Google and taxes and the UK and ... everyone everywhere?

This isn't strictly about taxation of IP - that £130m that Google are apparently coughing up to the UK tax authorities is apparently based on their revenues from selling advertising to UK customers rather than from licensing IP (according to press reports; I'm not inclined to assume that these are a guaranteed clear explanation of anything to do with UK tax). But, of course, anything Google earns is driven by IP so I figure it's pretty fair game for this blog.

If reasonably accurate, the reports are interesting, because UK tax rules (and the tax rules in most other countries too) aren't based on revenues booked in the UK alone. Instead, they're based on the UK profits attributable to taxable activities in the UK. We have some new rules here in the UK, which came into force in April, which attempt to tax profits which have been diverted out of the UK artificially - but that's still profits, not revenues, and they still need someone to be doing something in the UK.

The implications of the press reports - and general outcry of 'too low, too low' - are interesting. And possibly not entirely thought through.

To take another example IP business sector that's been mentioned a fair bit over the past year (albeit possibly mostly in specialist tax reports): knitting pattern designers - particularly freelance pattern designers selling though etsy or ravelry etc. Now, these have been mentioned regularly because of the EU VAT changes at the beginning of 2015, which pretty much required these designers to collect VAT at the customer country rate from customers - which, in the UK causes a fair headache because most of these designers don't earn enough to be required to be VAT registered here, but aren't below threshold elsewhere - and the compliance was a mess.

But the logical extrapolation of the Google etc reports is that one should pay income tax everywhere that one books revenues. Which rather suggests that VAT is going to be the least of a freelance knitting designer's worries: the VAT side of things can be (to an extent) dealt with by using payment aggregators like PayPal and others to deal with the VAT on your behalf - and it only applies to EU customers. But having to register for income tax and deal with that tax compliance in every single country from which someone buys your knitting pattern? Good luck ...

Yes, Google has sales people etc in the UK, so it's in a slightly different position to a pattern designer selling to a country other than the one they live in, but the calls for 'more tax' aren't based on those sales people being here, just on the sales revenue Google makes. And, frankly, Google could probably get most of the same UK revenues without a single person being needed here (AdWords signups seem pretty automated to me ...)

The OECD BEPS project has been trying to deal with this - and things like the UK diverted profits tax are an outcrop of that - but there isn't a simple solution (I'm pretty sure tax authorities would have found it by now, if there was one). So, those calling for Google et al to pay more tax simply because of the revenues they make here should think about the knitting pattern designers too.

OECD's Base Erosion and Profit Shifting

We’ve already briefly covered news of the OECD’s Base Erosion and Profit Shifting project and how it will affect the various patent or knowledge box schemes to reduce tax for companies based on profits accrued from intellectual property. The final package was put to the G20 Finance Ministers on 8 October in Lima, Peru, and has been adopted. The wonderfully named "Countering Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance: Action 5” which can be downloaded here contains the full meaty details of the OECD’s view. It’s a document that contains a lot of useful detail and this is a first post to explain thr broad thrust of the project. We’ll try and deal with some particular issues in separate posts over the next few weeks.

The thrust of the project has been to align taxation with substantial (economic) activity and ensure that taxable proits are not “artifically shifted away from the countries where value is created" (see para 24). The report recognises that IP-intensive industries are a key driver of growth and employment and there is no intention to prevent countries from adapting tax incentive for research and dvelopment in their own countries. The report’s thrust is to define the outer limits of an IP regime that grants benefits to R&D, but does not have harmful effects on the collection of tax by other countries.

The report examined various options and concluded that the so-called “modified nexus” approach was the best one to take. The tax benefits can be applied in countries to provide benefits to the income arising out of the intellectual poperty as long as there is a direct nexus or link between the income receiving the benefit and the expenditures contributing to that income. As the report explains, the purpose is to give the taxpaying company a tax reduction for the research and development work that the taxpaying company did itself - and not for R&D work done elsewhere. In other words, a patent or knowledge purchased in from elsewhere would not be entitled to the tax credit.

The report also sets out in detail the concept of qualifying expenditure, which is entitled to the tax credit, and total expenditure which includes elements on which no tax credit can be obtained. Countries will be allowed to define qualifying expenditures as long as these are only related to R&D activities - it should not include interest payments, building costs, etc. Qualifying expenditures do not include payments to third parties to carry out R&D work. 

It is also clear that only patents and similar rights, such as software, will be entitled to the benfits. This will rule out some countries’ schemes that have extended the benefit to design rights, copyrights or trademarks but there may be openings for smaller companies to include further rights.

The overall income that can benefit from the scheme must be derived from the IP asset itself, such as a royalty, capital gains or sale.

It was the introduction of the UK’s scheme that triggered the OECD work, particularly as Germany had objected to the scheme. The report will allow the UK and other countries to continue with their schemes with some minor modifications, and the UK has now published proposals for modification of its scheme. We’ll be interested to see whether Germany does introduce a scheme.  

%MCEPASTEBIN%

UK BEPS-compliant patent box proposals published

The UK announced on Thursday (22nd October) its (rather long awaited) proposals to update the patent box to make it compliant with the OECD BEPS proposals on amendments to patent/knowledge boxes. The UK proposals set out a series of questions for consultation, with draft legislation to come in December.

tl;dr version: it's more generous that it might have been on grandfathering, but companies had better get their accounting software ready to do some serious work in order to keep track once into the new regime. The added complexities that will be added may well put off companies from claiming.

There are no proposals to include software copyright as qualifying IP, although the BEPS project does permit this – and the Irish knowledge box draft rules, published on the same day, do include software (and the Irish knowledge box offers a 6.25% effective rate. Just in case you wondered).