Friday 31 October 2014

A Proposal for the U.S. to Adopt the Patent Box

In a recent article published in the Stanford Journal of Law, Business and Finance titled, It is Time for the United States to Implement a Patent Box Tax Regime to Encourage Domestic Manufacturing, Bernard Knight, current partner at McDermott, Will & Emery and former General Counsel to the United States Patent and Trademark Office (USPTO), and Goud Maragani, Senior Counsel at the USPTO, advocate for the United States to adopt the Patent Box.  The article argues that a loss of domestic manufacturing leads to the loss of “future follow-on innovation.”  Basically, out-sourcing is hurting the U.S. economy in more ways than just the loss of manufacturing jobs.  The article reviews the literature concerning “the link between domestic manufacturing and research and development (R&D) and explains why domestic manufacturing is critical to innovation.”  The article notes a Brookings Institute study which demonstrated that:  “within the United States, regions with higher patenting activity have higher productivity and lower unemployment.”  The article further reviews the patent box regimes of Belguim, Luxemburg, the Netherlands, China, France and the United Kingdom.  In concluding that the U.S. should adopt a variation of the patent box, the authors note:

For the reasons discussed below, it is unclear from the available data whether patent boxes are serving their intended purposes of attracting R&D and increasing the commercialization of innovative products. The available data is limited because of the newness of patent box tax regimes.  Although data about the efficacy of patent box tax incentives is limited, there is some evidence that patent box policies induce firms to patent more in countries with a patent box.  In addition, the GSK example discussed earlier demonstrates that a properly designed patent box--even one without a requirement for domestic R&D or manufacturing--can attract new manufacturing facilities.

Despite the limited evidence about the effectiveness of patent box regimes, it may be possible to predict what type of impact a patent box regime could have by looking at the relationship between the R&D tax credit and the amount of research conducted domestically by companies. The United States implemented an R&D tax credit in 1981, which only applies to research performed domestically. Studies have found that every dollar of foregone tax revenue attributed to the R&D tax credit leads to between $1.10 and $2.90 in additional domestic R&D spending by companies. A lower tax on profits from domestically-produced patented products may have a similar impact on investment in factories in the United States (i.e., investment in factories will increase).

Some observers believe there is evidence that “links patent box policies to increased patent activity, but not necessarily to job growth.” Part of the reason for this finding may be that each of the European patent box regimes does not require that some, or even all, of the R&D or manufacturing occur in the nation with the patent box regime. “The reason for this seemingly obvious shortfall is simple: The European Union prohibits member nations from conditioning commercialization incentives on the performance of R&D within that nation.”

As a result, under all of the regimes considered in this Article, a company could theoretically purchase patents from a third party, contract with a R&D company in a foreign jurisdiction to have the patents marginally developed and, then, hold the patent in the patent box country and license it to other companies for subsequent manufacturing. In doing so, the hypothetical company would be able to take advantage of a patent box regime without conducting any R&D or participating in any manufacturing activities in its domestic country.

As this hypothetical demonstrates, because the European Union nations cannot require domestic R&D and/or production, they “are not reaping the full benefits of their patent box policies.” In other words, the potential of innovation to drive economic growth and job creation higher appears tied to the amount of the innovation that is manufactured or developed locally. There is no equivalent law that would limit the United States' ability to require a company to engage in domestic production to avail itself of the lower tax rate in a patent box tax regime.

Hat tip to Professor Paul Caron’s Taxprof Blog.  The full article is available on LexisNexis, Hein Online or Westlaw. 

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