The Tax Cuts and Jobs Act (the “Tax Act”) introduced changes to the U.S. tax code in December 2017. Taking effect in 2018, tax reform is expected to have a substantial impact on both US and global business, including the valuation of intellectual properties and intangible assets.
From a valuation perspective, the value of any asset is based on the present value of after-tax cash flows to be generated from ownership of the asset. This is true for IP assets as well. Any cash flow that can be apportioned specifically to an IP asset will increase if a lower tax rate is applied. Therefore, all other things being equal, the value of IP assets that contribute to the generation of cash flows at a business will increase based on the now lower tax rate. This is simple valuation math: lower tax rate equals higher after-tax cash flows.
“With lower tax rates on corporate earnings, the benefits of transfer pricing transactions are likely to be reduced. Therefore, rather than viewing IP as a means to avoid taxes, corporate IP owners should now focus more attention on strategies to leverage their IP into additional earnings.”
IP can contribute to cash flows by enhancing the financial performance of the business using the IP, or through generation of royalties in a licensing transaction. To value IP assets based on their contribution to financial performance, the valuation analyst needs to undertake an apportionment exercise. The apportionment analysis assigns a portion of cash flows to each of the assets and resources that are used in the process of developing and selling the product or service. If a patent can be apportioned to 10% of a product’s cash flows, the patent’s valuation is based on 10% of the product’s forecast cash flow. Apportionment is the exercise employed to determine the 10% apportionment rate. The valuation of any royalties generated by licensing transactions will also be subject to a lower tax rate. All else being equal, lower tax rates should increase the value of cash flows generated by IP assets.
To date, many businesses with operations in multiple tax jurisdictions have used IP assets to lower their corporations overall tax expense. This works by domiciling the IP in a subsidiary located in a lower tax rate jurisdiction. Operations in higher tax rate jurisdictions pay a royalty to use the IP in order to lower their tax exposure in the high tax jurisdiction. Such transfer pricing is a topic beyond the scope of this post, but the Tax Act should change how IP owners employ their IP assets. With lower tax rates on corporate earnings, the benefits of transfer pricing transactions are likely to be reduced. Therefore, rather than viewing IP as a means to avoid taxes, corporate IP owners should now focus more attention on strategies to leverage their IP into additional earnings. As IP Strategy advisors, Nevium has helped companies ranging from non-profit organizations and rock bands to consumer products and technology companies identify and execute strategies to leverage their brand assets, copyrights and patents into additional earnings. Our work has included analysis of potential licensing opportunities, evaluating acquisition offers, and quantifying the impact of new pricing strategies. We suggest more IP owners consider new strategies to leverage their IP.