Permits and Intangible Assets

STD/NA(2001)24

1

STD/NA(2001)24

Permits and Intangible Assets

Introduction

1.The UK Office for National Statistics has been obliged to address national accounts classification issues, as a result of the auctioning of licences to mobile telephone companies for the use of the electromagnetic spectrum. The ensuing debate on how to classify the payments to allow the use of the spectrum as rent, tax, service charges or sale of an asset has provoked world-wide discussion. As this paper is written, there still remain a variety of views on the appropriate treatment in the national accounts. The debate has revealed confusion regarding the nature of the national accounts’ treatment of intangible assets and taxes.

2.This paper explores these concepts from first principles of economics, seeking to identify the characteristics of assets and taxes, which help to determine the appropriate national accounts’ treatment in specific cases. The paper questions some of the guidance in the SNA93 and ESA95, and as such is a contribution to a future revision, rather than solely an interpretation of existing guidance.

Land

3.Land is classified in the SNA93 as a tangible non-produced non-financial asset – AN.21. It is difficult to create a consistent story from opening to closing balance of the stock of land. This is due to major land improvement schemes being classified under Gross Fixed Capital Formation as a produced asset (AN.11). The resulting change in value to the non-produced asset of land must be artificially re-routed in the accounts so that increase in value due to capital formation under AN.11 can be reflected in the value of the stock of land (AN.21) through an adjustment item. This paper proposes a sub-classification of land into two distinct asset types - a non-produced asset and a produced asset, which will overcome this difficulty.

4.Land has two main characteristics - a physical manifestation and a space occupying property. The physical manifestation is recognised in that it can be seen, touched, stood upon, dug into, used for crop growing, etc. This is observed as the soil, the bedrock, the surface and its physical characteristics. The value of this aspect of land is that it provides a service to economic activities. For example the soil in a field used for agriculture provides an anchor for roots and a store for nutrients so that crops can grow. The bedrock of a building site provides suitable foundations for the erection of buildings. Sand provides a suitable material for playing in, at the seaside, or out of, on the golf course. Each of these characteristics of land is degradable, and in order to maintain its value, can require major improvement. Ownership rights can be established over these characteristics, separately from the second characteristic of space occupation.

5.These physical characteristics qualify land as an economic asset. Although it once occurred as a natural phenomenon, in developed countries most of land can be considered as a produced asset. Agricultural land will have been cleared of stones, have drainage systems, physical boundaries, surfaces levelled, etc. Building land will also have been drained, cleared, access created, etc. This characteristic of land qualifies as a produced, non-financial, tangible asset. It follows that payments which are made for use of the improved physical characteristics of the land should be classed as rentals, payments for the flow of capital services provided by the produced capital asset.

6.We use the word “improved” here to reflect the fact that capital formation has occurred to increase the value of the asset - it does not reflect any social judgement as to what is or is not improvement. We may feel as members of society that an original forest is a better asset than a field of corn, but the logging, clearing and access creation in economic and national accounts terms is taken as an improvement.

7.In the absence of maintenance and improvement, the produced part of land will suffer degradation over time and can be exhausted. It follows that the normal theories linking services, capital consumption and capital value can be applied. To establish the value of agricultural property of land, we can use the standard relationship set out in the OECD manual on measuring capital stock. In an efficient market the value of the produced asset can be determined by the net present value of the sum of future rentals for agricultural use.

8.A second characteristic that land possesses is as an occupier and delineator of space. This can give rise to a second type of payment, which is different in nature to the rental described above. It is a payment, which reflects the right to control access to the space occupied. It is impossible to value this aspect of territorial control by using the net present value model linking the net present value of future rentals to the asset value. Control of the space will last as long as there is legal title. If a unit were prepared to pay $5 a year for right of access, then for a zero discount rate, the calculated value as the sum of the discounted flow of services would be infinite.

9.So the payment for right of access must be a payment for permission, and the market price will be determined by competitive market factors – can the user of the permission provide a subsequent product at a price which the market will meet? The payments for right of access do not seem to be for a service, as there is no economic output included in Gross Domestic Product that is required to provide the access. This suggests that the accounting treatment is to show it as a current transfer out of income – in fact consistent with the current SNA treatment of rent for land.

10.A third aspect of land as an asset is its value as an original non-produced asset, untouched by economic development. It is the contention of this paper that such areas of land are relatively few in number, and can be treated as special cases. Economic value can be recognised in them through considering their net present value as generators of income from tourism. Again this payment is for the use of an asset not created through the normal production process, and so again should be treated as a transfer of income

11.The above proposal to identify three different characteristics of land as an asset does not consider the measurement issues. It may be extremely difficult in practice to split the value of a golf course in the suburbs of a major city into

a)its value as a golf course, reflecting the investment and maintenance needed to allow golf to played, from

b)its value as a potential access, in that cars driving through it may find this a very convenient route to the heart of the city from the suburbs and pay a toll for so doing,

c)its value originating from its natural original state of rolling hills, good natural drainage, and glorious views.

12.In most cases, the main value will lie in the produced asset value. For a golf course such as Saint Andrews in Scotland, it can be argued that the value of the golf course still reflects the naturally occurring characteristics of the original land on the site: - short grass, rolling greens, undulating fairways etc. Such phenomena with economic value are relatively few in number. They can be treated as special cases by inclusion in the stock of assets of the economy valued through their use as a tourist attraction, or their harvest in the case of natural growth forests etc. Even in the case of Saint Andrews, work in re-shaping the greens, the tees, fertilising, building drainage systems for the fairways, the building of access roads and ancillary buildings, drainage systems, have all been such a large and ongoing investment over the years that their contribution to the existing asset value far outweighs the original value of the asset as a gift from nature. It is necessary to single out national parks, original forests and other large scale natural geographical phenomena to identify significant cases of what may still be termed non-produced tangible economic assets.

13.This however leaves the treatment of building land in the suburbs rather uncomfortably placed. The land can command high prices due to its proximity to the city, but the allocation of value between access, the original state of the land, and the investment necessary to allow building to take place, is not an easy one.

14.Land can be split into three kinds of asset

−a produced tangible asset reflecting previous fixed capital formation

−a non-produced tangible asset, reflecting value due to the original non-developed state of nature, and

−a non-produced intangible asset, reflecting the space occupying characteristic which allows revenue to be raised through access permission.

15.In the case of land and buildings, they are often treated as one asset because of measurement issues (SNA93 7.131). Similarly, for developed land it will often be appropriate to classify it under one asset type, and this will often be that of a produced non-financial asset reflecting where the main value of the asset lies.

Government

16.We now consider the special role that government plays in the use of permissions as a means of raising funds. In the role of regulator, the government can apply a variety of fiscal tools to regulate social and economic activity in national territorial space. It is responsible for the administration of the national legal system, the national tax system and has an international role in regulating access across the borders of the territory.

17.Government can raise revenue through fiscal authority. Through a legal framework, the government can require citizens and businesses operating on national territory to make payments to the government. These payments are usually not requited - no direct payment for corresponding services rendered. They can be unrequited transfers that enable the government to implement polices of national defence, income redistribution and social and economic development and to provide or fund public services.

18.The existence of the territorial borders sets out the limits within which the government applies the regulatory framework. Revenue raised by government will be mainly through taxes. Some of the taxes will reflect permission under a regulation for an activity to take place in the territory. For example, a person or company may pay the government money for a permission to operate a vehicle on the public roads within the territory. The granting of a licence usually evidences such permissions. If the money raised by this permission is much more than the regulatory activity in administering the collection system and monitoring compliance, then the licence payments are considered to be taxes.

19.This ability to raise money through permission has led to consideration of the possibility that the licences representing the permission can be considered as intangible assets - constructs of society which in creation cause an asset of value to be brought into being. Can these permissions for regulated activities, be considered as economic assets?

20.Peter Hill wrote an article in a recent issue of SNA News and Notes, on the subject of the treatment of patents governing scientific inventions, and during the article said the following:

21."An artistic original is classified as an intangible fixed asset in the 1993 SNA and recorded under AN.112 in the asset classification. By definition, therefore, the acquisition of an original counts as gross fixed capital formation. Notice that the copyright does not appear anywhere in the asset classification because the copyright is not itself an asset, being only a legal instrument providing evidence of ownership over an asset (current authors' underlining). Any payments received by the owner of the asset i.e. the holder of the copyright - from other units who are licensed to use the asset are conceptually equivalent to the rentals received by owners of tangible fixed assets who lease them out."

22.This line of reasoning highlights that the creation of a legal instrument governing the use of assets does not imply that the instrument itself should be treated as separate asset. The value remains in the underlying asset, and the legal instrument determines who should be considered the "owner" from a practical point of view. If the legal instrument, to all intents and purposes, transfers ownership of the asset to the second party, then there is a de facto sale of the underlying asset from the first party to the second party. Alternatively, the legal instrument may only govern the use of the underlying asset by the second party, under conditions that reveal that the first party remains the owner of the asset in practice as well as in legal title. In this case, the payments for the use of the asset are rentals for produced assets, and rent for non-produced assets.

23.Consider the special case of a licence, which affords a degree of exclusive access to part, or all of the territorial space. If we accept that the licence is an economic asset, what are the implications? The volume of the capital services provided by the licence does not degrade over the period of the licence. Assuming a discount rate of zero, and the licence holder expecting a service worth £1,000 each year of a five year term, the issue price will be £5,000. If the actual payment is less than this, there will be a competition to get licences, but if it is more, there is likely to a shortage of applicants for the licences. Where the degree of exclusivity is fixed, but the expected economic return from holding the asset is unknown, an auction may be held as an efficient means of determining the appropriate economic value at issue. So it can be seen that the licence is similar to a legal instrument determining access to artistic originals under copyright.

24.major barrier to considering the licence as an asset of value at point of issue now appears. At time of issue, the stock of real economic assets of the territory has risen by £5,000 and yet to a visitor to the territory there is no discernible increase. It is true that one economic unit has an advantage over others due to the possession of a licence, but in terms of the overall economy there has been no net increase in the flow of capital services. If we accept the licence as an asset of value, but no net increase in the overall stock of economic assets and associated services, corresponding to the creation of the licence asset, there must be an extinguishing of asset value elsewhere in the economy. But it is difficult to imagine what that might be? Can we imagine that the government has an intangible asset called the right to give permissions, which has been reduced by the issuance of a licence? What value can we put on this right, given the opportunities to issue other licences? Could we impute a reduction in the stock of goodwill held by other companies operating in the same field? How could we impute such a nebulous value across the range of potential competitors?

25.Using a reductio ad absurdium approach, consider the case of government issuing monopoly rights to a firm to trade in certain goods, in a situation where a free market has existed up to this point. This completely exclusive licence is of immense value to the holder - say for example that only one distributor of imported cars was allowed in a country. To the holder, the permission represented by a certificate, a warrant, a licence, is of great value and will be reflected in the valuation of the company, through a rise in stock value and a recognition of increase in what is termed goodwill. And it is likely that other companies in the same business will see a corresponding decrease in the goodwill component of their market valuation.

26.he company may chose to show the licence as an asset in the accounts, and amortise the value through the profit and loss accounts over the term of the licence. But the fundamental barrier remains for the national accountant. The granting of permission has not increased the stock of economic assets or increased the corresponding flow of capital services to the territory as a whole. In fact, market economic theory suggests a decrease in economic performance may be expected due to the monopolistic behaviour of the holder of the licence.

27.This example suggests that the national accountant must seek another way to record the payments.

Tax

28.What is a tax? The definition is given in the SNA93 7.48:

"Taxes are compulsory unrequited payments, in cash or kind, by institutional units to government units. They are described as unrequited because the government provides nothing in return to the individual making the payment, although governments may use the funds raised in taxes to provide goods or services to other units, either individually or collectively, or to the community as a whole"

29.Note that this does not stop the taxpayer benefiting from the use to which the tax is put. The government may "promise" that money raised from road fund licences will be used to build new roads, but their right to divert the money elsewhere demonstrates the unrequited nature of the payment.

30.If we consider current SNA guidance that fees paid for items such as a hunting licence should be recorded as a tax, it is interesting to consider how the taxpayer views the transaction. If asked, the hunter may feel that he has received a service for his money - the right to hunt under certain conditions. This will feel like a service to the hunter - he or she will feel that the tax payment is requited, and that a service fee is paid. This demonstrates that the definition of tax in the SNA93 can be expanded as follows.