C. P. Schumann, P.C.
Business Valuation, Accounting, and Litigation Support

Legal Aspects of Intangible Assets

Intellectual Property

Legal Aspects of Intangible Assets

Before considering various classes and types of Intangible Assets, it is helpful to be aware of their legal position. Some protection dates back to antiquity. As early as 500 B.C. in the Greek city of Syracuse, any cook who created a unique dish had exclusive rights to the profits from it for one year. "Adaptations" were frowned upon and punished.

In the fourteenth century, European monarchs began granting temporary monopoly privileges to encourage local industry such as the spinning of wool. This was done by a document called a "Letter Patent." As the printing press spread and fostered distribution of information throughout the Western world, under common law, judges with feudal powers in England and France created the concept of "copyright," which, for a limited time, gave the author control over his work.

Underlying Principles

Intellectual Property law is based on two principles: fairness, and the public encouragement of creative intellectual endeavors.

The first, which is a philosophy rather than written in stone, has been disputed for many years. For example, in declining the offer of a patent, Benjamin Franklin stated:

"As we enjoy great advantages from the inventions of others, we should be glad of an opportunity to serve others by the invention of ours, and this we should do freely and generously."

Alas, that lofty notion has been adhered to only rarely. One shining exception is Banting and Best in the 1920s offering newly discovered, laboratory-created insulin free to diabetics.

The second principle is based on the concept that both, economic incentives and certainty of financial returns are required to encourage creative activity. Since Intellectual Property rights help ensure a return from innovation, there is a strong belief that their protection promotes investment, transfer of technology and international trade.

Therefore, for a specific period, set out in local statutes, the law gives inventors of new products or processes the right to control and profit from the exploitation of their ideas. It also shields those who use certain marks to distinguish their products or services.

While ideas are often the basis of commercial success, it may not always be possible to protect them as Intellectual Property. Examples include scientific principles; mathematical theorems, surgical techniques, business methods, etc. Some patents, which are being disputed, have been granted in the US for the latter two. In another category, that of higher life forms, further conflict is likely in the future. For instance, the Harvard Mouse was patentable in the US, but not in Canada nor in various other countries. A splendid article on the practical and legal fundamentals of Intellectual Property is available at www.fplc.edu/tfield/pLfip.htm.


In the late nineteenth century, patents created popular myths and heroes. Thomas Edison, who was granted over 1,000 patents in his lifetime for inventions, such as the light bulb, the phonograph, even movies, was such a folk hero. Crowds mobbed his laboratory to see what he was doing. Robber barons fought for control of his patents, giving rise to widespread criticism of Intellectual Property rights as protecting the interests of those with the resources to pursue litigation over those of the individual inventor. Edison described a patent as nothing more than an "invitation to a law suit," stating with some exasperation:

"My electric light inventions have brought me no profits, only forty years of litigation."

However, he did not die a poor man.

What is a Patent?

Patents protect inventions. They give the inventor of a new product or process the exclusive right to make and sell it in a particular country for a fixed period, usually twenty years. The monopoly period begins on the date the patent application is filed, but does not become enforceable until it is granted, usually two to three years later.

There are five categories' of patents: art, process, machine, manufacture, or composition of matter. In general, they are granted to protect functions, such as the interaction of parts of a machine or product (product patent), or the steps of a method (process patent). In the U.S., they also protect designs and, in the case of some pharmaceuticals, how the drug works in the body.

A separate application must be made in every country, or group of countries in which protection is desired. It consists of two parts:

  1. The disclosure that describes how the product is made, or the best way to perform the process or method, and
  2. The claims, which define the boundaries of the monopoly.

Before issuing a patent, a Patent Office compares the application with other known products and processes, often in the form of previously issued or rejected patents. During the review, the application may be reworked to have it properly reflect its innovative aspects.

The Role of Patents

At the beginning of the third millennium, while Intellectual Property does not grasp public imagination in quite the same way as in Edison's time, a situation reminiscent of the great patent wars of the late nineteenth century seems to be shaping up. The number of patents issued in the United States (over 150,000 per year between 1998 and 2002) is nearly double that of a decade ago. The European Union's Patent Office has a slower growth rate, which is partly due to its search for objections and opposition before issuance.

Patents are not global, as they do not give protection outside the country of issue. However, if an idea has been patented in one country, only the same person can patent it in another. For example, only the person who holds the patent for, say, a "left-handed non-reciprocal screwdriver" in Italy can apply for a parallel patent in Brazil.

To satisfy growing demands from inventors for global patents, the world's patenting systems are slowly becoming more uniform by means of an international patent mechanism arranged by the United Nations' World Intellectual Property Organization.

The Scope of Patents

Such globalization may prove difficult, because the rules of one country as to what is patentable may be rather different from regulations in another.

For example, in the U.S., software and business processes can be patented; so can software in Canada, but neither are patentable in Europe. Laws relating to bio-technological composition of matter encompass more items in the U.S. than in other developed countries. Patents may be obtained not only on microorganisms and biological material, but also on plants and animals, such as the previously mentioned Harvard Mouse. In Europe, no such patents would be granted. In the U.S., applications have even been made concerning genes, and patents are being issued not only for pharmaceuticals, but also for antibodies used in genetic testing and for modified agricultural products, such as canola (rapeseed).

More and more software-related patents, including those for business processes (as was done for instance by Alcoa), are being issued in the U.S. However, for two reasons, they are becoming less relevant for high-tech firms. First, technology changes so rapidly that a patent can easily be obsolete by the time it is granted, which usually means that high costs have been incurred without much practical gain. Second, many young companies do not have the financial resources to apply for, maintain and protect patents, which require disclosure of much, often highly significant information concerning the product. Therefore, most early-stage enterprises tend to rely on trade secrecy laws instead of patents.

Recent Trends

The attitude that a patent was not an "incentive to creativity," but a "tool of monopoly" was prevalent from about 1890 to 1980. That year, the Supreme Court found in favor of several patent-holders in a contested case that previously would likely have been turned down. At the same time, Congress set up an appeals court to which all patent disputes were to be referred. This procedural reform, intended to clarify inconsistent decisions, had a dramatic effect: previously, roughly one in three patent-holders won their cases; now two in three are successful.

Enterprises increasingly realize that among the few remaining barriers to entry are patents that grant twenty-year monopolies. One entity was particularly smart in quickly to recognize this: Dell's manufacturing and testing procedures required by its build-to-order systems are complex, but without patents on the process, others could copy it without much difficulty. By mid-2002, Dell had 77 patents protecting different parts of its methods and processes, giving it a competitive edge.

Patents can be crucial to building a company. Bio-tech firms, which often make no profit for years, depend almost totally on their Intellectual Property to establish their worth for raising funds. Other technology companies exploit their patents to increase earnings. Until the 1990s, IBM, which obtained ten new patents throughout the world every business day, treated its portfolio as a means of defense, but then their strategy changed. An active licensing program helped build the market for its know-how, and boosted such revenues by 200% between 1994 and 1999; in the last year, they represented close to 20% of total profit.

Entities are no longer merely patenting goods they have already made, but are using strategic patenting to colonize new areas of technology. Things to be patented do not have to be completed by an inventor as long as he can plausibly describe how he plans to make it. Valuation analysts should enquire if a Reporting Unit's operating methods may infringe on one of the numerous "business process" patents and take into account that possibility in establishing its Fair Value.


It is considered that there is a general social benefit to providing authors with control of their original literary, musical, dramatic or artistic works. For this reason, a copyright grants him a bundle of exclusive rights to authorize {or prohibit} the following uses:

  • Reproducing it in whole or in part
  • Making a new (derivative) version
  • Distributing copies by selling, renting, leasing, or lending
  • Performing (e.g., reciting, singing, dancing, or acting) it in public
  • Displaying it, directly or by means of film TV, slides, or other devices or processes

Those rights are violated when anyone copies, adapts, publishes or takes excerpts from a copyrighted work without explicit permission.


The above definition uses the term "author," which includes artists, composers, photographers, computer software programmers and other creative individuals. Since copyrights are sometimes granted to businesses, e.g. Walt Disney movies, an author can be a corporation or other business entity.

Basically, while ideas cannot be copyrighted, the process provides legal protection regarding the original expression of ideas and the way they are presented. In most instances, the author of the original work owns the copyright, but there are three exceptions:

  1. If, in the normal course of employment, an employee creates the copyrighted material, the employer owns the copyright. This is called work made for hire.
  2. If the copyrighted material is commissioned by a patron and the author so agrees, the patron owns the copyright. An example of this may be the creation of a TV commercial.
  3. If the author sells the copyright, it is owned by the buyer regardless of whether the purchaser is an individual, a corporation, or some other entity.

Categories Covered

The fact that a copyright provides legal protection in the form of the expression of an idea, but not for the idea itself, applies to a wide range of manifestations, including: paintings, drawings, sculptures, photographs, recordings, films and broadcasts, as well as literary and musical works.

Copyright arises automatically at the time the "original" work is created. Therefore, registration is not required by law, but is recommended since it establishes ownership and simplifies possible litigation and recovery of damages.

While statutory protection varies from country to country, the following is a summary of the U.S. situation.

  • Artistic (paintings, sculptures, and drawings)
  • Choreographic (ballets)
  • Dramatic (plays, operas, musicals)
  • Literary (books, manuscripts, newspapers, magazines, poetry, advertisements)
  • Musical (compositions, song lyrics, advertising jingles) covering both the compositions themselves and recordings
  • Pictorial (cartoons, pictures, maps, prints, drawings, and photographs)
  • Video and audiovisual (movies, commercials, music videos, and TV programs)

None of the material has to be published, recorded, or performed in order to be protected. For example, an unpublished and never performed play is covered.

Not all the material in an original work that has compilation has to be new; a compilation of existing works may be an accepted expression subject to copyright.

Term of Protection

Not many things last as long as copyright protection. Indeed, an author's work is often long forgotten before the copyright expires. The term of copyright protection in the United States depends on when the work was created. The 1909 Copyright Act offered protection till 1976. After December 31, 1977, a new Act, which is still current, applies.

Under it, copyright in works created after 1977 by individuals usually lasts for the life of the author plus an additional 70 years. If there are two or more authors, the term is extended to 70 years after the last one's death. Copyright in works, such as software, created anonymously by employees or contractors (work made for hire), lasts for 95 years from the date of publication, or 120 years from the date of creation, whichever is shorter. Copyright in works published before January 1, 1978 lasts for 75 years from the date of publication, if it was renewed on time. An unpublished pre-1978 work is treated under the current law. If published by December 31, 2002, its copyright will not expire before December 31, 2047, if renewed.


Copyright created arises automatically when the "original" work is created. While, as stated previously, it is not necessary to work for it to be protected, it is desirable to do so, as:

A registered creative work is protected by copyright the moment it assumes a tangible form, legally “fixed in a tangible medium of expression.”

It allows the use of a copyright notice on a published work, which commonly appears in this form: "© (year of publication) (author or other basic owner)." Such notice on a work that is distributed to the public prevents others from copying it without permission, claiming they did not know whether or not it was covered by copyright. This is important, as it is much easier to recover damages from a deliberate as opposed to an innocent infringer.

Registration within three months of the work's publication, or before any infringement actually takes place, makes it much easier to sue and recover damages. Specifically, it creates a legal presumption that the copyright is valid, and allows the legal owner to recover up to $100,000 and possibly legal fees without having to prove any monetary harm.


Various rights under a copyright can be, and often are, sold or transferred in whole or in part. In fact, such transfers are the most common way for authors to commercialize their works. When all such rights are transferred unconditionally, it is generally termed an "assignment"; when only some of the rights are transferred, it is known as a "license." An exclusive license allows the appropriate rights to be exercised only by the licensee. If it is nonexclusive, others may also take advantage of them.

Licensing, the most common means of transfer, allows splitting the bundle of legal and economic rights associated with a copyright as follows:

Any of the exclusive rights that make up a copyright can be subdivided or split into smaller and smaller pieces and then transferred to one or more parties. An example is how books are marketed. In addition to hard and soft cover rights, there are audio rights, foreign translation rights, performance rights, film adaptation rights, and even future technology rights. Each exclusive right is jealously guarded and any conclusion concerning such an Intangible Asset is sure to be subject to revision.

Integrated Circuit Typography Registration

The Semiconductor Chip Protection Act of 1984, a chapter of the U.S. Copyright Act, prevents unauthorized reproduction and distribution of computer chips. Mask works, which are most simply described as firmware, or software stored permanently on a ROM chip as stencils for integrated circuits, also fall under that Act, which is administered by the Copyright Office.

This Intellectual Property right is very important, since a new family of semiconductor integrated circuit designs can cost several hundred million dollars to develop, and another billion to build the required sophisticated production plant. In some countries, the design of a computer chip is protected through an integrated circuit typography registration, which covers the three-dimensional configuration of the circuitry embodied in the design. Usually, it also contains trade secrets protected under local laws.

Domain Names

Software that is available for sale or license to customers may have associated trademarks or service marks. A relatively new area of dispute related to both trademarks and data processing in general is the use of domain names, or electronic addresses, on the Internet. Domain names have been issued for years without any checking against registered trademarks, which has resulted in recent claims of trademark rights' violations against domain name holders.

Trade Secrets

Trade secrets are data, or "know how," collected or created by an entity or individual for private commercial use. Black's Law Dictionary (7th ed.) parallels the language of the Uniform Trade Secrets Act when it defines them as:

"A formula, process, device, or other business information that is kept confidential to maintain an advantage over competitors; information – including a formula, pattern, compilation, program device, method, technique, or process – that (1) derives independent economic value, actual or potential, from not being generally known or readily ascertainable by others who can obtain economic value from its disclosure or use, and (2) is the subject of reasonable efforts, under the circumstances, to maintain its secrecy.

While trade secrets are confidential, owner/operators typically document their trade secrets for various commercial purposes. Such purposes include product production management/scheduling, product/service quality control, employee training, and so on. While this documentation is often maintained in secrecy, it typically does exist."


Examples of product/process trade secret documentation include: food product recipes, chemical formulations, engineering drawings, production process schematics, process flow charts, plant layouts and designs, distribution system drawings/mylars, computer software programs, clothing and other product patterns, blueprints, laboratory notebooks, system flowcharts and diagrams, employee manuals, user manuals, customer files, etc. Each of which is a tangible embodiment of an owner/operator's trade secret, and each has intellectual property content.

Trade secrets are recognized as Intangible Assets only when one of the criteria is met, which is likely to be the case when laws or regulations exist that protect future economic benefits. They include all confidential, commercially valuable information. Trade secrecy law applies to any person who has acquired confidential information from its owner - no matter by what means.

In many ways, trade secrets are the most important manifestation of Intellectual Property, yet, as their owners usually only have common law to rely on, they are the least protected. Very few countries have followed the U.S., where in some States they are protected by the Uniform Trade Secrets Act, which codifies common law.

An entity's core technologies frequently consist of a mixture of patents, copyrights, licenses and trade secrets. In determining their Fair Values, under SFAS 141 and 142, the differing degrees of protection must be taken into account, especially in establishing their remaining useful life (“RULs”).

U.S. Tax Aspects of Intangible Assets

The Internal Revenue Code contains three sections, 167 (A), 197 and 1060, which relate to the tax treatment of intangible assets.

Section 167 (A)

This allows a "depreciation deduction" as a reasonable allowance for the wear and tear, exhaustion and obsolescence of property used in a trade or business, or held to generate income.

Subsection (a)(3) specifically permits the depreciation (amortization) of any intangible asset, except goodwill and going concern value, if the taxpayer can establish that it meets a three-part test:

  1. The asset must be isolated and separated from residual goodwill.
  2. The asset will have value in the production of income for only a limited period.
  3. That period must lend itself to being estimated with reasonable accuracy.

The term "limited period" mentioned in this section is normally the same as the Intangible Assets' RULs and is an essential determinant of value. Both the type of asset and its practical context are factors in establishing the RULs:

Type of Asset Practical Context RUL
Patents/Copyrights Legal/Statutory Definitive
Documents Judicial Definitive
Loans/Leases Contractual Definitive
Engineering Drawings Physical/Functional Subjective
Computer Software Technological Subjective
Computer Software Economic Quantitative
Credit Card Portfolios Analytical Quantitative

26 U. S. C. §197(a)

This establishes a uniform fifteen-year amortization period for the following specified intangible assets acquired after August 10, 1993:

  • Covenants not to compete, and franchises
  • Customer and supplier based intangibles
  • Goodwill (G)
  • Going concern value (G)
  • Information base (G)
  • Know-how (trade secrets)
  • Licenses
  • Permits
  • Rights granted by a governmental agency
  • Trademarks or trade names
  • Work force in place (G)

Items marked “(G)” are regarded by FASB as part of Goodwill; the others are Intangible Assets with shorter useful lives.

26 U.S.C. §1060, Special Allocation Rules for Certain Asset Acquisitions, and IRS Regulations 1.338-6 and 1.1060-1

The tax allocation of the Target's purchase price in a Business combination is dealt with by this section of the Code and the Regulations. Under those, seven major classes of assets are created, for deemed or actual asset acquisitions on or after March 16, 2001:


  1. Cash, demand deposits and general deposit accounts other than certificates of deposit ("CDs") of banks, savings & loan associations and other depository institutions.
  2. Actively traded personal property within the meaning of IRC Section 1092 (d) (1), as well as CDs and foreign currency, even if not actively traded. It does not include stock of the Target's affiliates, whether or not actively traded, other than stock described in IRC Section 1504(a) (4), which includes U.S. government securities and publicly traded stock.
  3. Assets marked-to-market, at least annually for federal income tax purposes, and debt instruments, including accounts receivable.
  4. Stock in trade or other property of a kind that would be inventory if owned at the close of the taxable year, or property held primarily for sale in the ordinary course of business.
  5. All assets other than those in Classes 1, 2, 3, 4, 6 and 7.
  6. All intangibles as defined in IRC Section 197, except goodwill and going concern value.
  7. Goodwill and going-concern value, whether or not qualified under Section 197.

The concept of Fair Value used in SFAS 141, 142 and 144 is not the same as Fair Market Value in the Internal Revenue Code. Therefore, in a Business Combination, the allocation for accounting purposes will be different from that for tax purposes.

Newark Morning Ledger Case

FASB is not the first organization to consider the issue of separating intangible assets from goodwill. This was addressed by the U.S. Supreme Court in a case known as Newark Morning Ledger v U.S., 507 U.S. 546 (1993), concerning a dispute between the IRS and the buyer of a newspaper over the value assigned for tax purposes to the subscriber list.

The IRS contended that the subscriber list should be valued at its replacement cost. This was the expense required to obtain and record the names and addresses of subscribers, a relatively nominal amount. It asserted that the remaining value the taxpayer had allotted to the list was goodwill and invoked a common law definition of goodwill as the "value of the expectation of continued customer patronage." Using this, the IRS argued that the "expectancy of future income" from current subscriptions and anticipated renewals were clearly goodwill. The taxpayer retorted that the list was worth much more, because it incorporated the value of expected repeat customers.

The Supreme Court decided in favor of the taxpayer, noting that the historical behavior of the subscribers was sufficiently known to anticipate an ongoing stream of business. In essence, the Court decided that the IRS had erred by valuing "the wrong asset by the wrong method." As the customers on the list were expected to continue as subscribers through renewals, the use of replacement cost was inappropriate. The Court also concluded that the IRS' definition of goodwill was not applicable.

Ultimately, the Court adopted the premise, that any asset capable of being valued separately and with a reasonably estimated economic life was depreciable as a matter of law. While this is somewhat different from the criteria adopted by FASB, they are conceptually similar.

A key conclusion was that it is important to distinguish between a customer list and a customer relationship, the latter including the economic benefits of renewals. This difference is reflected in the position taken by FASB in SFAS 141. Another important inference is that it is critical not only to apply the right valuation methods, but also to apply them to the correct asset.

The Newark Morning Ledger case should not be used as authority for applying or interpreting the previously discussed criteria defining Intangible Assets set out in SFAS 141, but it is interesting to note that an unidentifiable customer base forms part of Goodwill. This conclusion is consistent with some of the commentary in that 1993 decision:

"One must distinguish between a galaxy of customers who may or may not return, whose frequency is unknown, and whose quantity and future purchases cannot be predicted, against subscribers who can be predicted to purchase the same item, for the same price on a daily basis."

Request a consultation or submit a question.