Patent Box Debuts in Washington in July
Although the U.S. Congress has not been particularly attentive to the Base Erosion and Profit Shifting (“BEPS”) project of the G-20 and the OECD in the past, recent developments in Washington suggest Congressional attitudes may be changing. The International Tax Bipartisan Tax Working Group of the Senate Finance Committee issued its report (the “Report”) on July 7, 2015. The Report recommends, inter alia, that the United States adopt an “innovation box.” In addition, on July 28, 2015, Rep. Charles Boustany, Jr. (R-La.) and Rep. Richard E. Neal (D-Mass.) introduced a discussion draft of patent box legislation – the “Innovation Promotion Act of 2015 – which would provide for a reduced rate of tax on “innovation box profit.”
International Tax Reform Working Group
The co-chairs of the International Tax Reform Working Group are Sen. Rob Portman (R-Ohio) and Sen. Charles Schumer (D-NY). The Report recommends changes to the tax law in five areas: (i) ending the lockout effect, (ii) patent box regimes, (iii) base erosion, (iv) interest expense limitations and (v) deemed repatriation. The report acknowledges the work of the BEPS project and notes that “concurrent with the increase in these discounted tax regimes around the globe, the United States will continue to experience an increase in the migration of intellectual property out of the country.” The Report also acknowledges the modified nexus approach for patent boxes that is being advocated as part of BEPS Action 5.
As to patent boxes, the Report concludes:
The co-chairs agree that we must take legislative action soon to combat the efforts of other countries to attract highly mobile U.S. corporate income through the implementation of our own innovation box regime that encourages the development and ownership of IP in the United States, along with associated domestic manufacturing. They continue to work to determine appropriate eligibility criteria for covered IP, a nexus standard that incentivizes U.S. research, manufacturing, and production, as well as a mechanism for the domestication of currently offshore IP.”
The Innovation Promotion Act of 2015
Also in July, but after the Report was issued, the Innovation Promotion Act of 2015 (the “Act”), which is only a discussion draft, was released. It would effectively tax “innovation box profit” earned by a corporation at a rate no higher than 10 percent. (There is no equivalent provision for partnerships and other pass-through entities.) Consistent with the BEPS Action 5, the Act includes a nexus requirement which limits the benefit based to the ratio of the taxpayer’s “5-year research and development expenditures” (determined by reference to the deduction allowed by section 174 for research and experimental expenditures) to “5- year total costs.”
The income eligible for the tax benefit is determined by reference to “qualified gross receipts,” which is broadly defined to include gross receipts from the sale, lease, license or other disposition of “qualified property.” The definition of “qualified property” includes intangible property defined in section 936(h)(3)(B), computer software and product which is produced using intangible property. As the definition of intangible property is quite broad, including patents, copyrights and trademarks, income from most product sales appears to be eligible for the reduced tax rate.
At this time there are no revenue estimates for this proposal; however, it is safe to say that such a proposal would entail a very significant tax expenditure by the Congress. Thus, the challenge for those advocating an innovation box in the context of revenue neutral tax reform is finding politically palatable offsetting revenue raisers.
A key element of the OECD’s modified nexus approach is the requirement that the R&D activity be performed in the country providing the tax benefit in order for the associated income to be eligible for the reduced tax rate. By contrast, the existing patent box regimes, which will be phased out as part of the BEPS project, have not for the most part required the R&D to be performed in country. Those regimes merely required that ownership or funding of the associated R&D expenditure be provided by the entity claiming the tax benefit.
The author is not aware of any economic studies examining the responsiveness of the R&D function itself to tax incentives (i.e., how likely those functions would be to emigrate from the United States in response to a tax incentive). One would expect that issue to be studied before any change in law is made. A priori, one would expect new R&D activity to be more responsive to such incentives than existing activity because companies can choose when establishing a new facility. One also would expect some geographic stickiness of the R&D function, at least in the short run, because of benefits associated with the existing U.S. corporate R&D infrastructure and externalities stemming from being part of a larger local U.S. R&D community (U.S. research universities, Austin, Boston, Palo Alto, etc.). Depending upon where the economic analysis comes out, it may be that the United States may not need to match other countries’ tax incentives dollar for dollar in order to remain competitive in R&D jobs and the associated income.
KEYWORD: Corporate Tax Reform
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