA contains a tangential definition of ‘intangible assets’, it is in the context of ‘block of assets’ that can be depreciated. As a result, it has a very limited use for the purpose of determining Capital Gains Tax (“CGT”) implications for transfer of a capital asset. For instance, by virtue of an amendment made by the Finance Act, 2021, goodwill of a business/profession has been expressly excluded from the said definition of intangible assets. However, any gains on sale of goodwill of a business will not be exempted from CGT on account of this exclusion.
As a result of the wide import, gains on transfer of all such intangible assets that fulfil the test of being a ‘property held by an assessee’ will be liable to CGT under the ITA. Let us consider the likelihood of the satisfaction of this test by different kinds of intangible assets:
· Category 1: Traditional Intellectual Property Rights (IPRs), such as patents, copyrights, brand-names, trademarks, goodwill, technical information (in the form of a dossier), etc.
· Category 2: Commercial rights (other than the IPRs mentioned above) that are often transferred between businesses, such as licenses, right to collect toll, customer data.
· Category 3: Comparatively recent additions, such as Crypto-currencies, Non-Fungible Tokens (NFTs), and other virtual assets.
While the Indian jurisprudence on this aspect is evolving, it is generally observed that intangibles under Category 1 are readily accepted as ‘Capital Assets’. Even through treatment of rights listed in Category 2 as ‘capital assets’ is a subject matter of occasional challenges, more often than not, the Courts accept their characterization as ‘capital assets’. Regarding the recent entrants (enumerated under Category 3) their legal position is, at best, in its nascent stages.
Non-Residents (NR) and their capital gain taxation in India
Any income earned by a NR is taxable in India only if it accrues or arises in India (or is deemed to accrue or arise in India), or has been received by the NR in India. Tax treaties may provide respite from such taxation, in certain cases.
While the concept of ‘accrual’ is undefined and extremely broad, section 9 of the ITA specifies the incomes that are deemed to accrue or arise in India – which expressly includes all incomes accruing/arising, whether directly or indirectly, through the transfer of a capital asset ‘situate’ in India. While the situs of a tangible asset is unambiguously its physical location, in the context of an intangible asset the question arises – Where is it ‘situated’?
After all, this was the root of the (in)famous Vodafone tax battle, wherein the Indian Revenue argued that rights of management/control (again, an intangible) in relation to an Indian company are also capital assets, and that such assets are situated in India - which was subsequently legislated through a series of amendments in 2012.
Situs of IPRs from the perspective of taxability of the gains on their transfer has been debated both internationally and in India. The core question that arises is: at which of the following places is an intangible situated?
1. Domicile of legal owner of the intangible;
2. Country where substantial expenses have been incurred on development of the intangible;
3. Jurisdiction where the IP is registered, and which offers protection from its infringement;
4. Place where the IP is exploited; or
5. At more than one of these places.
Under Indian tax jurisprudence, the word so far has been the decision of the High Court of Delhi in case of CUB Pty Ltd. v. UoI wherein it was held that if the Indian legislature wished to tax CGT on intangibles owned by NRs, then it could have created a deeming fiction as regards the location of such intangibles (as it has done, for shares that derive their value substantially from assets located in India) but, it has not done so. As a result, situs of the owner of an intangible asset would be the closest approximation of the situs of an intangible asset.
At the same time, there already exist instances (particularly in international jurisprudence) where it has been held that if an intangible has become an integral part of business activity that has been occurring regularly in a jurisdiction, its situs can be said to be in such jurisdiction; irrespective of the fact that neither its owner is domiciled in that place, nor is the IP registered therein.
With an ever-growing focus upon contribution of intangibles to valuation of Business Transfer Transactions undertaken worldwide, and the application of DEMPE analysis for implementing the arm’s length principle for transfer pricing, it is unlikely that principles of application of CGT to intangibles will remain stagnant. Also, the ongoing pursuit for taxation of digital economy and highly digitized businesses is also likely to impact the CGT implications for the digital intangibles such as cryptos and NFTs. For example, experts have been pondering over recently, on whether transactions in crypto-currencies could be subjected to the 2% Equalization Levy (“EL”) in India. Now, if that becomes a settled position, would it mean that NR sellers (that do not ‘trade’ in such alt-coins) will pay this EL? Furthermore, will they be exempt from CGT on their crypto investments?
Lastly, tax treaty provisions will also acutely impact the CGT implications for intangibles. While certain treaties (such as the India US DTAA or the India UK DTAA) do not interfere at all with Source State’s right to tax any capital gains, most other treaties exclusively restrict taxing rights for CGT on intangibles, to Resident States, since they fall under residual category of capital assets.
It is, therefore, imperative, that due care is taken when planning any sale or alienation of intangible assets – taking into account all the factors outlined above.
As for the riddle at the beginning – there could be several responses. The one that’s my favorite is…music.
 Sec. 2(11)(b): Intangible assets, being know-how, patents, copyrights, trademarks, licenses, franchises or any other business or commercial rights of similar nature, not being goodwill of a business or profession.  241 Taxman 278 (Del.) Development, Enhancement, Maintenance, Protection and Exploitation (DEMPE) of intangibles
Cite This Article: Gaurav Singhal, 'Capital Gains Tax on Intangible Assets' (Tax Terminal Blog, 1st September 2021) <https://www.taxterminal.in/post/capital-gains-tax-on-intangible-assets>
Disclaimer - The views presented in this Article represent solely the views of the Contributor and do not in any way reflect or represent the views of the Organization with which the Contributor is associated.