Exploitation of US Intellectual Property Rights in Ireland This paper is a high level discussion of the benefits the Irish tax regime can offer to a US multinational which decides to exploit its Intellectual Property (IP) from Ireland with a view to consolidating its rest of world (ROW) earnings in Ireland at a low tax rate. This paper summarises the key aspects of the Irish tax regime that have made Ireland one of the most attractive locations for outbound US investments, as well as a more detailed discussion of the particular aspects of the Irish 12.5% tax regime that need to be satisfied by a company engaged purely in the exploitation of IP. This paper also discusses mechanisms that can be utilised to migrate the technology to Ireland as well as a high level discussion of how US tax deferral on foreign earnings can be achieved. The US Subpart F rules that can limit the US tax deferral of income earned by controlled foreign corporations are quite complex and the discussion is necessarily simplified to convey the nature of the issues that need to be addressed for a US parented group as well as an outline of how they can be dealt with. The individual factual circumstances of each client must be assessed before any investment or structural decisions are made. There are many US and Irish tax implications to be considered in implementing the offshore Intellectual Property holding structure outlined and it is important that any prospective client seek their own specific advice regarding the tax implications of migrating and exploiting its IP from/through Ireland. Irish Taxation Regime Irish Government strategy to attract inward investment has been to create a favourable economic and fiscal environment that is supportive of industry. From 1 January 2003, on foot of an agreement reached with the EU, a corporate tax rate of 12.5% applies to Irish trading profits. This change has made Ireland an extremely attractive location from which multinationals can exploit their Intellectual Property, one of the key instruments used by multinationals in organising their international tax planning. Key characteristics of the Irish regime, which make it an attractive location for the holding of IP rights, in addition to its low nominal tax rate, include: 1. Predictability regarding future changes in tax law. 2. Tax free exit - Corporate plans being subject to change, it may be that, at some point in the future, a group may wish, for tax or non-tax strategic reasons, to move the non-us Intellectual Property from the location of the cost sharing entity to a new location. With appropriate planning, IP can be migrated from Ireland without triggering an exit charge. 3. Ability to repatriate profits tax free While Ireland has a dividend withholding tax regime, exceptions apply in relation to groups ultimately parented in treaty countries (including the US). In such a scenario it is possible to repatriate earnings free of withholding tax to an intermediate holding company located in low tax/zero tax regimes.
4. Absence of significant transfer pricing legislation The absence of significant transfer pricing legislation, including the absence of interest imputation rules, facilitates additional tax savings opportunities, e.g. the ability to advance retained earnings/surplus cash inter-group interest free to a location where investment income can be earned at low/zero tax rates (as opposed to Ireland s tax rate of 25% on passive income). 5. An extensive and growing treaty network. 6. A business friendly regulatory environment. 12.5% Tax Rate What constitutes a trade? The Irish Revenue are aware of the potential damage to Ireland s relationship with its tax treaty partners if the 12.5% regime allows for the effective transfer of significant profit to Ireland without a corresponding level of economic investment and activity. Accordingly, in order for licensing income of a company to be subject to the 12.5% corporate income tax rate in Ireland, it will be necessary for that income to be viewed as income of an Irish trade, as distinct from passive income or income from a foreign trade, which would be taxed at 25%. In general, where a company owns an asset and the mere ownership of that asset produces an income, the company s income from this asset will not be trading income. Routine ancillary services such as invoicing or accounting would not change the nature of the income to trading income where it is primarily generated by the ownership of the asset. Because Intellectual Property is an asset, the mere ownership of which yields an income, there are hurdles to be cleared before the income of a company from licensing such property could be regarded as trading income. If the income of the company was held to be passive income, the risk is that not only would it be subject to tax at 25% but in some cases taxable on the company s gross receipts. In the event that there would be ongoing future investment in Intellectual Property rights, this fact in itself would be strongly supportive of a trading position. On the assumption that in such a scenario the trading argument could be substantiated, the issue to be addressed then is whether the trade would be perceived as an Irish trade and taxable at the 12.5% rate or a foreign trade and taxable at 25%. To ensure that the income is viewed as income of an Irish trade, it would be necessary for the Irish company to illustrate physical presence in Ireland, as represented by employees of the company actively involved in the exploitation of the Intellectual Property. This might include employees being actively involved in the management and negotiation of licenses and/or managing the research and development/marketing activities. It is in this area of creating meaningful substance, that Sentinel has had significant success with clients from both the US and Canada. Over the last seven years, Sentinel has developed a structure whereby the Irish subsidiary of the client can employ people to undertake a role that makes real commercial sense. This activity is managed by Sentinel and might take the form of ongoing R&D, production, order fulfilment etc. The structure has been successfully used for clients operating in the following industries: Biotechnology, Pharmaceutical, Software, Film/TV Distribution and Animation.
Migration of the Intellectual Property (i) Cost Sharing Cost sharing is a means of transferring, over time, beneficial ownership of a portion of Intellectual Property from the location where R&D is performed to locations where ownership of Intellectual Property is desired, for tax and other business reasons. An R&D cost-sharing agreement is an arrangement under which the participants agree to share the costs of development of one or more intangibles, in proportion to their relative share of reasonably anticipated benefits from the exploitation of the interests in the intangibles assigned to them under the arrangement. In practice, cost sharing agreements generally divide ownership of intangibles along geographic lines. US tax rules sanction qualified cost sharing arrangements because ownership of technology accrues directly to foreign affiliates, as costs are incurred. Cost sharing is potentially beneficial to a US parented group for a simple reason: income derived from the exploitation of Intellectual Property is, in general, taxed in the jurisdiction where the Intellectual Property is owned. Where an appropriate amount of a US company s Intellectual Property can be transferred to a low-tax jurisdiction (such as Ireland), a significant amount of the US company s future profits will be subject to a lower rate of tax. The result, all else being equal, should be increased earnings per share and a higher share value, provided the income is not subject to immediate US taxation via the Subpart F regime. Cost sharing implies that Intellectual Property is either under development or, if it has reached the commercial exploitation stage, requires ongoing maintenance expenditures to preserve its commercial value. As such, the full benefits of an R&D cost sharing strategy will not be realized for a period of years. Furthermore, a cost sharing arrangement will likely increase a US company's US taxable income (or decrease the taxable loss), at least in the short term, by reducing its US R&D expense deductions, as part of those deductions are offset by the cost sharing payments made by the Irish company. (ii) Buy in or License in the IP A US company will use the cost sharing technique to transfer intangible property from the US to the foreign jurisdiction as R&D is carried out. For currently existing technology, however, the Irish company will be obligated to pay a royalty on exploitation commensurate with the income derived from previously developed intangibles. For in-process technology (i.e., not yet commercially viable), the Irish company can "buy-in" to this technology with a so-called buy-in payment that can be structured in various ways, one of which is a royalty. An initial buy-in royalty should generally decline over time, perhaps, ultimately, to zero, as the older technology declines in value. The combination of the cost sharing payments and royalties may increase US income in the short term that could lead to an increase in a group's effective tax rate in the short term (subject to the existence of unbenefited US net operating losses (NOL's)). Note, however, that strategies are available to mitigate this effect. Furthermore, once the Irish company has fully bought into the developed intangibles, the group will likely realise significant tax benefits from the offshore exploitation of its intellectual property.
Subpart F and Exceptions As discussed above, a US multinational corporation can operate in foreign jurisdictions through foreign subsidiaries (i.e., an Irish subsidiary) and conduct various operations in such subsidiaries. This memorandum discusses two activities: (1) licensing business in Ireland; and/or (2) sales of US parent's goods. A US parent company can transfer (e.g., via cost-sharing technique) the future economic rights to its Intellectual Property from the United States to a jurisdiction, such as Ireland, where the earnings from the exploitation of the Intellectual Property will be subject to a rate of tax significantly lower than the US federal tax rate. The reason for such a transfer is to defer the future income from the exploitation of the Intellectual Property in the United States to Ireland. When properly structured, such a transfer can benefit the earnings per share and shareholder value. To achieve the deferral goal, and reduce the US multinational corporation's overall foreign tax position, the Intellectual Property exploitation will need to avoid the US Subpart F income tax rules (i.e., US anti-deferral tax rules). These anti-deferral rules apply to earnings of "controlled foreign corporations" ("CFC"), which are defined as foreign corporations of which more than 50% of the stock by vote or value is owned by US shareholders. A US shareholder is defined as a US person (e.g., US corporation) that owns at least 10% of the voting stock in the CFC. Generally, a US company that does business in a foreign country through a foreign subsidiary pays no current US tax on the profits of its foreign subsidiary unless or until the earnings of the foreign subsidiary are distributed to the US parent, or deemed distributed. Accordingly, a US company operating in a low-tax foreign jurisdiction through a foreign subsidiary can maintain a relatively low effective tax rate by deferring the US tax on the unrepatriated earnings of a foreign subsidiary. The anti-deferral rules, however, require US shareholders of a CFC to include in their gross income certain types of income ("Subpart F") and investments of the CFC that otherwise would not be currently taxable to them under general tax law (i.e., a deemed income inclusion). In general terms, Subpart F includes, among other things, two types of CFC income: "passive" or investment-type income; and income generated through transactions with related parties. Passive-type income (known as foreign personal holding company income ("FPHC")) includes, among other items, certain dividends, interest, rents, royalties and annuities. The income from related-party transactions is known as foreign base company income ("FBCI"). A class of FBCI is foreign base company sales income ("FBCSI") that may not include all sales income earned by a CFC, but generally consists of income from transactions involving the purchase and sale of personal property, where the transactions have no connection with the CFC's country of organization and involves a related party. FBCSI does not include transactions with unrelated parties, sales of products manufactured in the CFC's country of organization, and sales of products for use in the CFC's country of organization.
Irish Company Licensing Intellectual Property After the transfer of Intellectual Property from the US parent, the Irish company may also engage in licensing technology to unrelated parties. As stated above, FPHC income can include royalty income and the Irish company would need to qualify for an exception to the general rule. One such exception provides that FPHC income does not include royalties which are received from a person other than a related person and which are derived in the active conduct of a trade or business. Generally, royalties are considered derived in the active conduct of a trade or business only if they are (1) derived from property developed by the Irish company, or (2) derived in connection with certain marketing functions. To qualify under the active marketing exception, the Irish company, through its own staff in Ireland, must maintain and operate an organization that regularly markets and the marketing activities are substantial in relation to the amount of royalties derived. The active business may be viewed as "substantial"' in relation to the royalty when active licensing expenses equal or exceed 25% of the adjusted licensing profit. As stated at the outset, the above commentary is necessarily simplified and designed to convey the issues that need to be addressed for a US multinational corporation. The manner in which US tax deferral is best achieved for any given US multinational corporation will naturally be a function of its particular fact pattern and sales model. Exploitation of IP - Lower than 12.5% effective tax rate For any given US multinational, the most suitable structure for its offshore exploitation of Intellectual Property will be a function of its particular fact pattern, i.e. will the Irish CFC be selling product or licensing IP, will it engage contract manufacturers or buy from related parties, will it license the IP/sell goods to related or unrelated parties? These are just some of the variables, which will influence the most appropriate structure for a given corporation. One potential structure envisages the IP being held offshore Ireland in a zero tax location. Such a structure, which marries the beneficial aspects of a number of regimes together, can in fact succeed in reducing a US parented corporation s effective tax rate on its ROW earnings to single digits. (See Appendix A) The foregoing is merely an outline of how a US multinational with valuable IP might be able to avail of significant tax benefits by establishing an operation in Ireland. There are many US and Irish tax implications to be considered in implementing the offshore Intellectual Property holding structure outlined and it is important that any prospective client seek specific advice regarding the tax implications of migrating and exploiting its IP from/through Ireland.
APPENDIX A How to reduce effective Corporation Tax below 12.5% US Parent Non-Resident Irish Subsidiary (Bermuda/Cayman) Transfer of I.P.; Cost Sharing Sale of Non-US Rights Licence I.P Irish Resident I.P. Co. Licence/Sale of Product Customers 1. A US Parent Company transfers its Intellectual Property (IP) rights for Non-US markets to an offshore subsidiary company. This subsidiary is an Irish registered company, which is resident in a tax haven, such as Bermuda or the Cayman Islands. The US Parent and this subsidiary company enter into a cost sharing agreement regarding the future development of the IP, whereby the subsidiary company acquires all future rights to markets outside of the US. This transfer may also be done by way of an outright sale of such IP, which could be most efficient in circumstances where there are losses forward in the US Parent. 2. This Non-Resident Irish company then licences the IP to an Irish resident company, which is also within the overall group structure. In circumstances where the nature of this licence would give rise to Patent Royalties or Annual Payments (Irish Tax concepts), a Dutch or a Cypress company may be inserted between the non-resident Irish company and the resident Irish company, for purposes of avoiding potential Irish withholding tax. [Under Irish tax law, payments in the nature of patent royalties or annual payments may be subject to Irish withholding tax to non-treaty jurisdictions.]
3. The Irish company then licences the IP rights (or sells product, depending on the circumstances) either directly to third parties or thought low margin foreign sales companies within the group. Conclusion: The basic concept of this structure is that most of the profits are earned in the non-resident Irish company in the tax haven, with modest profits left in the Irish resident company. This structure is well established and typically results in effective tax rates significantly lower than the standard 12.5% Irish corporation tax rate.