The Merit of Patent Boxes

In a new paper on the merit of patent boxes, Should There Be Lower Taxes on Patent Income, Fabian Gaessler, Brownyn H. Hall and Dietmar Harhoff, examine several questions:

1. When a transfer of patent ownership occurs between countries, is the choice of target country affected by the difference in tax treatment in the two countries and the presence of a patent box? . . .

2. Is the choice of priority country influenced by that country’s treatment of patent income? We are motivated to some extent by the observation that the share of patents with a priority country that differs from the location of the invention has risen in the recent past.

3. Does patentable invention in a country increase after the introduction of a patent box? That is, does this policy instrument have the desired effect?

In addition, we hypothesize that more valuable patents (that is, patents that are more likely to generate income, via own profits or licensing) are more likely to be subject to transfer.

The abstract states the general finding of the paper:

We find that the impact on transfers is small but present, especially when the tax instrument contains a development condition and for high value patents (those most likely to have generated income), but that invention itself is not affected. This calls into question whether the patent box is an effective instrument for encouraging innovation in a country, rather than simply facilitating the shifting of corporate income to low tax jurisdictions.

The paper is available, here.  [Hat tip to Dean Paul Caron’s TaxProf Blog.]

Israel's budget confirms expansion of IP incentives for tech

Israel's budget for 2017-18 confirms some measures for tech companies announced last year, with the changes applying from 1 January 2017.

Firstly, the budget reiterates the 'innovation box' regime proposed last year, introducing a 6% corporate income tax on 'technological earnings'.

The budget also expands on the tax incentives for 'preferred technological enterprises' and 'special preferred technological enterprises':

For PTEs:
- the corporate tax rate is 12% instead of 24% on tech earnings (or lower, if in a development area)
- the withholding tax on dividends out of tech earnings of qualifying companies is reduced to 4% (unless lower by treaty)
- the capital gains tax rate on the sale of qualifying intangibles to a related nonresident is reduced to 12% where the assets were bought from a non-resident (unusual to see a tax incentive for outbound sales of IP)

For SPTEs:
- the corporate tax rate is 6% on tech earnings
- the withholding tax rate on dividends of tech earnings is reduced, as above; the withholding tax rate on all dividends to a nonresident parent is reduced to 5% (unless lower by treaty)
- the capital gains tax rate on qualifying intangibles (as above) is 6%
- the requirements to be an SPTE are modified, reducing the required preferred income by one third, and total required annual income by half

UK: Draft Finance Bill changes to patent box - including CSA interests

From today's draft Finance Bill overview:

"2.13. Patent Box: cost sharing for collaborative Research and Development (R&D)

As announced at Autumn Statement 2016, the government will legislate in Finance Bill 2017 to add specific provisions to the revised Patent Box rules introduced in Finance Act 2016, covering the case where R&D is undertaken collaboratively by 2 or more companies under a ‘cost sharing arrangement’ (CSA). The provisions will ensure that companies are neither penalised nor able to gain an advantage under these rules by organising their R&D in this way.

The new rules provide that:

• where a company acquires an interest in or increases its interest in a CSA, an appropriate amount of the consideration paid counts as acquisition cost for the purpose of calculating the R&D fraction, to the extent any Intellectual Property (IP) assets are held within the CSA
• where a company disposes of an interest or reduces its interest in a CSA, an appropriate amount of any consideration received is treated as IP income, to the extent any IP assets are held within the CSA
• activity of participants in the CSA to develop IP or products is appropriately treated in the company’s R&D fraction

This has effect for accounting periods commencing on or after 1 April 2017. Draft legislation (provision 24) and a TIIN has been published on 5 December."

This should be filed under "not particularly surprising", it's been a gap in the legislation/guidance for some time.

UK - Autumn Statement and IP tax

The devil will no doubt follow in the Finance Bill detail, but the heads up on IP tax points from the Chancellor's statement is:

Fiscal:
- the new (post-1 July 2016) patent box rules are to be updated by adding provisions to deal with cost sharing arrangements so that companies using these are not advantaged/disadvantaged when it comes to calculating the R&D fraction

- 'new spending' of £4.7 billion between 2017 and 2021 to enhance the UK’s position as a world leader in science and innovation (whatever that means …), apparently to be rolled out as £425m in 2017-18, £820m in 2018-19, £1.5bn in 2019-2020, and £2bn in 2020-2021. This is apparently direct funding (grants) into an Industry Strategy Challenge Fund, to be modelled on the USA's Defense Advanced Research Projects Agency programme, as well as allocating funding more generally.

- £0.7 billion to support the market to roll out full-fibre connections and future 5G communications

Non-fiscal:
- review tax environment for R&D to build on the R&D Expenditure Credit for large companies 'to make the UK an even more competitive place to do R&D'
- more Science & Innovation Audits

Can the Donald Keep Up with the EU: EU Tax Reform and Venture Capital Fund

After the hangover of the U.S. presidential election subsides, some serious issues will be addressed, including our current tax and innovation system.  Will the U.S. adopt a patent box?  Will the U.S. lower the corporate tax rate?  What will the Donald do?  I am hopeful that he will push more resources to research and development (which has been in decline in real dollars), and education. Perhaps a gaze across the pond will not only give him some inspiration, but may also solve some of our problems.  

On October 26, the EU Commission announced a new way to tax corporations operating in the EU.  The EU Commission website states:

EU Commission have announced the Common Consolidated Corporate Tax Base (CCCTB), a new EU-wide tax system to improve the Single Market, combat tax avoidance and support growth and investment in the EU. The CCCTB will also support Research and Development (R&D) through tax incentives for companies that invest in real research activities. 

In particular, the proposal includes super-deductions for R&D costs: big companies may deduct 100% of their costs, in addition to 50% deduction for R&D expenses up to €20 million and further 25% deduction for R&D costs that will exceed this amount.
The draft also grants super-deductions for small starting companies without associated enterprises (i.e. start-ups) which may deduct up to 200% of their R&D expenses.

For more information, including videos, please see the CCTB website here.  The EU Commission also recently announced the “European Investments Fund (EIF) . . . , a Venture Capital fund of funds programme of €400 million to boost start-ups' growth and increase investments opportunities of institutional private investors.”  

Statistics: make of them what you will - UK patent box vs R&D reliefs

The UK tax authority has recently released statistics for take up of the patent box in 2013-14 (the first year of the relief); on the same day, it released the latest statistics on use of the UK’s R&D tax reliefs for the same tax year. The reports make for some interesting compare and contrast points:

Total claims in 2013-14
- patent box: 700
- R&D tax reliefs: 22,415

Total value of claims in 2013-14
- patent box: £342.9m
- R&D reliefs: £2.45bn

SME claims in 2013-14
- patent box: 475 (68%)
- R&D reliefs: 19,990 (95%)

Value of SME claims in 2013-14
- patent box: £15.7m (5%)
- R&D reliefs: £1.165bn (48%)

The largest claimant sector (for both patent box and R&D) is, unsurprisingly, manufacturing (63% of patent box claims; 30% of R&D claims). The second largest for R&D is Professional, Scientific & Technical, with about 20% of claims - but this sector only made 6.3% of patent box claims. This might relate to the nature of the patent box, and particularly the extra hurdle for claiming on services income. The other sectors are somewhat more difficult to analyse as numbers of patent box claims are so low that sectors have been combined to prevent commercial information being disclosed.

The R&D relief requires a company to be undertaking a project which seeks an advance in the global state of knowledge in an area of science or technology, it would seem logical that a successful R&D-relief qualifying project would often lead to something capable of being patented – and, in the 14 years for which we have R&D statistics, 141,000 claims for relief have been made. Fair enough, R&D relief claims can be made for unsuccessful projects, but out of 141,000 R&D relief claims, it seems pretty likely that there are more than 700 companies within the scope of the patent box … the report doesn’t speculate upon why the take up is so low in terms of numbers (and for comparison, the impact note when the patent box was introduced estimated the first year cost to the Treasury at £500m).

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).

EU giving up investigation into patent box schemes - Hola!

Bloomberg reported on 5 February that the European Commission will be giving up its investigation into patent box schemes in the European Union. Apparently it has found that it's hands are tied by a 2008 decision to approve Spain's system. The agreement reached last Autumn/Fall between the UK and German governments (reported here) to modify the UK's scheme to restrict the tax break has probably also contributed to the commission's desire to stop the investigation.

Basically the UK has agreed to modify its scheme so that only patents based on activities in the UK can contribute to the tax break (the so-called nexus approach) with some provision for expenditure which has not been directly incurred by the UK company (hence the term "modified nexus approach"). The discussions continue in the context of the OECD's discussion on harmful tax practices.

The message coming from the commission seems to be clear: if the OECD will approve the patent box, then the European Commission can and will have no objection. In the meantime, the current UK scheme will be wound down and it remains to be seen whether the next UK government will put a replacement scheme into place, as the opposition labour party has been critical of the scheme.

From tax break to breaking the box: an article

Via Chris Torrero comes a link to this item posted on Economia last week. Entitled "Closing the loophole: Tax breaks on IP and patents", by Liz Loxton, it discusses winding down the current Patent Box regimes in countries that have adopted unacceptable and market-distorting regimes for patent-based tax breaks and draws attention to an issue that this blogger had hitherto overlooked: the potentially damaging effect of reform on whichever countries are first to dismantle their Patent Box systems while other jurisdictions still have theirs in place.

UK patent box "watered down" -- but with a spot of grandfathering

"George Osborne waters down flagship controversial tax break" is the strident headline of this Guardian post by Simon Goodley, subtitled "Patent boxes allow firms to pay much lower taxes on profits from patented inventions, but critics say it gives UK too much of a fiscal advantage". According to this article, in relevant part:

"George Osborne has watered down one of his flagship policies following a long-running dispute with Germany over a controversial UK tax break. ...

The incentives were introduced last year to encourage hi-tech businesses to commercialise their intellectual property in the UK by charging just 10% tax on the resulting income. But Germany led numerous countries in arguing that the regime encouraged artificial shifting of profits to avoid tax elsewhere.

Osborne described the new agreement as “a great deal for Britain” that protected the UK’s vital scientific research while making sure there were international rules that stop aggressive tax avoidance. It would involve the UK winding down its patent box rebates and joining other OECD countries in only granting tax breaks for patents directly tied to research and innovation at home.

Germany’s finance minister, Wolfgang Schäuble, said: “We have reached an important agreement on patent boxes. Preferential tax treatment of intellectual property must be dependent on substantial economic activity. More and more countries are speaking out against allowing too much leeway for large multinationals to minimise their taxes. Just because something is legal, does not mean it is fair in tax terms. Multinationals must contribute their fair share to public budgets – just like any other company has to.”

The Treasury denied it had performed a U-turn on the issue, although it has previously defended its original policy ... [and] countered that it had won important concessions including so-called “grandfathering”, which will allow intellectual property within existing regimes to retain tax benefits until June 2021".

While the notion of the patent box will continue to attract support, not least among patent-exploiting tax-payers, it would be sad if countries were to engage in an unseemly rush to offer the lowest rate for the sake of attracting the relocation of patents alone: tying the tax break to patents grown within the jurisdiction is therefore a wise proposition.  

Mike Mireles' posts on US thinking about patent boxes can be found here and here
"Death of a Travelling Patent Box" by Rob Harrison can be accessed here
Rob's post on the OECD report which gave the UK's patent box scheme a reasonably clean bill of health is here

Thanks go to Chris Torrero for spotting this item

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. 

Money for (old rope) new patents

The Australian Financial Review has published an article today report on an initiative by IP firm Wrays and R&D tax advisor Swanson Reed which calls on the Australian government to provide assistance to companies of up to 50,000 Australian dollars for the preparation and filing of the patents. The authors of the proposal argue that Australian companies need support and that their proposal would be cheaper than the suggested patent box initiative.

The initiative is dismissed by Rui Rodrques who is an investment manager at a Sydney venture capitalist Tank Stream Ventures who argues that online tech industries do not need patents and that the support would only go to traditional industries.

The proposal is reminiscent of Germany's SIGNO SME patent initiative which supports small companies with their first application in both Germany and internationally. This has supported between 400 and 700 companies in the past fifteen years. The last evaluation report in 2009 reported that the learn process by which start-up companies began to understand the patent process was one of the key features of the programme. However, the "innovation market" project to encourage exploitation of IP did not fulfil its potential. The evaluators recommended that the financial support nonetheless be continued. Similar schemes exist in some other countries, such as in China. This author's experience of the scheme does suggest that the financial support helps to kick-start the patenting process as it reduces some of the financial burden on the company. It also helps start the discussion of the value of a company's intellectual assets to its business strategy and the appropriate protection with intellectual property rights (and not just patents).

The objections to the proposals mentioned in the AFR article are that such schemes do not necessarily help online companies and that the patenting process moves too slowly. It's also true that it can be hard for a small company to pursue patent infringements and that the financial penalties in Australia are low. This traditional view of patenting would seem to discourage start-up companies from filing. On the other hand, patents do provide assets which can be used to strengthen licensing programmes and also provide potential purchasers with additional leverage. A recent study carried out for the France Brevets investment fund suggested that - at least in France - patent savvy companies tended to be more successful than other start-up companies in which venture capital firms had invested.

Patent Box Regimes Globally - OECD/G20 respond

The UK's patent box regime  under which companies can get significant tax reductions for income deriving from patented products has been criticized by several countries, notably Germany (see here), as resulting in unfair competition for foreign investment. This blog noted back in July that the EU commission was looking into the issue.

Germany's Finance Minister lecturing his audience
about the evils of the patent box

The OECD in conjunction with the G20 group of major economies has now published a detailed report (available for download here) on countering harmful tax practices more effectively. It includes a number of pages devoted to the patent box regime and seems to approve generally the UK practice, which differs from other countries with similar regimes. One issue that appears to be controversial is the extent to which outsourced research and development activities can later qualify for tax relief, and both the UK and Spain entered reservations on this section of the report. The report emphasizes that marketing-related IP assets such as trademarks should not qualify for the tax benefits, which would appear to impact on schemes in some countries.

It's probably not surprising that the report is at least generally supportive of favourable tax treatment of intellectual property given that a number of countries have introduced such regimes over the years (although Ireland abandoned their tax break, as reported here). The report's main recommendation is that there needs to be a clear link between the revenues and the IP right. This will probably complicate calculations in the future, but the authors noted that taxpayers may chose this in order to exploit the opportunity to benefit from an optional tax benefit. Indeed by harmonising the reporting requirements among different jurisdictions may lead to an overall reduction in complexity.

German chancellor Angela Merkel's
X-ray eyes 

And Germany's response? Well, the news magazine Spiegel reported over the weekend that the German finance ministry was considering introducing a patent box benefit in Germany and the German Industry Group BDI welcomed this move on Monday.

Ireland supports Commission review of patent boxes

Is the patent box an unfair
way of saving on tax payments?

An article by Ciarán Hancock, which appears in The Irish Times, reverts to the vexed question of Ireland and the Patent Box. Readers of this weblog will recall that, in July, this blogger listed Ireland as a country that already had a patent box tax break, only to be told by a reader that the Emerald Isle had scrapped its patent box regime back in 2010.  Well, the topic appears to be back on the table again, this time within a wide European Union context, in the hope that some sort of consistency of approach can be achieved.  The article, in relevant part, reads as follows:

Review of patent tax regimes in EU has Irish support

Ireland supports the EU review of all patent box regimes – under which certain member states offer tax breaks for intellectual property – and has decided to take a “wait-and-see approach” on the issue until guidance is provided by the European Commission. This has emerged from briefing documents provided recently by the Department of Finance to its newly-appointed Minister of State Simon Harris.

A patent box is a special tax regime offering a rate that is lower than a country’s standard corporation tax rate. Questions have been raised as to whether it breaches state aid rules, with the UK’s scheme being closely scrutinised by the commission.

The Ecofin council of EU finance ministers recently requested that the commission carry out an assessment of all patent boxes by the end of 2014. It is examining schemes in the UK, Belgium, Cyprus, Spain, France, Hungary, Luxembourg, Malta, the Netherlands and Portugal.

The briefing note to Mr Harris states that 

“Ireland is supportive of the . . . decision to look at patent boxes. There has been a lack of clarity around the issue of patent boxes for some time, and therefore we believe there should be a thorough analysis of these measures. In particular, given the persistent calls on Ireland to introduce a patent box, it would be helpful to get guidance from the commission. Ireland can adopt a ‘wait-and-see’ approach on this issue.”

Harmful competition

The briefing note adds some EU countries consider the patent box to be a “form of harmful tax competition, with Germany’s finance minister Wolfgang Schäuble making comments to the effect that they are contrary to the European spirit”. ...

Our thanks go to Chris Torrero, for spotting this link.

The Patent Box: Tips, Predictions -- and a special offer for blog readers

"Patent Box: Tips and Predictions" is the title of a seminar coming up on Tuesday 9 September, in the comfy setting of the Rembrandt Hotel, London. This is the sort of seminar that IP Finance approves of, since it offers a generous discount on its registration fee for the benefit of blog readers.

The programme itself focuses, as the title suggests, on the institution of the Patent Box (on which see, for example, earlier IP Finance posts here, here, here, here and here), and specifically on its UK version. The organisers (Management Forum) explain its ethos as follows:

"The Patent Box regime has bedded in - is it working? Big companies are obtaining major savings on tax through the regime - are you? The EU has asked questions about the legal validity of the regime - where might this end? Ensure you're adopting the best practice Ensure you're future proofing your IP tax measures".

The cast of this event is chaired by Gwilym Roberts (a partner in the London-based IP practice of Kilburn & Strode, and a person whose curiosity drives him to make every effort to keep himself well informed regarding the latest IP developments), and  the speakers are drawn from each discipline that has something to offer those seeking to get a decent tax break (and, in the case of Her Majesty's Commissioners for Revenue and Customs, to stop them getting indecent ones).

The discount (which can be enjoyed by readers of this blog and/or the IPKat) can claim a 20% discount on the full fee of £598 plus VAT) by emailing their registration applications to Sue at registrations@management-forum.co.uk, quoting the VIP blog-readers' code IPKat20%.  According to this blogger's calculations, that should bring the price down to £478.40, but you should check the arithmetic for yourself first, since he has done the sum five times and managed to get three different results ...

Death of a Travelling Patent Box

Blogger Jeremy's recent report on the first birthday of the UK patent box system lead to one commentator noting that the Irish had given up their system. This blogger was intrigued by the report, since he knew that at least one patent aggregation entity had set up in Ireland and assumed that this was because of the favourable tax regime. Setting up in the UK was probably not an option since the UK's scheme contains a development condition and an active ownership condition that were designed to stop PAEs from exploiting the British system.

The abolition of the Irish patent royalty relief scheme was one of the conclusions of the Irish Commission on Taxation set up in 2008 to review the appropriateness of the Irish taxation system. The committee was tasked to consider how the Irish tax system can best support economic activity and promote employment and prosperity in the country. It seems therefore strange that the UK government is promoting the patent box as a means of promoting economic activity.

The Irish scheme was a great deal simpler than the UK scheme. Basically any royalty income derived from a "qualifying patent" was exempt from income tax and corporation tax. A qualifying patent was a patent made on an invention for which the R&D work was carried out in a country in the European Economic Area.

An individual was only entitled to the royalty income if he or she were an inventor or a co-inventor. An annual limit of EUR 5 million was placed on the relief.

Dividends paid by a company our of patent income were also tax exempt. The commission concluded that the relief had not resulted in any increase in R&D activity - although they provide no data to back up their statement. It was also noted some companies were using the scheme as a taxi avoidance device to remunerate employees.

Intriguingly the commission concluded that the patent income exemption is a "windfall gain" after a successful invention, and not an incentive to encourage research and development. This is definitely an interesting claim and it would be highly useful to have some statistics to back it up. It would also seem to contradict the view of the British government that the tax savings would put more money into the innovation ecosystem. The Commission did conclude that R&D tax credit incentivises research and development activity more directly than the patent royalty scheme.

So how much did the Irish government actually save by eliminating the tax exemption for patent royalties? A mere EUR 84 million per annum in 2006. Certainly nothing like the millions that the UK scheme is supposed to release for R&D. On the other hand the Irish corporation tax rate for trading income is 12.5%, which is not significantly higher than the 10% headline rate that patent box is supposed to bring - and in practice is higher because of the need to deduct marketing assets and routine returns.

So do the Irish regret scrapping their scheme? Maybe - a discussion recently featured in the pages of the Irish Times.

The Patent Box Coming to the United States Soon?

Congresswoman Allyson Schwartz recently introduced a bill in the House of Representatives to establish a patent box similar to that adopted by some European countries (she previously introduced the bill in 2012 and here is the press release for that bill).  The bill provides a lower tax rate on profits from the exploitation of patented technology developed in the United States.  The patent box is designed to lure entities to the home of the box and thus, create jobs.  The effective tax rate for qualifying profits appears to be 10%.  Here is a link to the proposed legislation and links to several news articles about the 2012 and 2013 proposed legislation here, here and here.  In a helpful 2012 article by Pricewaterhouse Coopers, Is it Time for the United States to Consider the Patent Box, the authors state:

According to the most recent OECD data, as of 2009 the United States ranked 24 out of 38 countries (including 32 OECD members plus Brazil, China, India, Russia, Singapore, and South Africa) in the value of tax incentives provided per dollar of R&D. Because the U.S. research credit expired December 31, 2011, the U.S. incentive provided for R&D is now even lower than indicated by the OECD ranking.

Moreover, according to 2011 OECD data, the combined federal and average state statutory corporate tax rate in the United States (39.2 percent) is second highest among OECD countries, and more than 14 percentage points greater than the average for the other countries (25.1 percent). Therefore, royalty and license income earned from U.S.-held IP is taxed at a 50 percent higher rate than IP held in the average OECD country. The disparity in taxation of IP is even greater when compared with countries with patent box regimes, where qualified IP typically is taxed at rates between 5 and 15 percent.

The time appears to be closer.  What do you think?  The article also has a useful chart comparing patent box legislation in Belgium, France, Luxemburg, Netherlands, Spain and the U.K. 

Asian Subsidiaries Royalty Rising

The London Financial Times has an interesting story today about rises in the royalty rates that Asian subsidiaries are expected to pay to their parent companies. Apparently a number of investment funds have been gaining exposure in Asian markets by buying shares in a locally listed subsidiary of a multinational company, such as Unilever or Nestlé. The investors are concerned by the recent rises in the rates of royalties paid by these local subsidiaries for the use of "shared services" such as research and development, marketing, branding etc. This author's experience with several such agreements suggests that rates between 5% and 8% are generally paid to recognise not just the goodwill in the company name but also, for industries in which innovation plays a key role, the use of patents and know-how. Thus Unilever's rise to a royalty rate 8% of sales from 3.5% does not seem unreasonable in this context. On the other hand, it is not surprising that that investors in Unliver's Indonesian subsidiary - who have happily collected dividends - are not happy. Uniliver justifies its rise by stating that the rise is about cost recovery and that the royalties are apparently subject to the same level of tax both at home as abroad.

One issue not pointed out in the article is that the rise in royalties paid to a UK company seems to coincide with the introduction of the UK's patent box regime under which revenue attributed to patented products is taxed at a lower rate. It is almost certain that a substantial proportion of the royalties from the Indonesian (and other foreign subsidiaries) will be based on patented products and thus the royalties will be taxed at an effective rate of 10% rather than the usual rate of 23% of coloration tax. This probably makes it rather interesting for a company like Unilever to repatriate as much as its revenue from overseas subsidiaries in the form of royalties on patented products. There is clearly tension here between the interests of investors in separately quoted companies that are interested in getting a maximum level of profits from the local companies and the interests of the parent company in repatriating its profits in a tax-efficient manner Such locally quoted subsidiaries have traditionally enjoyed a premium on their share price because they are regarded as being well-governed. It's clear also in many cases that they have benefited from an undervaluation of the use of the groups intellectual property. The Swiss company Holcim has only paid 1.5% to date - which is substantially under market value despite Holcim's technological innovation and the rise to 5% will still put it at the lower end of the going rates for royalties.

The article concludes that the authorities in the local regions should wake up to what is happening and ask whether the trend is welcome. From their point of view the grand is probably not welcome as it will reduce taxable profits locally. However, the rates being talked about are well in line for going rates negotiated at an arms length basis for the use of technology - and this point is not make in the arcticle.

UK Patent Box: further details expected

The UK's Coalition Government is expected to announce further details of the Patent Box regime in this Wednesday's Budget. The Patent Box regime, which will be effective as of 1 April 2014, taxes profits arising from qualifying IP rights, mainly patent rights, at a reduced rate of 10% (this compares favourably with the current 26% rate of UK corporation tax).

Although the introduction of this regime is evidence of the Government's stated intention of ensuring that the UK has the most competitive tax regime in the G20, whether the regime will attract businesses to the UK is moot. However, it should make patent-rich businesses think twice before leaving or investing outside the UK.

The details of the regime have been the subject of consultation for over a year now, and interested parties have persuaded the Government of the benefit of certain amendments to it. These include extending the benefits of the regime to supplementary protection certificates and data exclusivity. However, the Government have made it clear that it does not want to extend the benefits of the regime to IP rights related to branding and marketing: profits relating to such rights are explicitly excluded.

Fuller details of the Patent Box can be found here.  Updates during and following the Budget can be found here.