Exploitation of Intellectual Property

Originally published April 2004

TABLE OF CONTENTS

1. INTRODUCTION

2. WHAT IS INTELLECTUAL PROPERTY?

   1. In General

   2. Patents

   3. Trademarks and Servicemarks

   4. Copyrights

   5. Trade Secrets

3. ISSUES RELATING TO TAX-EXEMPT STATUS

   1. Primary Purpose Test

   2. Scientific Research

      1. Public Interest Requirement

      2. Relevance of Ownership of Intellectual Property

      3. Exploitation of Intellectual Property as Primary Purpose

      4. Exploitation of Intellectual Property as an Insubstantial Purpose

   3. Publishing

   4. Private Benefit Test

   5. Prohibition Against Private Inurement

4. UNRELATED BUSINESS INCOME TAX ISSUES

   1. Overview

   2. Imposition of UBIT

   3. "Relatedness" of Intellectual Property Commercialization Activities

      1. Scientific Research

      2. Broadcasting

      3. Publishing

   4. Exclusions from UBTI

      1. Research Income

      2. Royalties

5. STRUCTURES FOR COMMERCIALIZING INTELLECTUAL PROPERTY

   1. Licensing Intellectual Property in Exchange for a Cash Royalty

      1. Business Aspects of Licensing

      2. Typical Arrangements

      3. Tax Aspects

   2. Licensing Intellectual Property in Exchange for a Non-controlling Equity Interest

      1. Business Considerations

      2. Typical Arrangements

      3. Tax Aspects

   3. Using Controlled Subsidiaries for Commercialization of Intellectual Property

      1. Business Considerations

      2. Tax Aspects

      3. Tax Planning for Controlled Subsidiaries

   4. Joint Ventures

      1. Overview

      2. UBIT Issues

      3. Tax Exempt Status Issues

6. SHARING ROYALTIES WITH CREATORS OF INTELLECTUAL PROPERTY

   1. Impact of the Bayh-Dole Act

   2. Private Inurement and Private Benefit Issues

      1. Reasonable Compensation

      2. Incentive Compensation

      I. INTRODUCTION

      Many exempt organizations own valuable intellectual property rights that can be used by the organization to achieve the exempt purposes for which it was established or to provide an additional source of revenue for the organization. Where the value lies in an organization's intellectual property will depend to a large extent on the nature of the organization and its activities. For example, many large public charities that are well known and widely supported have valuable trademarks, reflecting the value of the organization's goodwill. Many scientific organizations and universities own valuable patents. This has been particularly true since the passage of the Bayh-Dole Act in 1980, which permits nonprofit organizations and universities to patent inventions resulting from federally funded research. Finally, organizations that accomplish their exempt purposes through publishing, broadcast, or other media may own valuable copyrights.

      As with any business or investment transaction, a transaction involving intellectual property can be structured in many different ways, and many business and tax considerations are taken into account in deciding on the appropriate structure. Thus, an exempt organization may transfer or assign its intellectual property to a corporation or joint venture in exchange for an equity interest, or it may license its intellectual property to a third party for a royalty payment.

      This outline discusses some of the business and tax issues that arise in connection with the exploitation of intellectual property by exempt organizations and considerations in structuring such transactions.

      II. WHAT IS INTELLECTUAL PROPERTY?

   1. In General

      The most common types of intellectual property are trademarks and servicemarks, copyrights, patents and trade secrets. Each of these types of intellectual property is governed by a different set of laws.

      B. Patents

      A patent issued by the United States Patent and Trademark Office ("USPTO") confers on the inventor certain exclusive rights in his or her invention. To obtain a patent, an application must be filed with the USPTO showing that the invention is patentable. A patent generally will not be granted if the invention has already been patented or described in a publication more than one year prior to the filing of the patent application. The inventor is entitled to own the patent unless he or she has entered into an agreement providing otherwise. Universities, for example, frequently enter into agreements with faculty members regarding the ownership of patents for any inventions arising from university-sponsored research projects and the division of any income earned from such patents.

      The property right conferred by the patent grant is, in the language of the statute and of the grant itself, "the right to exclude others from making, using, offering for sale, or selling" the invention in the United States or "importing" the invention into the United States. What is granted is not the right to make, use, offer for sale, sell or import, but rather, the right to exclude others from making, using, offering for sale, selling or importing the invention.

      Generally, the term of a new patent is 20 years from the date on which the application for the patent was filed in the United States or, in special cases, from the date an earlier related application was filed, subject to the payment of maintenance fees. U.S. patent grants are effective only within the United States, U.S. territories, and U.S. possessions. Under certain circumstances, patent term extensions or adjustments may be available.

      There are three types of patents:

      Utility patents may be granted to anyone who invents or discovers any new and useful process, machine, article of manufacture, or compositions of matters, or any new useful improvement thereof;

      Design patents may be granted to anyone who invents a new, original, and ornamental design for an article of manufacture; and

      Plant patents may be granted to anyone who invents or discovers and asexually reproduces any distinct and new plant variety.

      C. Trademarks and Servicemarks

      A trademark is a word, name, symbol, or device that is used in trade with goods to indicate the source of the goods and to distinguish them from the goods of others. A servicemark is the same as a trademark except that it identifies and distinguishes the source of a service rather than a product. The terms "trademark" and "mark" are commonly used to refer to both trademarks and servicemarks.

      Trademark rights may be used to prevent others from using a confusingly similar mark, but not to prevent others from making the same goods or from selling the same goods or services under a clearly different mark.

      The basis for enforcing a right to a trademark arises from its use in commerce, not from registration. Trademarks may be registered on the basis of actual use or a bona fide intent to use. If registered on the basis of intent to use, the registrant may file for an extension of time for successive six-month periods up to a period of three years and then must file a Statement of Use, showing actual use.

      Trademarks that are used in interstate or foreign commerce may be registered with the USPTO. Registration is not required, but it offers certain benefits.

      D. Copyrights

      Copyright is a form of protection provided to the authors of "original works of authorship" including literary, dramatic, musical, artistic, and certain other intellectual works, both published and unpublished. The 1976 Copyright Act generally gives the owner of a copyright the exclusive right to reproduce the copyrighted work, to prepare derivative works, to distribute copies or phonorecords of the copyrighted work, to perform the copyrighted work publicly, or to display the copyrighted work publicly. The owner of a copyright is the creator unless the work is a "work made for hire" as defined in the Copyright Act. "Works made for hire" include works prepared by an employee within the scope of his or her employment and certain specially commissioned works if the parties agree in writing prior to creation of the work that it will be treated as a work made for hire. The copyright for a work made for hire is owned by the employer or commissioner of the work.

      Unlike a patent that protects an idea, a copyright protects the form of expression rather than the...