Licensing deals and milestone payments

Is the licence distinct, and what kind is it?

A licence is distinct if the licensee can benefit from it on its own or with resources it can obtain, and if it is separately identifiable from other promises. A licence of a drug candidate that the licensee can develop itself, or with other contractors, is usually distinct from research services the licensor also provides. If the licensee could only use the licence with the licensor's specialised know-how, the two are combined and recognised together, usually over time. Most drug licences give a right to use the molecule as it exists at the licence date, recognised at a point in time, because the licensor's later activities do not change it. See IFRS 15 licences.

Milestone payments: a licensing deal from signing to sales

A biotech licenses a Phase II drug candidate to a large pharma company. It receives US$ 50 million upfront and will provide research services for two years. It is eligible for 30 million when Phase III starts, 100 million on regulatory approval and 75 million when annual sales first exceed $1 billion, plus royalties. The stand-alone selling price of the research services is 10 million; the licence has no observable stand-alone price, so the biotech uses the residual approach and allocates the remaining 40 million of the upfront fee to it.

The biotech recognises 40 million on signing even though the drug may never reach the market, because the licence has been transferred and the upfront fee is not refundable. Each development or regulatory milestone, once included, is allocated to the performance obligations on the same basis as the upfront fee, so most goes to the already-transferred licence and is recognised at once.

Why are development milestones usually recognised only when achieved?

IFRS 15 includes variable consideration in the transaction price only to the extent it is highly probable that a significant reversal will not occur. Clinical and regulatory outcomes depend on trial results and regulators' decisions outside the licensor's control, and often on the licensee's own decisions about whether to proceed. A licensor rarely has the evidence to say a milestone is highly probable before it is reached. Milestones within the licensor's control, such as delivering a data package, can be included earlier. See variable consideration.

How are sales milestones treated?

Under the sales-based royalty exception, consideration for a licence of intellectual property that depends on the licensee's sales, both royalties and sales milestones, is recognised only when the sales occur, or when the related performance obligation is satisfied if later. The licensor does not estimate future sales milestones even if it expects the drug to sell well. See sales-based royalties.

What if the licence is not distinct?

If the licensor's ongoing research is essential to the licensee's ability to benefit from the licence, the licence and services form one performance obligation, usually satisfied over time as the research is performed. The upfront fee and any milestones included in the transaction price are then recognised over that period using a measure of progress, such as costs incurred, rather than on signing. Where both parties share development risks rather than one buying from the other, the partner may not be a customer at all; see collaboration agreements.

How does the licensee account for the payments?

Under IFRS, the licensee capitalises the upfront payment as an intangible asset, because separately acquired rights meet the IAS 38 recognition criteria. Milestone payments are usually capitalised when they become payable, as additional cost of the intangible, although practice varies for development milestones. Under US GAAP, upfront and pre-approval milestone payments for rights with no alternative future use are expensed as research and development. See acquired in-process R&D and pharma accounting.

This guide is general information. It is not tax or legal advice for your situation.