Defining Intellectual Property The Tax Implications

Transcription

1 Sutherland Tax Roundtable - Silicon Valley April 29, 2015 Robb Chase, Partner Michele Borens, Partner Defining Intellectual Property The Tax Implications 1

2 Overview The Irresistible Force and the Immovable Object The state, federal and international tax environment is in flux as tax authorities seek to curtail the use of perceived tax avoidance strategies, but also implement tax-related incentives designed to attract investment. Minimize Tax Avoidance Incentivize Investment 2

3 Overview Caught in the Middle Highly mobile income, such as IP profits, are a key target under the current reform proposals and investment initiatives. Minimize Tax Avoidance Incentivize Investment 3

4 Overview The Playing Field Tax authorities are taking a twoheaded approach to tax reform. Defense Tax Reforms Offense Transparency; tightening of IP profit allocation rules; GAAR Requiring other tax authorities to avoid harmful tax practices 4

5 Overview Prepping Your Team While tax authorities sort out their approach, companies need to be prepared for the potential changes on the horizon. Evaluate the longevity of any tax benefits on IP income. Identify modified or replacement IP structures expected to secure tax benefits after reforms. Quantify the short term and long term costs versus benefits of making any structure changes. Prepare or sensitize management to these analyses. 5

6 A Tortured Relationship: IP Development and Tax Incentives 6

7 IP Development Incentive Regimes U.S. R&D Credit Regime Benefit of tax credit equal to amount of qualifying R&D expenses Benefit inures to party performing R&D at its risk; 15 yr amortization for acquired IP Amount of tax credit determined w/o regard to value of profits created by R&D activity IP Box Regime Benefit of lower tax rate on IP profits Benefit inures to IP entrepreneur or group member performing R&D; may be amortization for acquired IP Amount of profit subject to benefit relies on TP analysis De facto Systems Benefits vary but could be a de facto low zero tax rate on profits earned outside country Benefit inures to IP entrepreneur performing R&D (directly or through contract R&D) Amount of profit subject to benefit relies on TP analysis 7

8 The Tipping Point Patent Boxes Recent years have seen the rise of patent or innovation boxes, particularly in the EU, bringing the question of permissible tax incentive versus harmful tax practice to a head. Permissible Tax Incentive Harmful Tax Practice 8

9 The Tipping Point Patent Boxes (cont d) Although they vary by country, the principal features of a patent box regime can be illustrated by UK Patent Box Regime: Phased in beginning April 1, 2013 and providing for 10% corporate tax rate on worldwide profits derived from qualifying patents and similar IP. Eligible companies include UK taxable entities that undertake qualifying development activities. Activities conducted by group companies can satisfy development requirement - accommodates CSAs and acquired IP. Qualifying IP must be owned or exclusively licensed. Portion of IP income eligible for benefit determined by applying transfer pricing rules. Pfizer cited this 10% rate as a motive for its proposed $100B takeover of AstraZeneca, which was subsequently abandoned. 9

10 Patent Box Permissible Incentive Regime or Harmful Tax Practice? EU EU Code of Conduct Group State Aid attacks EU measured reaction to UK Patent Box OECD BEPS Action Plan (July 2013) BEPS Action 5 Report (September 2014) BEPS Action 5 Agreement (February 2015) Various Countries Germany publicly reacts to UK Patent Box UK-German Statement (November 2014) UK-German Agreement (February 2015) 10

11 Consensus Building for IP Regimes 11

12 Consensus Building for IP Regimes? UK-Germany Agreement on UK Patent Box Germany responded strongly to the UK Patent Box Regime, arguing that it was a harmful tax practice, particularly because acquired IP could be imported into the UK regardless of where developed. Following discussions between the governments, the UK- German Agreement calls for agreement by June 2015 on a practical tracking and tracing approach to determine eligibility of IP for patent box regime. IP must be connected to the jurisdiction providing the benefit, although a limited uplift benefit is provided for related party outsourcing and third party acquisitions. UK agreed to closure of existing regime to new participants as of June 2016, and the elimination of the regime for grandfathered companies by June

13 Consensus Building for IP Regimes? The UK-Germany Approach reflects the OECD recommendations in its Action 5: Countering Harmful Tax Practices. Under Action 5, the OECD has proposed adoption of a modified nexus approach for purposes of determining whether an IP incentive regime, such as a patent box, is a permissible incentive or a harmful tax practice. This approach focuses on whether the taxpayer engages in substantial activities in the regime to warrant the tax incentive. Existence of substantial activities is determined on the basis of the location of qualified expenditures. Approach permits jurisdictions to provide benefits to income arising out of IP to the extent there is a direct nexus between the income receiving the benefits and the expenditures contributing to that income. 13

14 Consensus Building for IP Regimes? The OECD Modified Nexus Approach: The proportion of IP income that may benefit from an IP regime is the same proportion as that between qualifying expenditures and overall expenditures. Qualifying IP Expenditures Total IP Expenditures Overall IP Income Eligible IP Income So long as the amount of income receiving benefits under the IP regime does not exceed the amount determined under this nexus approach, the regime satisfies substantial activities and is permissible. 14

15 Consensus Building for IP Regimes Query the U.S. Approach - Comprehensive tax reform continues to fill the U.S. headlines, but with little or no specific action. Camp Option C (2011) Sought to reduce the incentives to locate intangibles in low- or no-tax jurisdictions by providing for neutral tax treatment of intangible income. Income of a CFC from use of intangible property would be subpart F income subject to US tax at 25% rate. 40% DRD available for income from use outside the US (yielding 15% rate). 40% deduction for domestic corporations for income from use of intangibles outside the US (yielding 15% rate). Camp Discussion Draft (2014) Similar to Option C, it purports to neutralize the incentive to shift income from intangibles, although mechanically there is no specific link to intangibles. 15

16 Consensus Building for IP Regimes Query the U.S. Approach - Comprehensive tax reform continues to fill the U.S. headlines, but with little or no specific action. President s FY 2016 Budget International Proposals 19% minimum tax on foreign income; 14% tax on retained foreign earnings. Limit shifting of income through intangible property transfers. Close loopholes under subpart F. 16

17 Query the U.S. Approach? U.S. patent box regime? General discussion of traditional IP and patent box regimes has yet to meet with the introduction of specific proposals. Tension with R&D credit? Does it have to be either or? Relationship to reduced corporate rates generally? Practical Difficulties in Coalition Building Although taxpayers share common goals, the means of getting there impact each taxpayer differently. Issue seems to be not what you want, but what you are willing to give up to get it. 17

18 How will the States React? IP Holding Companies were once a common part of corporate structures. States have more closely scrutinized IP structures in the last 30 years. States have enacted various regimes and rules to limit the tax benefit from licensing IP Expense Disallowance or Addback Statues Combined Reporting Expanded nexus statutes Certain types of IP Holding Companies have survived some scrutiny in some states. IP licensing by insurance companies. IP licensing by robust operating companies. 18

19 Devil is in the Details: Defining IP Assets 19

20 Devil is in the Details: Defining IP Assets Current U.S. Rules Generally Broadly Defined Section 367(d) - Taxes outbound transfers of intangible property in nonrecognition transactions and defines IP broadly to include any of the following if it has a substantial value independent of the services of any individual: Patent, invention, formula, process, design, pattern, or know-how; Copyright, literary, musical, or artistic composition; Trademark, trade name, or brand name; Franchise, license, or contract; Method, program, system, procedure, campaign, survey, study, forecast, estimate, customer list, or technical data; or Any similar item, Foreign goodwill or going concern value is not included in the definition of intangible property for purposes of section 367(d). 20

21 Devil is in the Details: Defining IP Assets Current U.S. Rules Generally Broadly Defined Section 197 Also defines intangible broadly to include: Goodwill and going concern value, Workforce in place including its composition and terms and conditions (contractual or otherwise) of its employment, Business books and records, operating systems, or any other information base (including lists or other information with respect to current or prospective customers), Any patent, copyright, formula, process, design, pattern, knowhow, format, or other similar item, Any customer-based intangible or any supplier-based intangible,and any other similar item, 21

22 Devil is in the Details: Defining IP Assets Current U.S. Rules Generally Broadly Defined Section 197 Also defines intangible broadly to include: Any license, permit, or other right granted by a governmental unit or an agency or instrumentality thereof Any covenant not to compete (or other arrangement to the extent such arrangement has substantially the same effect as a covenant not to compete) entered into in connection with an acquisition (directly or indirectly) of an interest in a trade or business or substantial portion thereof, and any franchise, trademark, or trade name. Sections 1060 and In the case of an applicable asset acquisition (i.e., an acquisition of all of the assets of a business) sales proceeds and purchase price are allocated among the assets acquired in order by class, including Class VI intangible property described in section 197 other than goodwill and going concern, and Class VII, all other property including goodwill and going concern. 22

23 Devil is in the Details: Defining IP Assets OECD Modified Nexus Proposal IP Assets in contrast to existing U.S. definitions, the OECD modified nexus proposal narrowly defines IP Assets as patents and other functionally equivalent assets. Marketing-related IP assets such as trademarks would not qualify, setting up a significant valuation question. Where a product incorporates multiple IP assets, determining the income attributable to a specific IP asset may not be practicable. Defining the IP asset is also critical to determining the qualifying expenditures. Whither the existence of cost sharing arrangements? Where R&D activities give rise to IP assets in multiple jurisdictions, the implications on the qualifying expenditure definition are uncertain. The OECD has suggested that further guidance on the definition of IP will be forthcoming. 23

24 Devil is in the Details: Defining IP Assets OECD Modified Nexus Approach Qualifying Expenditures - must have been incurred by a qualifying taxpayer and must be directly connected to the IP asset. Qualifying Directly connected Incurred by the qualifying taxpayer Potential Uplift Acquisition costs Outsourcing to related parties Non - Qualifying Not directly connected Not incurred by qualifying taxpayer Outsourcing to related parties 24

25 Devil is in the Details: Defining IP Assets OECD Modified Nexus Approach Qualifying Expenditures - must have been incurred by a qualifying taxpayer and must be directly connected to the IP asset. Uplift may be provided to take into account certain non-qualifying expenditures. The OECD Agreement on Modified Nexus and Explanatory Paper builds on the UK-Germany Joint Proposal and permits a 30% uplift for expenditures for outsourcing to related parties and acquisitions from unrelated parties. Post-acquisition expenditures related to acquired IP can qualify as qualifying expenditures. 25

26 Devil is in the Details: Defining IP Assets OECD Modified Nexus Approach Uplift for non-qualifying expenditures, example 1: Unrelated Seller $10 Purchased IP MNC (Country A) $100 Q.E. Third Party $40 R&D (Country B) Maximum uplift amount = 100 * 30% = 30 Overall qualifying expenses including limited portion of outsourcing and acquisition costs =

27 Devil is in the Details: Defining IP Assets OECD Modified Nexus Approach Uplift for non-qualifying expenditures, example 2: Unrelated Seller $10 Purchased IP MNC (Country A) $100 Q.E. Third Party $15 R&D (Country B) Maximum uplift amount = 100 * 30% = 30 Overall qualifying expenses including limited portion of outsourcing and acquisition costs = 125 Uplift is capped by the amount of actual expenditures. 27

28 Devil is in the Details: Defining IP Assets OECD Modified Nexus Approach Overall Expenditures the sum of all expenditures that would count as qualifying expenditures if they were undertaken by the taxpayer itself. IP acquisitions costs are included in overall expenditures but not in qualifying expenditures (though acquisition costs may be taken into account through uplift ). Overall Income limited to net overall income derived from the IP asset (after allocation of expenditures). May include royalties, capital gains and other income from the sale of an IP asset and embedded IP income from the sale of products directly related to the IP asset. 28

29 Devil is in the Details: Defining IP Assets OECD Modified Nexus Approach Grandfather Rules for Existing Regimes Taking a cue from the UK-Germany proposal, the OECD modified nexus approach suggests phased elimination of existing, nonqualifying regimes. Close old regimes to new entrants on the earlier of (i) new regime consistent with modified nexus approach taking effect or (ii) June 30, New entrants only include those that fully meet substantive requirements of regime application alone is not sufficient Abolish old regimes by June 30,

30 Devil is in the Details: Defining IP Assets OECD Modified Nexus Approach Transition Rules for New Regimes Little discussion has been devoted to how existing IP may be transitioned into new incentive regimes, if at all. Potentially could apply only to new expenditures, but consider whether that will give rise to section 197-type anti-churning rules. 30

31 Devil is in the Details: Defining IP Assets Most state tax definitions of intangible property are contained income tax provisions. States do not impose sales tax on intangible property. Many states impose sales tax on software (often considered IP), but their state definitions define tangible personal property to include software 31

32 Devil is in the Details: Defining IP Assets State Tax Definitions California Reg (b)(4) "Intangible property" includes, but is not limited to, patents, copyrights, trademarks, service marks, trade names, licenses, plans, specifications, blueprints, processes, techniques, formulas, designs, layouts, patterns, drawings, manuals, trade secrets, stock, contract rights including broadcasting rights, and other similar intangible assets. Also define marketing intangibles, mixed intangibles and manufacturing intangibles. Massachusetts Sec. 31I(a) "Intangible property", patents, patent applications, trade names, trademarks, service marks, copyrights, mask works, trade secrets and similar types of intangible assets. 32

33 IP Planning in the Face of Tax Reform Uncertainty 33

34 IP Planning in the Face of Uncertainty Recent EU and OECD actions are indicative that consensus may be forthcoming on IP incentive regimes, but in the absence of specific rules what should taxpayers do to prepare? Depends on the taxpayer BEPS and similar initiatives are focused on alignment of income and expenses (i.e., modified nexus approach). For taxpayers in existing regimes that are under attack, the need to transition may be more immediate. For other taxpayers, active participation in the worldwide legislative discussion may be appropriate. 34

35 IP Planning in the Face of Uncertainty In the absence of specific rules what should taxpayers do to prepare? In all cases, important to ensure that non-tax business and legal teams are aware that landscape may be changing, which may result in recommended operational or structural changes. 35

36 Questions? Michele Borens Sutherland Asbill & Brennan LLP Robb Chase Sutherland Asbill & Brennan LLP

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