The Patent Box: Innovative Idea or Another Tax Complication?
- Generally speaking, a patent box provides a lower tax rate for income attributable to patents
- Forthcoming international tax proposals in the House and Senate are expected to include a similar type of incentive
- Under a patent box regime, it would be incredibly difficult to determine how much of a company’s profits are attributable to its intellectual property
With the new Congress in full swing and the Senate’s tax reform working groups getting ready to report their findings, there has been growing chatter about patent boxes, an incentive used by many of our trading partners to attract research and development, manufacturing, and high-skilled jobs. Representative Charles Boustany, Jr. (R-LA) told reporters that his imminent international tax reform plan will include an innovation box, a provision similar to a patent box but broader in its applicability.
As the Senate Finance Committee's bipartisan working groups examine the tax code for opportunities for reform, discussions have included support for many of the same familiar faces: lower corporate tax rates, a permanent R&D tax credit, and a competitive territorial tax system. Although the topic of patent boxes has been raised before, it is now gaining traction. As more trading partners adopt these types of incentives, more lawmakers—on a bipartisan basis—seem to be embracing the idea. While Senate Majority Leader Mitch McConnell (R-KY) has stated tax reform isn't happening in 2015, key lawmakers, including Ways and Means Committee Chairman Paul Ryan (R-WI), have stated their belief that some type of tax reform measure could happen by summer's end.
What IS a Patent Box?
Generally speaking, a patent box (or intellectual property box) provides a lower tax rate for income attributable to patents. Countries have been adopting this incentive in increasing numbers over the past decade or so; the rates offered generally range from 5% to 15%. The patent box trend in the European Union is consistent with the Lisbon Strategy to make the EU the “most competitive and dynamic knowledge-based economy in the world capable of sustainable economic growth with more and better jobs and greater social cohesion.”
In testimony before the Senate Finance Committee in February, Dr. Laura Tyson, former chair of the National Economic Council, discussed how EU countries are attracting global companies using patent boxes, as they are viewed as “legitimate means to promote innovation and economic development provided the income taxed under such regimes is substantively connected to in-country activities.”
Although similar to R&D incentives in the type of activity and investment encouraged, the timing is different. A company can use an R&D incentive when it incurs the relevant expenses, but patent boxes can reduce its taxes when the applicable income is earned. Countries provide patent boxes as an incentive to keep R&D and commercialization of intellectual property within their borders. The UK, France, Belgium, the Netherlands, Switzerland, Luxembourg, and Hungary are among the countries that have already enacted these types of regimes.
Why Congress Is Talking About It Now
With Washington gearing up for the 2016 presidential elections, many believe that if tax reform doesn’t happen in 2015, it won’t happen before 2017. The Senate Finance Committee created five tax reform working groups, similar to those formed in the House Ways and Means Committee during the last Congress. The working groups’ reports and recommendations are near completion; the co-chairs of the international tax working group, Senators Rob Portman (R-OH) and Charles Schumer (D-NY), appear to support a U.S. patent box.
The incentive is seen as yet another way other developed countries are courting American businesses to their shores. Senator Schumer, the Senate’s second most powerful Democrat, said that other nations are “trying to lure our research” and added, “[w]hether it’s high tech, pharma or high-end manufacturing, we believe research is best kept here. . . . These are our crown jewels.” During a hearing on international competitiveness in March, he said, “I want our jobs to remain red, white and blue—not the EU!”
Many in Congress are concerned about the research and jobs moving overseas as other countries offer lower rates and valuable incentives. This problem is bound to get worse, since many countries require companies to increase their local investment in order to take advantage of patent boxes. The Organisation for Economic Co-operation and Development also wants to make sure that there is economic activity in patent box countries. Under its modified nexus approach, the OECD provides that companies can receive a reduced tax rate for income derived from intellectual property only if they perform R&D activities within the country. U.S. companies may therefore decide to relocate R&D activities and jobs. As Senator Schumer put it, “It’s a wake-up call for all of us who want to keep R&D and associated manufacturing jobs in the U.S.”
Boustany’s forthcoming international tax proposal is expected to include an innovation box that would likely provide a reduced rate for income derived from trade secrets and copyrights, and possibly marketing as it relates to intellectual property. From Boustany’s perspective, a proposal needs to go beyond patents and be broad enough to meet the realities of global markets.1 Meanwhile, Senator Portman recently commented2 that the international tax reform working group will also likely include an innovation box proposal, with a rate possibly as low as the single digits, as an option in its report due this month. It is not yet known whether the group’s report will be made public, however.
Even supporters of patent boxes acknowledge that the issue is costly and complicated. All industries will want to be able to use patent boxes; even if Congress is able to agree on what to include, critics point out that it will be incredibly difficult to determine how much of a company’s profits are attributable to its IP. Martin Sullivan arguesthat a patent box regime would put pressure on the weakest points of the tax system—valuation and transfer pricing—and that Congress would be better off expanding the R&D credit.3
The cost of this type of incentive is tricky, in part because it could come at the expense of a lower tax rate, something all industries could benefit from. If revenue neutrality remains a goal, lowering the corporate rate to 25% will become more difficult. As noted by Thomas Barthold, chief of staff to the Joint Committee on Taxation, “There’s a budget constraint, and at some point members are going to decide they can’t afford to do it all.”4
Although the prospects for any type of corporate or business tax reform this year are up in the air, lawmakers are actively exploring options to make international tax rules more globally competitive. Many of the arguments in support of reform remain the same, but OECD and EU activities could be the game changer this year and help spur some type of legislative action. Rather than simply discussing how American jobs may move to low-cost jurisdictions, we may begin to see companies shift more IP and R&D activities overseas as a result of the modified nexus requirement.
In light of the tax reforms taking place around the world, and the fact that the United States still has the highest corporate tax rate in the developed world, it will become increasingly difficult for U.S. companies to make the case for staying here.
1.Kaustuv Basu and Luca Gattoni-Celli, "Boustany Eyeing Summer for International Reform Plan," Tax Analysts, May 14, 2015; and Stephen K. Cooper, "Boustany Says Cost of Innovation Box Complicates Tax Reform Plan," Tax Analysts, June 11, 2015.
2.Stephen K. Cooper, "Boustany Says Cost of Innovation Box Complicates Tax Reform Plan," Tax Analysts, June 11, 2015.
3.Martin A. Sullivan, "Economic Analysis: Patent Boxes, Research Credits, or Lower Rates?," Tax Analysts, June 1, 2015.
4.Andrew Velarde, "JCT Chief Highlights Challenges of Constructing Patent Box," Tax Analysts, May 19, 2015.