Tax Issues Impacting Intellectual Property Transactions 101 & 102

Transcription

1 Tax Issues Impacting Intellectual Property Transactions 101 & 102 June 8, 2016 By: Charles E. Hodges II: Chair, Domestic & International Tax Practice 2013 Kilpatrick Townsend

2 INTERSECTION BETWEEN IP & TAX Have you structured a transaction or a litigation settlement involving IP with your internal or external tax advisors? a) Yes. We worked together to maximize the taxefficient structure of the transaction while ensuring the IP remained protected for infringement purposes. b) I think so. They were in the room drawing on white boards so I think they were involved. c) No. I avoid our tax advisors. Have you met them? 2

3 Intersection of Tax and IP q Where do IP Tax and Legal Issues Arise? Ø Creation and Acquisition of IP Ø Valuation of IP Ø Licensing or Sale of IP Ø Mergers, Acquisitions, Reorganizations involving IP assets Ø Intercompany/Affiliate Transactions with IP Ø Management of IP and IP Portfolios Ø Litigation over IP 3

4 What Drives IP/Tax Planning? 4

5 WHY IP TAX PLANNING MATTERS Based on the prior slide, which country would be the best jurisdiction to report deductions such as payment of royalties? a) Ireland. b) United States. c) Whatever country the guy next to me says as I stopped paying attention to you as soon as you said you were in tax. 5

6 Disconnects Between Tax and IP Planning/Management q Terminology q Valuation of IP q Ownership of IP q Location of IP q Enforcement of IP rights 6

7 Terminology Disconnect q Terminology can mean different things. For example: Ø Ownership in the IP world normally simply means the registered owner or title owner, while in the tax world it s a nuanced concept dependent on having a bundle of rights (benefits and burdens of ownership) which may not align with legal ownership Ø Transferring IP in the IP world normally simply means getting the IP from entity A to entity B as a legal matter, while in the tax world the transfer is a critical issue, requiring proper tax characterization as a contribution, a license, or a sale q Close attention must be paid to drafting IP transfer agreements to ensure intended tax treatment is supported 7

8 Valuation Disconnect q IP professionals often want a high valuation of an IP asset in order to increase damages in litigation, arbitration, and other disputes q Tax advisors often want a low valuation to minimize the gain on a sale or the income attributed to a license on a transfer of IP 8

9 Ownership Disconnect q Tax ownership versus legal ownership Ø Legal ownership is based on holding legal title to the IP o E.g., Registered owner of a trademark or patent Ø Tax ownership is based on possessing the benefits and burdens of ownership o This bundle of rights is not necessarily held by the legal owner Ø Example separating trademark goodwill from the legal title of a U.S. mark in order to achieve a particular tax ownership result may destroy the mark for IP legal purposes 9

10 Location Disconnect q IP professionals often want U.S. ownership in order to benefit from U.S. legal protections and enforcement avenues for the IP q Tax advisors often want non-u.s. ownership when available within a group structure in order to benefit from foreign IP patent box regimes and other incentives in order to achieve overall tax efficiency q Other location issues include poor contract drafting - words can inadvertently create permanent establishments or tax presence in countries when excessive authority is granted to certain affiliates/ employees with respect to the IP 10

11 Enforcement Disconnect q Tax/corporate structuring could have a negative impact on IP legal enforcement and damages Ø Example: o Patent holder enters into non-exclusive license with an affiliate Tax considerations resulted in a license and not a sale of the IP o Patent holder sues a third party for patent infringement o Court finds patent holder is not entitled to lost profits because it is not selling the items covered by the patent, its affiliate is o Court finds that the affiliate also is not entitled to lost profits because it has a non-exclusive license o Damages are limited to reasonably royalty not lost profits q Poly America v. GSE Lining Technology 11

12 IP Considerations Relevant to Tax q Legal Protection q Enforcement q IP Treaty Network q Litigation Environment 12

13 Coordinate Tax and IP Planning q Goal IP that is legally protected and held or transferred in a tax efficient manner q Coordinating tax and IP professionals can avoid problems, including: Ø Compromising tax positions or triggering taxable income Ø Undermining legal ownership, enforcement, and defense of IP rights q Critical to collaborate during planning and drafting phases 13

14 IP Tax Planning Tools q Patent Box Regimes q IP Holding Companies 14

15 IP HOLDING COMPANY Does your company have an IP Holding Company? a) Yes. b) No. c) Do not know. They don t tell me anything around here. 15

16 IP Tax Planning Tools Patent Box Regime PATENT BOX What is it? q A tax incentive providing relief from corporate tax on income generated from certain types of qualifying IP, especially patents. q A patent box provides tax relief once an invention has become profitable, while R&D tax credits (the usual IP related tax incentive), provide tax benefits only at the front end of the innovation life cycle. q Patent boxes generally either provide a reduced tax rate on patent box income or a deduction. q Patent box regimes are well established in the Netherlands, Luxembourg, Belgium, France, Spain, Hungary, Ireland, and U.K. q The U.S. has been noticeably absent from the patent box mix. 16

17 q The U.S. Patent Box - introduced by Rep. Boustany and Rep. Neal in July 2015 q Proposes to: Ø Lower U.S. effective tax rate to about 10% on income earned from qualifying IP Ø Permit tax free migration of foreign based IP to the United States o Allowing domesticated IP to qualify for the innovation box tax benefit q What is qualifying IP? Ø Patents, inventions, formulae, processes, designs, patterns, know-how, computer software, and the property they produce q How will this be accomplished? Ø Allowing U.S. companies to deduct 71% of innovation box profit earned from qualifying IP - resulting in an effective tax rate of about 10% on those profits q What is innovation box profit? The U.S. Patent Box: Innovation Promotion Act of 2015 Ø Gross receipts from the sale, lease, or license of qualified IP to third parties less associated costs (e.g., cost of goods sold, interest expense, taxes) multiplied by a function of expense allocated to U.S. based R&D 17

18 The U.S. Patent Box: Innovation Promotion Act of 2015 q What can U.S. companies can do now? Ø Protect the IP and its tax benefits apply for patents o Income qualifying for the patent box tax benefits clearly will include income generated from qualifying transactions with patents Sale, lease, or license to third party of patent Ø Increase R&D spending in the U.S. o The calculation for the tax benefits is designed to tie increased tax benefit to larger U.S. based R&D expense o The calculation looks back to U.S. R&D expense over the last 5 years Ø Track R&D spending Ø Qualifying expenses should include those that are deductible under section 174 of the U.S. Tax Code 18

19 New Developments Impacting IP - What is BEPS? q BASE EROSION AND PROFIT SHIFTING Ø The practice of a multinational operating in at least two different countries taking profits and moving them to where they are taxed at a lower rate, and taking expenses and moving them to where income is taxed at a higher rate Ø Essentially exploiting differences in multiple different tax regimes q The OECD (Organisation for Economic Co-operation and Development) published a report Addressing Base Erosion and Profit Shifting in February 2013, followed by an Action Plan on BEPS identifying 15 specific actions countries should take to combat BEPS activities, many focused on IP Ø IP assets lend themselves easily to BEPS transactions for multinationals operating across many different tax regimes q BEPS Final Report approved October 2015 q Participating countries are now implementing action items primarily via local legislation, including the U.S. 19

20 IP Holding Companies q Why create an IP HoldCo? Ø Migrate the tax burden of the IP to the HoldCo country (e.g., use a patent box or no or low tax country or state) Ø Royalties or fees paid to the IP HoldCo are accumulated as IP revenues taxed at the lower tax rates in the HoldCo country Ø Those royalties or fees are generally deductible by the operating company as costs/expenses of its business Ø Ensure that profits distributed from a foreign HoldCo (as dividends) are not subject to withholding tax drag Ø Be mindful of new and increasing substance requirements for IP HoldCo (e.g., under BEPS legislation) 20

21 IP Migration q Transfer of IP rights to IP HoldCo can be accomplished via: Ø Contribution Ø Sale Ø License Ø Cost Sharing Arrangement 21

22 Contribution of Foreign IP FOUNDERS/INVESTORS U.S. Parent US IP Tax ownership of foreign IP rights Foreign IP Foreign IP Company 22

23 Contribution of IP q Contribution of IP to HoldCo subsidiary Ø Domestic to domestic contribution of IP generally tax free under Code Section 351 Ø Domestic to foreign contributions of IP generally taxable under special outbound transfer rules of Code section 367(d) which deem an ongoing and taxable royalty payment from the foreign subsidiary to the domestic parent, known as the SUPER ROYALTY PROVISION BEWARE Never transfer IP to a foreign affiliate without first considering the tax implications!! 23

24 Sale of Foreign IP FOUNDERS/INVESTORS Assignment or exclusive perpetual license of foreign IP rights U.S. Parent Foreign IP Company Purchase Price 24

25 Sale of IP q Sale to HoldCo Ø Effected by assignment or exclusive perpetual license of foreign IP rights Ø IP HoldCo purchases the IP for its fair market value Ø Downside: upfront tax cost on gain can be prohibitive o generally need low valuation or losses available to offset gain Ø Be aware of transfer pricing rules applied to related parties 25

26 License of Foreign IP FOUNDERS/INVESTORS Nonexclusive right to exploit foreign IP U.S. Parent Foreign IP Company Royalty 26

27 License of IP q License to HoldCo Ø Effected by non-exclusive license to exploit foreign IP Ø IP HoldCo pays a royalty to U.S. owner Ø Upside: tax efficient method for high value IP Ø Downside: royalty income is taxable in the U.S. and foreign withholding tax could apply to royalties Ø Be aware of transfer pricing rules applied to related parties 27

28 Cost Sharing Arrangement FOUNDERS/INVESTORS U.S. Parent Buy-In payment Pre- Existing IP U.S. IP Agreement to share costs of developing IP Foreign IP Company Foreign IP 28

29 Cost Sharing of IP q Effectively a joint venture where two parties agree to co-develop an IP asset using a cost sharing agreement (CSA) under U.S. tax rules q The parties share IP development costs in exchange for, and in proportion to, an ownership interest in any resulting future IP Ø Ownership may be divided e.g., based on geography q The parties share profits/losses from the IP q At least one party contributes/licenses/sells existing IP to the arrangement and the other party pays a buy in price to use that IP q Issue how to value contributed or exclusively licensed IP q Benefit each party owns co-developed IP q Extensive documentation and planning required 29

30 IP HoldCo Substance Requirements q Sufficient business substance needed in IP HoldCo to support expected U.S. benefits Ø Cannot be a paper transaction only Ø Corporate formalities must be observed Ø Some level of commercial substance required (employees, business functions, decision-making, etc.) to maintain and exploit IP q Substance also required under foreign law and now BEPS q Impacts potential foreign ruling requirements (tax rate and duration) and eligibility for incentives q Foreign withholding reduction and treaty benefits may require local substance q Increased focus by foreign tax authorities (BEPS etc.) 30

31 IP Legal Risks of IP HoldCos q Validity, Protection, and Enforcement of IP ownership Ø Is IP HoldCo country a signatory to key international IP treaties? o Example: BVI offers great tax advantages, but a trademark held in the BVI would not benefit from e.g., the Madrid Protocol Ø Is the transfer, especially sublicense, of IP valid and effective o Tricky where multiple transfers are made in the structuring Ø Does the HoldCo country recognize the validity of the IP? Ø Is goodwill assigned with a transferred trademark Ø Example: under U.S. law transfers of a trademark without goodwill are invalid Ø Check if creator s rights are accounted for in the structuring o France copyright law gives creators the right to be paid a percentage of gross revenues of films Ø Will the IP HoldCo have the right to defend and enforce the IP it holds? Is that country a good legal environment from which to defend/enforce? 31

32 Where to Locate an IP HoldCo Key Tax Considerations Ø Effective Tax Rate Ø Withholding tax rates Ø Repatriation costs Ø Tax treaty network Ø Exit strategy Key IP/Business Considerations Ø Business Environment Ø Legal protection/enforcement Ø Registration Ø IP treaty network Ø Operating costs Possible Jurisdictions Ø Ireland Ø Netherlands Ø Luxembourg Ø United Kingdom Ø Delaware 32

33 Intellectual Property State Tax Considerations Licensing intellectual property into a state may create tax filing obligations in that state. Example: a franchisor licenses its name and trademarks to franchisees in the state, which creates an income tax filing obligation with that state. KFC Corp v. Iowa Dep t of Rev., 792 NW2d 308 (Iowa 2010). Royalty income must be sourced for state tax purposes, but states have different sourcing rules: State(s) of use (most common rule). Customer commercial domicile (typical historic rule). Proportionately among customer office locations (minority rule). Sourcing proceeds from patent infringement lawsuits The states have different sourcing rules, including to exclude the payment from the sales factor in some states. 33

34 In-depth knowledge of both TAX and INTELLECTUAL PROPERTY is key for structuring any domestic or international intellectual property transaction. Kilpatrick Townsend s Tax Team gives you both Kilpatrick Townsend & Stockton LLP 34

35 Charles E. Hodges II Chuck Hodges is the Chair of the Domes4c & Interna4onal Tax Team of the law firm of Kilpatrick Townsend & Stockton, LLP. Mr. Hodges focuses his prac4ce on civil and criminal federal tax controversies and complex tax planning. He has been involved in more than 100 cases against the IRS and state revenue agencies, represen4ng a broad range of taxpayers, including individuals, estates, closely held businesses, tax- exempt organiza4ons, and publicly traded corpora4ons. A substan4al number of these engagements have involved the defense of TEFRA partnerships and limited liability companies. Mr. Hodges handles approximately fipeen cases against the IRS per year, recovering more than $1 million for his clients from the IRS in reimbursement of arorneys fees at the conclusion of their trial victory. As a tax li4gator, he has handled all stages of tax controversies, including all administra4ve and judicial levels from examina4on through court proceedings. Mr. Hodges has been a key li4gator in various cases earning him honors and recogni4on. He has been listed as a "Leader in the Field" for Taxa4on by Chambers USA: America's Leading Lawyers for Business each year since He was recognized by his peers in the 2015 edi4on of The Best Lawyers in America, and each of the five years immediately preceding, for the area of Tax Law. In 2014 and each of the five years immediately preceding, Mr. Hodges was named a Georgia Super Lawyer and previously a Georgia Rising Star by SuperLawyers magazine. Throughout his career, Mr. Hodges has provided insight as an industry leader for some of the na4on s top news outlets including the Wall Street Journal, Bloomberg, BusinessWeek, Forbes and Law360. He is AV rated by Mar4ndale- Hubbell. 35