Gene Ferraro, Mazars USA LLP New York, NY William D. James, BKD, LLP St. Louis, MO

Transcription

1 How to Plan for IP?

2 Gene Ferraro, Mazars USA LLP New York, NY William D. James, BKD, LLP St. Louis, MO Cormac Kelleher, Mazars Dublin, Ireland Jon Jenni, Plante & Moran, PLLC Chicago, IL 2

3 1. What is Intangible Property (IP)? 3

4 What is IP? 4

5 What is IP? OECD Guidelines definition Changed definition of intangibles in 2015 Final BEPS Report (Chapter VI) which is not a physical or financial asset, which is capable of being owned or controlled for use in commercial activities, & whose use or transfer would be compensated had it occurred in a transaction between independent parties in comparable circumstances. OECD didn t want the definition to be too broad or narrow Examples include, but are not limited to: Patents Know-how & trade secrets Trademarks, trade names & brands Rights under contracts & government licenses Licenses & similar limited rights in intangibles Goodwill & ongoing concern value 5

6 What is IP? OECD Guidelines Items such as corporate synergies, market advantages, location savings & assembled workforce are not considered intangibles because they cannot be controlled by a specific entity Should be considered as comparability factors No distinction between types of intangibles (i.e., trade vs. marketing) Generally seen as trying to broaden the scope of intangibles for transfer pricing purposes 6

7 What is IP? Internal Revenue Code 482 Definition per (b)(1-6) Patents, inventions, formulae, processes, designs, patterns or know-how. Copyrights & literary, musical, or artistic compositions. Trademarks, trade names, or brand names. Franchises, licenses, or contracts. Methods, programs, systems, procedures, campaigns, surveys, studies, forecasts, estimates, customer lists, or technical data. Other similar items. For purposes of section 482, an item is considered similar to those listed in paragraph (b)(1) through (5) of this section if it derives its value not from its physical attributes but from its intellectual content or other intangible properties. 7

8 2. Important IP Considerations in a Post- BEPS World

9 Important IP Considerations in a Post-BEPS World End of the cash box 9

10 Important IP Considerations in a Post-BEPS World Development, enhancement, protection & exploitation of intangibles socalled DEMPE functions. Implications for functions & substance needed to sustain intangible returns. It is not essential the legal owner physically performs all of the functions related to the development, enhancement, maintenance, protection & exploitation of an intangible through its own personnel in order to be entitled ultimately to retain or be attributed a portion of the return derived from the MNE group from exploitation of the intangibles. If the legal owner neither controls nor performs the functions related to the development, enhancement, maintenance, protection & exploitation of an intangible, the legal owner would not be entitled to any ongoing benefit attributable to the outsourced functions. Focus is supposed to be on which entity is controlling the intangible activity (such as R&D) & making the key decisions. 10

11 Important IP Considerations in a Post-BEPS World Development, enhancement, protection & exploitation of intangibles socalled DEMPE functions Implications for functions & substance needed to sustain intangible returns Certain functions will have special significance: Design & control of research & marketing programs Direction & establishing priorities for creative undertakings including determining the course of bluesky research Management & control of budgets Control over strategic decisions regarding intangible development programs Important decisions regarding defence & protection of intangibles Quality control over functions performed by other entities that have a material effect on the value of the intangibles 11

12 3. IRS Backstop

13 IRS Backstop IRS Backstop Per IRC 367(d) if a U.S. person transfers intangible property to a foreign corporation in certain non-recognition transactions, the U.S. person is treated as selling the intangible property for a series of payments contingent on the productivity, use, or disposition of the property that are commensurate with the transferee s income from the property. The payments generally continue annually over the useful life of the property. 13

14 Transfer of Intangible Property Models

15 IRS Transfer of Intangible Property Models Intangible assets are generally transferred under three models: 1. Licensing 2. Services 3. Cost sharing arrangement 15

16 Licensing Model Intangible assets are held by one party Intangible assets are then licensed to group affiliate(s) Intangible licenses can be for: Technology (e.g., know-how, patents, processes, formulas, designs, etc.) Marketing (e.g., customer lists, trademarks, trade names, etc.) The licensor pays a royalty to the licensee for the use of the intangibles Royalty is usually based upon a percentage of sales (can be in the form of lump sum or milestone payments) Licensee is usually the entrepreneur Usually an at risk entity for which a guaranteed return is not given 16

17 Services Model Services Model Used when one party develops an intangible asset & another party desires to beneficially own the intangible asset These parties may enter into a service arrangement where the party desiring to exploit the intangible asset pays the performing entity a service fee Usually on a cost-plus or hourly rate basis The payment conveys the economic beneficial ownership to the payor Need to consider: The compensation or cost-plus agreement Non-adequate arm s length payment may put the ownership of the intangible asset in jeopardy Legal ownership Intangible asset should be registered in the contracting entity s name 17

18 Cost Sharing Arrangement Model Cost Sharing Model Agreement under which the participants to the qualifying cost sharing arrangement ( CSA ) share the development costs of the intangible asset Costs are shared regardless if the development is successful or not Like a joint venture or co-development agreement There are no intercompany licensing payments for IP developed under the cost sharing agreement as both parties own the intangible asset (as distinct from the license for the pre-existing intangibles) The parties are free to exploit the intangible asset in their respective territories Divisional rights are assigned usually based upon geographic territories but other divisions can be used (field of use) Division of rights must be non-overlapping, exclusive & perpetual 18

19 Cost Sharing Arrangement Model 1. Purchases (Buys-in) Rights to Pre-existing Intangibles U.S. Co. New Entity (Low Tax) 2. Shares all future IP development (R&D) costs under cost sharing arrangement 3. Sublicenses IP to OpCo which uses IP to develop/manufacturer/sell products in its territory Foreign OpCo 4. Sells to unrelated customers in its territory (U.S.) 4. Sells to unrelated customers in its territory (ROW) Third Party U.S. Customers Third Party Rest of World Customer 19

20 Cost Sharing Arrangement Model (Cont.) Cost Sharing Arrangement Model The intangible development costs ( IDC ) are shared based upon the participant s share of the reasonably anticipated benefits ( RAB ) (Treas. Reg (e)) Often based upon revenues in respective territories - example U.S. & Ireland entities enter into CSA U.S. has U.S. intangible asset rights while Ireland has non-u.s. rights U.S. entity s revenues are $1,000 (66% of total revenues) & Ireland s revenues are $500 (33% of total revenues) Overall development costs of $50 Therefore, U.S. bears $33 of R&D costs while Ireland bears $17 20

21 Cost Sharing Arrangement Model RAB share The measure of anticipated benefits must be consistent for all participants Direct measures reference estimated additional income generated or costs saved through use of the intangible Indirect measures may include: number of units sold or produced, revenue, operating profit or other measures 21

22 Cost Sharing Arrangement Model CSA participant must buy into or buy out of the existing CSA Referred to as a platform contribution transaction ( PCT ) Potential scenarios for a buy-in, if a participant: Contributes pre-existing intangibles Enters a CSA & acquires an interest in intangibles Transfers benefit to another participant Buy-ins governed generally by Treas. Reg (g) Transfer pricing methods & principles used for determining the arm's length value in connection with transfers of intangible property are also applicable 22

23 Cost Sharing Arrangement Model Example of buy-in for existing intangibles: USACo develops software v1.0 for sale worldwide USACo & UKCo enter into a CSA to develop Software v2.0 for sale in their respective territories UKCo must make a buy-in payment to USACo for its territorial right to pre-existing v1.0 intangible asset that would be embedded in v2.0 23

24 Cost Sharing Arrangement Model Key elements of a CSA include Must include two or more participants Must determine what buy-in or buy-out provisions are necessary Must provide a method (i.e., RAB share) to calculate each participant s intangible developments costs (IDC) Must be recorded in a cost sharing agreement Transfer pricing study for PCT IDC should include Operating expenses related to development (excluding depreciation & amortization) Equipment used in development Allocation of costs that relate to other functional areas Stock compensation 24

25 Challenges of Migrating Existing IP Two key considerations in moving existing IP, especially in a CSA Timing & Valuation of buy-in Substance of IP HoldCo 25

26 4. Creation of New IP

27 Flexibility on location New IP to be created by group company Distinct from anything the parent may have created to date While location could in theory be anywhere, other non tax factors may ultimately decide Availability of employee talent Access to government subsidies Clustering effect Time zones & language capabilities 27

28 Operating models R&D Company Contract Research 28

29 R&D Company High Tax Jurisdiction Low Tax Jurisdiction Group effective tax rate Group effective tax rate Repatriation of funds Onshore or offshore jurisdiction? R&D tax credit regime Substance requirements Employee taxation - personal rate R&D regime & country capabilities Potential migration of IP? Withholding taxes 29

30 Contract Research Why contract? Allows for optimized location of IP ownership Cost-sharing model supported by contractual relationships Initial scale does not justify incorporating a new subsidiary Specialism & time sensitivity of project Projects may not be large enough to be income generating only a small element in overall product 30

31 Contract Research & Principal Company Ownership of IP Withholding on invoices Who claims R&D credit? Secondment of employees - PE risk? Impact on patent box regimes Nexus impact for Principal in home territory? 31

32 IP holding country locations Ireland Cyprus Malta IP Switzerland Singapore 32

33 5. IP Migration Existing IP

34 Challenges of Migrating Existing IP Two key considerations in moving existing IP, especially in a CSA Timing & Valuation of buy-in Substance of IP HoldCo 34

35 Challenges of Migrating Existing IP: Valuation Valuation of existing IP inherently subjective, controversial In US, strong bias toward Income Method What is life of Platform Contribution Infinite?? Pressure will always be on a higher valuation for original IP owner Setting aside initial valuation, pressure of repeated true ups to adjust initial buy-in to subsequent financial results Timing is everything When to move IP? Main premise of economic ownership of IP is bearing of financial risk of failure Tension between Minimizing losses in IP HoldCo in tax advantaged jurisdiction Minimizing size of Buy-In payment in high tax jurisdiction 35

36 Value Timing of IP Migration Risk of R&D Failure/Risk of Losses in HoldCo Size/Tax Impact of Buy-In Where is sweet spot? When to migrate? Time Companies tend to over-weight current development costs/losses relative to unknown buy-in valuation. Wait too long! 36

37 Challenges of Migrating Existing IP: Substance Cashbox HoldCo s in zero-tax Caribbean locales cannot play same roles as in past To satisfy DEMPE requirements, HoldCo s need operational substance to contribute to IP development, maintenance, etc. Substance means functionality Functionality means people Profits will flow where the people are. 37

38 Upshot Both rules & human behaviour conspire to increase size of buy-ins. Substance requirements means jurisdictions with reduced tax impact Late term migration of existing IP is often unattractive We do a lot of feasibility studies, not so much implementation Best strategy is to build planning around IP creation: Set up HoldCo where you can get best resources More focus on IP creation with CSA from beginning 38

39 Gene Ferraro, Mazars USA LLP New York, NY William D. James, BKD, LLP St. Louis, MO Cormac Kelleher, Mazars Dublin, Ireland Jon Jenni, Plante & Moran, PLLC Chicago, IL 39

40 DISCLAIMER Scope and Limitations Disclosure This communication is limited in scope and content, and is strictly limited to the issue(s) addressed and based solely upon representations of facts presented herein. This communication is intended to provide general information for discussion purposes only and cannot be relied upon to avoid tax exposure, penalties, or any other purpose. 40

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