This is part two in a series of Insights looking at key international tax issues for multinational entities (MNEs) in the Tech, Media & Communications sector. In this article we look at the three most common incentives offered to companies rich in Intellectual Property (IP) to undertake research and development (R&D) and hold IP in a jurisdiction.
To read the other parts in the series, please click on the following links:
- Part One looks at recent and forthcoming VAT changes
- Part Three looks at the debate around profit attribution for tax purposes to digital business
- Part Four looks at anti-avoidance rules and transparency
- Part Five looks at the practical issues that arise from the evolving international tax landscape
Lower headline corporate tax rates
With the ability for a MNE to develop and exploit its IP in low tax jurisdictions, it is no surprise that competition to attract IP rich companies has increased. Prior to the Covid-19 pandemic, headline corporate tax rates had gradually been decreasing across the world although there is always a limit on how low corporate tax rates can go in light of controlled-foreign company rules and anti-avoidance rules (for further detail – see Part 4 in this series), under which there is often a trigger where rates fall below a certain level.
Some countries, for example the US, have undergone significant tax reform to discourage domestic companies from moving profits overseas or to encourage repatriation of foreign profits. In the US a number of measures have been introduced, including a cut in the headline corporate tax rate, and deductions for dividends received from foreign entities. The US tax reform also introduced measures to incentivise US companies with IP in the US to expand abroad (the Foreign Derived Intangible Income (FDII) rules) and to tax foreign income of controlled foreign companies (many of which would be IP rich companies) at a stable albeit low rate of tax. The net effect of these rules is, broadly speaking, to achieve parity in the tax rates of US companies exploiting IP in overseas markets directly or, applying the effective minimum tax rates inherent in US anti-avoidance rules, through offshore subsidiaries.
Similarly in the UK, the controlled foreign company rules are generally targeted at income artificially diverted to offshore subsidiaries, albeit with a number of exceptions. One of these exceptions however is where the tax in the subsidiary is at least 75% of the UK tax that would have been payable.
In light of the race to the bottom that has been taking place through a general lowering of corporate tax rates there are signs that jurisdictions are pushing back on this. Notably through the OECD's BEPS project and its work centred on taxing the digital economy. This work includes a proposed anti-avoidance rules that internationally operating businesses pay a minimum level of tax. Under this proposal, although jurisdictions will be free to set their own tax rules and rates, certain anti-avoidance rules will kick in if the effective rate is too low to allow other jurisdictions to tax such income.
R&D tax credits
A further relief offered by many jurisdictions to boost local research and development activity is R&D tax credit/incentive regimes. As it is likely that technology companies will invest in their underlying products, they should consider whether they can benefit from such tax reliefs and credits which are available for companies undertaking R&D.
The UK provides generous tax reliefs for companies undertaking R&D. The small or medium-sized enterprise R&D tax relief allows companies to deduct an extra 130% of their qualifying costs from their yearly profit, as well as the normal 100% deduction, to make a total 230% deduction; and they can also claim a tax credit if the company is loss making, worth up to 14.5% of the surrenderable loss. Large companies can claim a taxable Research and Development Expenditure Credit of 13% (before the application of corporation tax) of the qualifying R&D expenditure for working on R&D projects.
Spain (amongst a number of other countries) also offers R&D tax credits at advantageous rates: a general credit of 25% over qualifying R&D expenses will apply; this credit can be increased to 42% over expenses in excess of the average spent in the previous two years. Moreover, additional rates can apply to specific groups of expenses (for example research personnel assigned exclusively to R&D activities).
Patent box or innovation box regimes have become increasingly popular to attract the holding of IP into jurisdictions. Following international scrutiny the use of these regimes has been looked at by the OECD pursuant to the BEPS project. The effect of this is that unless a patent box regime meets certain standards it can fall to be treated as a harmful tax practice under OECD rules. This has meant that many jurisdictions have amended their regimes such that they are on the right side of the line in this respect. Specifically such regimes should focus on hard IP such as patents rather than soft IP such as trademarks. Also there needs to be a "nexus" between IP generated and the R&D activities of the company claiming the relief.
Technology companies that generate profits arising from patented technology should therefore consider whether they can benefit from a 'patent box' (sometimes called innovation box) and this is often an important factor in determining where a MNE locates IP and related R&D. In the UK, this can provide a reduced corporation tax rate of 10% (compared to the usual rate of 19%) on the profits falling within the regime – albeit the way in which these are calculated ends up with a higher effective tax rate.
Spain also has a patent box regime, which allows for a reduced corporate income tax rate of 10% (compared to the usual rate of 25%) to apply over the profits within the regime. Broadly speaking, the incentive can apply to income derived from the licensing or transfer of, e.g. patents, utility models, legally protected drawings and even advanced software that derives from research and development activities.
In the Netherlands, where generally profits are taxed at a rate of 25% (2020 rate), Dutch qualifying innovative profits are effectively taxed at a rate of 7%.
Osborne Clarke comment
As IP and IT has meant that core business activities have become more mobile, tax competition between authorities has become more important. As well as a general lowering of headline corporation tax rates around the globe, tax incentives are available to attract businesses to locate R&D activities within certain jurisdictions, but as we discuss later in this series, the tax treatment for structuring payments for IP within a group can be challenging.
This is an area in which Osborne Clarke has a deep heritage, acting for both the leading players and the disruptors who have developed game-changing technologies and innovative business models, from complex platforms through to content delivery and data management.
Our international tax team can help you understand the complex tax issues inherent in the TMC sector, provide solutions and assist growth. We would be very happy to discuss any of these issues, provide more detailed guidance and examine how they might impact your business.