The OECD (Organization for Economic Cooperation and Development) – is an inter-governmental economic organization comprised of 35 member countries that was founded in 1960 to stimulate economic progress and world trade.
In October 2015, the OECD issued a report on its G-20 BEPS Project (Base Erosion and Profit Shifting) – which focused on providing governments with solutions for closing the gaps in existing international tax and transfer pricing rules that allow corporate profits to “disappear”, or be artificially shifted to low/no tax environments where little or no economic activity takes place. Much of BEPS centers on intellectual property (IP)-intensive industries.
According to the OECD, tax revenue losses from BEPS are conservatively estimated at $140-240 billion – or anywhere from 4-10% of total global corporate income tax (CIT) revenues.
Because of this massive tax revenue loss exposure – the international tax system, which encompasses transfer pricing, is rapidly changing. These changes are being manifested in coordinated actions by governments, and measures being undertaken by individual countries, to combat profit shifting and international tax avoidance by multinational companies (MNCs).
The OECD has produced a video, which illustrates how the whole BEPS scenario can unfold and spark the need to improve corporate transparency:
Challenges of Managing IP Tax Liabilities
MNCs are facing more challenges than ever managing their IP cost structures, including tax liabilities. There are multiple factors impacting the global taxation of IP generated income and consequently, the transfer pricing of IP.
The new tax and transfer pricing guidelines, reflected in the OECD BEPS Report, attempt to more closely align IP taxation with the venue of economic activity and value creation. These new rules will likely work to combat what have been deemed harmful, low-tax policies enacted by some countries are attempting to attract corporate IP activities – including revenue recognition/taxation on patented inventions and copyrighted software.
Some countries are using new BEPS-compliant IP tax incentives to attract new multinational R&D business activity. These schemes are known as patent boxes, innovation boxes and knowledge development boxes. These are different names for special tax regimes for intellectual property revenues. They typically have a lower tax rate on “qualified profits” derived from products that use IP patents, saving several percentage points off higher corporate tax rates. These schemes are often combined with R&D tax credits.
In the face of these IP related incentives, some countries are looking to publicly challenge and fine MNCs that they think are artificially diverting taxable profits from higher tax jurisdictions to countries offering IP-focused tax saving incentives. Ironically, some countries are doing both.
Uncertainty May Prevail
As these new tax policies take shape, an air of uncertainty is building. Tax uncertainty can hinder business innovation and the ability of IP to help drive corporate growth. The prospect of unpredictable tax liabilities is enough to give any CFO or other C-Suite Executives plenty reason to worry.
For example, the BEPS Report (Action 5) called for a “nexus” approach to qualifying for any IP incentives such as patent boxes, which would require a company to locate its R&D and associated jobs in the country offering the preferred tax rate. The report cites 16 countries and provinces whose tax codes did not align with this approach.
The situation may be further complicated by the rising tide of global tax transparency and new information sharing mechanisms among the world’s tax authorities.
These changes should cause savvy CFOs of MNCs to find the right balance between tax liability management and the risks of being non-compliant when it comes to aligning where IP value is created and where profits are reported. This may require risk/opportunity assessments and value-chain scenario planning which are key to establishing a transfer pricing structure.
For more information on our Intellectual Property Transfer Pricing planning capabilities, please contact:
Angela Sadang – Director, Advisory Services Group| Marks Paneth
212.201.3012 | firstname.lastname@example.org
This material has been prepared for general informational and educational purposes only and is not intended, and should not be relied upon, as accounting, tax or other professional advice.
Please refer to your advisors for specific advice.
Compliments of Marks Paneth, a member of the EACCNY