The Republican tax reform bill submitted in the House of Representatives earlier this week has buried in it patent provisions that would devalue certain patent transactions in terms of tax advantage.
Under current law, an individual who creates a patent and an unrelated individual who acquires a patent from its creator prior to the actual commercial use of the patent may treat any gains on the transfer of the patent as a long-term capital gain. To qualify, the transfer must be of substantially all the rights to the patent, or an undivided interest therein, and cannot be by gift, inheritance or devise.
Under the proposed provisions – Sections 3311 and 3312 of the bill and found at pages 248-249 – the rule treating the transfer of a patent prior to its commercial exploitation as being available for long-term capital gains treatment would be repealed. The provision, if enacted, would become effective for dispositions after 2017.
This proposed change is accomplished through a series of amendments to the tax code. In addition to several conforming amendments, and striking 26 U.S.C. 1235, the following amendments would be made (with additions bold and underlined and language removed struck through).
26 U.S.C.1221(a) In general. For purposes of this subtitle, the term “capital asset” means property held by the taxpayer (whether or not connected with his trade or business), but does not include… (3) a patent, invention, model or design (whether or not patented), a secret formula or process, a copyright, a literary, musical, or artistic composition, a letter or memorandum, or similar property…
26 U.S.C.1231(b)(1) General rule. The term “property used in the trade or business” means property used in the trade or business, of a character which is subject to the allowance for depreciation provided in section 167, held for more than 1 year, and real property used in the trade or business, held for more than 1 year, which is not… (C) a patent, invention, model or design (whether or not patented), a secret formula or process, a copyright, a literary, musical, or artistic composition, a letter or memorandum, or similar property…
26 U.S.C. 901(l) Minimum holding period for withholding taxes on gain and income other than dividends etc. (5) Determination of holding period. Holding periods shall be determined for purposes of this subsection without regard to section 1235 or any similar rule without regard to any provision which treats a disposition as a sale or exchange of a capital asset held for more than 1 year or any similar provision.
Obviously, it is disheartening to see Republican leadership move to treat patents in this way, which suggests they do not view patents as a private property right. Not viewing patents as a private property right has become a growing and disturbing trend. It will be interesting to see whether Conservative groups, who have been very outspoken on patents being a private property right, will push back on this latest push to chip away at a property right of Constitutional magnitude.