Post-Merger IP Integration: Reducing Global Tax and IP Risks

In many M&A deals, the acquiring company seeks to use the acquired company’s intellectual property to sell new products, license new technologies, or conduct new lines of research. To do so, the acquiring company must design a post-closing, intra-corporate licensing structure that conveys the newly acquired IP rights to designated affiliates for specific purposes.

But, as I explained in a recent Bloomberg Law article, this process—known as post-closing IP integration—can often lead to both tax and IP risks.¹ In this Legal Update, I discuss those risks and how a company acquiring IP through an M&A deal can mitigate the risks (and reduce the costs of the transaction) by conducting a pre-closing assessment of the tax and IP issues.

TAX RISKS

In recent years, national tax authorities have focused on post-closing licensing structures, particularly those raising transfer pricing issues through their use of cross-border licenses. For example, in several recent cases, national tax authorities have asserted an “exit” tax based on an acquiring company’s decision to license the IP rights of a newly acquired domestic subsidiary to a foreign affiliate. In each case, the authorities claimed that the acquiring company transferred the ownership of the IP out of the jurisdiction, even though the domestic subsidiary continued to hold legal title to the IP.

In making these claims, the tax authorities rely on a key distinction in tax law between the legal owner of IP (i.e., the affiliate holding legal title) and the economic owner of IP (i.e., the affiliate bearing the greatest economic risk in developing or using the IP). To determine the economic owner, many tax authorities use the so-called “DEMPE” factors of Development, Enhancement, Maintenance, Protection and Exploitation. Under these factors, an affiliate may be deemed to be the economic owner of certain IP (and therefore subject to greater tax liability) if it controls the development, exploitation, and/or protection of the IP.

In light of these developments, a company acquiring IP in an M&A deal should conduct a pre-closing assessment (detailed below) of the tax risks arising from its proposed IP integration strategy.

IP RISKS

Apart from tax risks, a post-closing licensing structure can also undermine the acquiring company’s ability to protect and enforce its newly acquired IP. To avoid these risks, the licensing structure must meet certain requirements that vary with each category of IP.

• Patents. In the case of patents relating to R&D technologies, the licensing structure must confer rights on the appropriate research affiliates, specifying both the scope of the research and the owner of any new IP produced by the R&D. Alternatively, if the patents relate to currently marketed products, the licensing structure must include licenses to the product-selling affiliates, vesting them with sufficient exclusive rights to confer standing to join a patent infringement suit. If the product-selling affiliates lack standing, the company won’t be able to recover lost profits or obtain an injunction. To be sure, the patent-owning affiliate can still bring the action (because it owns the patent), but it cannot recover lost profits or obtain an injunction if another affiliate is selling the patented products.
• Trade Secrets. If the case of trade secrets, the licensing structure must take several steps to protect the enforceability of the proprietary data. With respect to standing, only the “owner” of a trade secret can bring a civil action under the Defend Trade Secrets Act, but any party with lawful possession can bring a common law action for misappropriation. Consequently, the post-closing licensing structure must identify which entity will be the owner of the new trade secrets and which entities will be the licensees. Furthermore, to ensure enforceability, the licenses must impose on the licensees specific duties to protect the confidentiality of the trade secrets, including restrictions on employee access and use of the data.
• Trademarks and Copyrights. In the case of trademarks or copyrights, the post-closing licensing structure must identify which entity will be the registered owner of the marks or copyrights in each jurisdiction and which entities will be licensees. For purposes of enforcement, the registered owner in each jurisdiction will generally have standing to enforce the mark or copyright in that jurisdiction, and, in the United States, an exclusive trademark licensee may also have standing, depending on the rights granted by the underlying license.

CONDUCTING A PRE-CLOSING IP-TAX RISK ASSESSMENT

In light of the tax and IP risks arising from post-closing IP integration, an acquiring company should assess and mitigate those risks before closing the deal. This assessment may reveal ways in which the proposed licensing structure can be revised to reduce the tax and IP risks, while enabling the company to include any projected tax liability in the costs of the transaction. At a minimum, the pre-closing assessment should include the following steps:

• For each of the separate categories of IP (patents, trade secrets, trademarks, and copyrights), determine which affiliate will be the legal owner of that IP and which affiliates will be the licensees.
• Determine the jurisdictional scope of each of the proposed licenses.
• Determine which of the proposed licenses will be exclusive and which will be non-exclusive.
• Identify what specific DEMPE functions will be performed by which affiliates and determine the impact on any existing transfer pricing model.
• Determine if any of the potential tax risks can be reduced by designating different affiliates to perform any of the DEMPE functions (consistent with the company’s business objectives).
• Determine what impact the above analysis has on the costs of the transaction.
• Confirm that the proposed licenses will contain provisions sufficient to protect the enforceability of each of the separate categories of IP.

In this way, the company can mitigate the tax and IP risks of IP integration while assessing more accurately the costs of the transaction.

¹ J. Ferguson, “Mergers Involving IP Need Care to Lower Tax Risks, Enforce Rights,” Bloomberg Law (January 21, 2025) Copyright 2025 Bloomberg Industry Group Inc. (800-372-1033) www.bloombergindustry.com.