Felix Tann (LL.B.)*
Patent boxes seem to be the method of choice for establishing a knowledge-based economy to most major nations, as they allow for tax breaks and other incentives.1 As Graetz and Doud put it: research and development (“R&D”) “…is crucial to ongoing technological advancements, [but] is underproduced in the absence of government support”.2 While few have tackled this issue as early as Ireland did in the 1970s and then again in 2000,3 various countries have started to incorporate patent boxes into their legal framework in recent years.4 Although this method is commonly used among the Organisation for Economic Co-operation and Development (“OECD”) states, the exact specifications of individual regimes came under fire from the OECD/G20 Base Erosion and Profit Shifting Project (“BEPS”). BEPS examined the advantages and disadvantages of patent box systems in general, and even considered some of them to be harmful tax practices.5 After publishing their findings, BEPS recommended changes in current regimes, and thereby sparked massive legislative change in almost all major OECD countries. A joint statement by Germany and the United Kingdom6 – following the BEPS findings and recommendations – gave further impetus to this urge for change, and led most European countries to implement legislative amendments rapidly, resulting in a state of uncertainty and the possibility of ongoing alterations of what patent boxes will look like.
B. Patent Boxes and International Regulation
I. Defining Patent Boxes
A patent box can be understood as a fiscal instrument that supports the economic goals pursued by patents and their inventors − namely, the impulse to innovation.7 It incentives income stemming from intellectual property (IP) assets by separating the respective income from a taxpayer’s overall income and subjecting it to lower tax rates.8 The name patent box derives from the possibility to check a certain box on tax forms if one is willing to opt-in for the tax incentive.9
Although media coverage on this matter has increased notably in recent years,10 patent boxes have been around for a few centuries already. In fact, France and Ireland introduced such regulations as early as the 1970s and 1980s.11 However, the economic advantages of patent boxes might not be apparent at first glance. Are they just an institutionalised form of tax avoidance?12 And, if not, what incentivises an economy to offer a tax reduction via patent boxes?
Universally defining the nature of patent boxes is rather difficult due to the heterogeneous nature of such tax regimes.13 Even the term itself is disputed, as different jurisdictions use conflicting terms to describe the same mechanism.14 Denominations such as “patent boxes” (UK), “IP boxes” (Liechtenstein), “knowledge-development boxes” (Ireland) or “innovation boxes” (Netherlands) have been adopted.15 However, there are four characteristics commonly associated with the composition of patent boxes: (i) eligibility of existing patents; (ii) eligibility of acquired patents; (iii) eligibility of a wide range of IP rights; and (iv) the possibility of receiving tax cuts on embedded royalties.16
These characteristics can serve as a first attempt at defining patent boxes. In recent years, the difficulty of finding common ground in such tax regimes has increased, as national and international criticism has forced most jurisdictions to rethink the concept.17
II. OECD and EU Regulations
European patent box regimes are impacted by two major forces: (i) Action 5 on base erosion and profit-shifting project from the OECD, and (ii) the code of conduct for business taxation designed by the EU.18
* Der Autor ist Student an der Bucerius Law School, Hamburg.
1 Atkinson/Andes, Patent Boxes: Innovation in Tax Policy and Tax Policy in Innovation, 2011, p 8; Knight/Maragani, 19 Stan. J. L. Bus. & Fin (2013), 39, 47.
2 Graetz/Doud, 113 Colum. L. Rev. (2013), 347, 349.
3 Reddan, Ireland jumps on to the knowledge-box wagon early, Irish Times (2016), 1.
4 Cf Maute/Senn/König, Lizenz-Box Modell in Liechtenstein und der Schweiz, 2016, p. 1; Atkinson/Andes (fn. 1), p. 8.
5 Cf OECD, OECD/G20 Base Erosion and Profit Shifting Project – Countering Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance, Action 5: 2015 Final Report, 2015; Faulhaber, 101 Minn. L. Rev. (2017), 1641, 1643 ff.
6 Germany/United Kingdom, Joint statement: Proposals for New Rules for Preferential IP Regimes, 2014.
7 Faulhaber (fn. 6), 1641 f.
8 Faulhaber (fn. 6), 1642; s. Atkinson/Andes (fn. 1), 3; Graetz/Doud (fn. 2), 362 f.
9 Atkinson/Andes (fn. 1), 1; Faulhaber (fn. 6), 1648.
10 S. Barford/Holt, Google, Amazon, Starbucks: The Rise of “Tax Shaming,” BBC NEWS MAG; Duhigg/Kocieniewski, How Apple Sidesteps Billions in Taxes, N.Y. TIMES.
11 Altstadsaeter/Barrios/Nicodeme/Skonieczna/Vezzani, Patent Boxes Design, Patent Location and Local R&D, 2015, p. 7 f.; Graetz/Doud (fn. 2), 362 ff.
12 Cf. Graetz/Doud (fn. 2), 372; Blair-Stanek, 62 UCLA L. Rev. (2015), 4, 4.
13 Altstadsaeter/Barrios/Nicodeme/Skonieczna/Vezzani (fn. 12), p. 7; cf. Atkinson/Andes (fn. 1), p. 3; Graetz/Doud (fn. 2), 363 ff.
14 Gupta, 76 Tax Notes Int. (2014), 245, 300; Faulhaber (fn. 6), 1648.
15 Gupta (fn. 15), 300; cf. Graetz/Doud (fn. 2), 363 ff.; Faulhaber (fn. 6), 1647.
16 Altstadsaeter/Barrios/Nicodeme/Skonieczna/Vezzani (fn. 12), p. 8 f.
17 Cf. C. I. 3.
18 Action 5: OECD (fn. 6); Code of Conduct: see Report on a Resolution on a Code of Conduct for business taxation in the framework of the ECOFIN Council (EC) SN 4901/99.
1. OECD Guidelines Against Harmful Tax Practices
International tax regulations tend to enable companies to transfer profits to low-tax jurisdictions – also known as tax havens – and thus avoid reasonable taxation in their country of origin.19 The G20 and OECD targeted this seemingly dysfunctional system in the aftermath of the financial crisis of 2008 to improve confidence in the international tax system and reduce intergovernmental conflicts.20 A milestone was reached in 2013 when the OECD – supported by the G20 – identified a 15-point “Action Plan on Base Erosion and Profit Shifting” to counter harmful tax competition.21 This action plan evolved around three priorities:
a) introducing a new degree of coherence in national rules that impact transnational activities;
b) requiring substantive changes in the existing international standards to improve transparency; and
c) reinforcing certainty for businesses that do not take aggressive positions in terms of tax avoidance.22
Based on these priorities, the Action 5 chapter focused on an establishing a link between the location of value creation or economic activity and the location of a preferential tax treatment.23 This approach was translated – in agreement with the second priority outlined above – into the need for substantial economic activity for patent box eligibility.24 The so-called modified nexus approach was adopted in the 2015 final report.25 In essence, a BEPS-compliant patent box should respect the following formula:26
With aid of a simple illustration, this would mean that company A needs to divide the costs incurred by R&D activities of 1 million Euros (qualifying expenditures), by the incurred costs of 1 million Euros for R&D activities27 plus 2 million Euros for the construction of the new lab28 (overall expenditures or qualifying expenditures and non-qualifying expenditures combined). The ratio of 1/3 would then be multiplied with the overall income of 5 million Euros stemming from the patent on a new Kevlar alloy, which leaves a tax-incentivised income of roughly 1.7 million Euros.
By adopting this approach and focusing on IP-related incentives, the BEPS commission marked 16 patent boxes as incompatible and in need of revision.29 Those non-compliant tax regimes were ordered to be abolished or replaced by new nexus-compliant rules by 30 June 2021. Nonetheless, even if those 16 countries were willing to radically overhaul their current systems in the recent past, the OECD was forced to deal with arrangements to smoothen the transition period. This led to grandfathering provisions allowing new entrants (taxpayers who were not part of any patent box scheme and possess new IP assets) to access non-compliant tax regimes until 30 June 2016.
Keeping this development in mind, the OECD’s nexus-based approach will be a key driver in the future development of patent boxes, and will impact those regimes that are currently in existence (compare C.).
2. EU Law and the Code of Conduct for Business Taxation
The Commission of the European Union was fully involved in the BEPS discussions and worked parallel to the OECD to close loopholes in EU law, as well as in the domestic legislation of member states.30 In part, the participation in the OECD-BEPS investigation by the EU Commission can be regarded as a reaction to the widespread introduction of patent boxes all across Europe. Hungary, Belgium, France, the Netherlands, Luxembourg and the UK have all embraced the claim that preferential tax rates are fundamental to promote investment in technology and foster the economy in a digital age.31 However, by relying on a patent box design that lacks linkage between the tax benefit and the existence of a demonstrable intrinsic R&D activity,32 they have effectively allowed multinational enterprises (“MNEs”) to transfer IP profits to low-tax jurisdictions.33
In trying to avoid this race to the bottom, the EU Commission has reaffirmed the importance of the EU code of conduct on business taxation (“Code”) approved in 1999.34 The Code itself is non-binding, but clearly has political force according to the EU Commission.35 It aims at preventing “continuing distortions in the single market” and “supporting tax structures to develop in a more employment-friendly way”.36 However, the Code is a soft-law document that depends on the will of EU governments to import its principles into national regulations.37 Member states acknowledge that they will politically respect, but are not legally bound to implement, two central measures imposed by the Code, namely:
a) rolling back tax measures that can be considered as harmful tax competition.38
b) refraining from introducing measures which could be considered as harmful tax.39
19 Cf. Blair-Stanek (fn. 13), 4 ff.; s. Graetz/Doud (fn. 2), 350 ff., 392 ff.; who point at the creativity of large corporations to avoid taxation.
20 OECD (fn. 6), 3 f.; OECD, OECD/G20 Base Erosion and Profit Shifting Project – 2015 Final Reports, 2015, p. 3; s. Faulhaber (fn. 6), 1642 ff.
21 OECD (fn. 21), p. 3; s. Faulhaber (fn. 6), 1654 f.
22 OECD (fn. 21), p. 3.
23 OECD (fn. 21), p. 6 f.; Faulhaber (fn. 6), 1656.
24 OECD (fn. 21), p. 9.
25 ibid.; see also for an overview: Faulhaber (fn. 6), 1661 ff.
26 OECD (fn. 6), ch 4 subpara 30; with further explanations: Faulhaber (fn. 6), 1662 ff.
27 Cf. OECD (fn. 6), ch. 4 subpara 30 f., 39.
28 Cf. OECD (fn. 6), ch. 4 subpara 39.
29 OECD (fn. 6), p. 63; OECD (fn. 21), p. 7; Gupta (fn. 15), 301.
30 OECD (fn. 21), p. 4.
31 Gupta (fn. 15), 300; Sheppard, 77 Tax Notes Int. (2015), 383, 384.
32 Altstadsaeter/Barrios/Nicodeme/Skonieczna/Vezzani (fn. 12), p. 29.
33 Gupta (fn. 15), 300.
34 Gupta (fn. 15), 300 f.
35 S. http://ec.europa.eu/taxation_customs/business/company-tax/harmful-tax-competition_en.
36 S. Conclusions of the ECOFIN Council Meeting on 1 December 1997 concerning taxation policy (98/C 2/01), Official Journal C 002, 06/01/1998 P. 0001 – 0006.
37 Gupta (fn. 15), 300 f.
38 Report SN 4901/99 (fn. 19), para 4 sub-s c.
39 Report SN 4901/99 (fn. 19), para 4 sub-s d.
Furthermore, European patent box regimes came under scrutiny after Germany’s finance minister, Wolfgang Schäuble, described them as “going against the European spirit”, thereby strengthening the perception that they breach EU law.40 However, the inbound transfer of IP related income may not violate the Treaty on the Functioning of the European Union (“TFEU”),41 as pointed out by the European Court of Justice (“ECJ”) in Laboratoires Fournier SA.42 In addition, the EU finance ministers adopted a directive43 to implement the BEPS findings with uniformity across the EU. This instrument will exceed OECD standards. The aim of the directive, as stated by the finance minister of Slovakia, is to protect the internal market by improving domestic corporate tax codes against aggressive tax planning, as well as achieving a minimum level of protection for reliance on existing law for companies that use patent boxes or similar tax incentives.44
C. Comparative Perspective on Patent Boxes
I. United Kingdom
1. Current Regime
Under current UK legislation, the patent box regime is characterised by four main aspects: (i) qualifying companies, (ii) qualifying rights, (iii) qualifying development, and (iv) sophisticated methods to calculate when and how various forms of tax relief should be granted.45
First disclosed to the public in 2009, the patent box was directed at targeting the ongoing departure of high-tech companies from the UK.46 However, it was not until 2012 that the Finance Bill47 was finally passed by the House of Commons and the House of Lords to become the Finance Act,48 introducing new and critical provisions for the taxation of IP.49 The main incentive deriving from a patent box regime is an option to elect a corporate income tax of 10 percent for all revenue stemming from IP.50 Regarding the eligible income, there is no limitation on revenue arising from the sale of products in connection with IP.51 Eligible income might also be generated by royalty agreements or similar contractual agreements.52
Regarding the first major criterion for UK patent boxes mentioned above, companies are considered to qualify for the tax reduction if they hold or exclusively license qualifying IP and derive income from this. Another option allows businesses that have owned or licensed qualifying IP in the past, as well as groups of companies, to opt into the tax regime.53 Primarily, the definition of qualifying companies aims to exclude passive IP holding companies that only manage IP rights, but do not contribute to the economy by creating new content.54 This scope is made particularly clear by the condition that requires groups of companies to prove “active ownership” of the IP. Such provisions mean that there is an obligation to either carry out qualifying development or perform a significant amount of management activity in order to qualify for the tax reduction.55
Moving on to the second major criterion mentioned above: qualifying rights. According to section 357BB(1) of the 2012 Finance Act, qualifying rights must be listed in the 2012 Finance Act itself. Qualifying rights include “patents granted by the UK Patent Office, under the European Patent Convention or corresponding specified rights granted under the laws of certain specified EEA states”, or “supplementary protection certificates”, but also specific patents in connection with plant breeding or medicinal veterinary products.56 Keeping this collection of qualifying rights in mind, a clear focus on patents and other related instruments becomes apparent. As patents are most commonly associated with R&D activity, the criterion clearly aims at stimulating growth in this economic sector.
In addition to owning eligible IP, companies must also meet a development condition to qualify for tax breaks under the patent box regime. This means that they have to either create or contribute to the creation of the IP, or develop an application for the underlying patented right.57 In particular circumstances, groups of companies are allowed to transfer the development condition without directly contributing to the original development – for example, through an acquisition of the developing company – but
40 Altstadsaeter/Barrios/Nicodeme/Skonieczna/Vezzani (fn. 12), p. 3.
41 Nonetheless, the legality of patent boxes could also be questioned from the vantage point of state aid. For further information see: EuGH, verb. Rs. C-106/09 P and C-107/09 – Commission v Gibraltar, Slg. 2011, I-11113; Sheppard (fn 32), 385 and Burow, 77 Tax Notes Int. (2015), 482, 482 f.
42 EuGH, C-39/04 – Laboratoires Fournier SA v Direction des vérifications nationales et internationals, Slg. 2005, I-02057; Sheppard (fn. 32), 384; with further explanations on the possible implications: Faulhaber (fn. 6), 1676 f.
43 Directive of the European Council (EC) 2016/1164 of 12 July 2016 laying down rules against tax avoidance practices that directly affect the functioning of the internal market, Official Journal of the European Union L 193/1.
44 Directive 2016/1164 (fn. 44), p. 4 f.; see also for more details on the underlying problem of tax avoidance through IP: Blair-Stanek (fn. 13), 9 ff.
45 Short overview of the UK patent box: Knight/Maragani (fn. 5), 53 f.
46 Chancellor of the Exchequer, Pre-Budget Report December 2009, 2009, ch 1 s 1 ss 30 and ch 2 s 2 ss 33.
47 The Finance Act 2011 (Bank Levy: Amendment of Netting Agreements Provisions) Order 2011.
48 Finance Act 2012 (UK).
49 Halsbury’s Laws, vol 58-59, 2014, paras 2026-2035A.
50 Halsbury’s Laws(fn. 50), paras 2026-2035A; Encyclopaedia of Forms and Precedents, 2016, vol 21(3), s 601; Tolley’s Tax Planning, 2016, vol. 29, pt 29 sub-s 29.1; Simon’s Taxes, 2011, vol 3, vol 1 s Incentives; HM Revenue & Customs, Corporate Intangible Research and Development Manual, 2016, ch CIRD200110 Aim Of The Patent Box.
54 Halsbury’s Laws (fn. 50), para 2035B; Tolley’s Tax Planning (fn. 51), pt 29 sub-s 29.57; Simon’s Taxes (fn. 51), vol 1 sub-s D1.1203; HM Revenue & Customs (fn. 51), ch CIRD200110 Aim Of The Patent Box; HM Revenue & Customs (fn. 51), ch CIRD210100 Meaning Of ‘Qualifying Company’.
56 Halsbury’s Laws (fn. 50), para 2035C; Tolley’s Tax Planning (fn. 51), pt 29 sub-s 29.54; Simon’s Taxes (fn. 51), vol 1 sub-s D1.1203C; HM Revenue & Customs (fn. 51), ch CIRD210150 Qualifying IP Rights: Rights To Which Part 8A Applies; HM Revenue & Customs (fn. 51), ch CIRD210170 Qualifying IP Rights: Other Rights To Which Part 8A Applies.
57 Halsbury’s Laws (fn. 50), para 2035C; Tolley’s Tax Planning (fn. 51), pt 29 sub-s 29.57; Simon’s Taxes (fn. 51), vol 1 sub-s D1.1203 pt Qualifying IP Right; HM Revenue & Customs (fn. 51), ch CIRD210190 Qualifying IP Rights: Meaning Of ‘Qualifying Development’.
these are considered exceptions to the general rule which states that no relief should be granted without development.58
Finally, after all requirements are met, a complex methodology comes into operation to calculate the resulting tax deduction. Without going into unnecessary depth, two unique methods of calculation can be identified. Both options are viable and may be freely chosen by the applicant:
First, a standard method that requires the applicant:
a) to determine the total gross income during one accounting year, excluding finance income;
b) to calculate the relevant IP-related income (“RIPI”);
c) to divide up the revenue from the trade, according to a RIPI to total gross income ratio;
d) to deduct 10 percent from profits based on certain specified costs (for example, personnel or machinery); and
e) to subtract the return from marketing assets from the sum that was calculated up until this point (also called qualifying residual profit, or “QRP”), leaving the company with the relevant IP profits, or RP.59
Second, the streaming method, which involves the first two steps of the standard method, but substitutes the subsequent steps with a process that divides expenses between RIPI and other incomes by adhering to a so-called “just and reasonable standard”.60 By applying this method, a so-called RIPI-stream is identified that divides relevant from irrelevant income and is responsible for the method’s name.61
After having set out the basic structure of the UK patent box regime, one needs to address the issue of anti-avoidance clauses. These provisions are set out to prevent tax abuse arising from using the patent box as an enabler for fraud.62 Due to the unpredictable nature of tax avoidance, these clauses are intentionally formulated in a broad manner. As a result, these provisions are often criticised, considering that they potentially put participating companies at risk or deter them from opting into the patent box regime.63
2. Advantages and Disadvantages and Target Audience
In comparison with other European regimes, the UK approach to patent boxes is advantageous for businesses licensing patentors selling products that rely on the underlying IP. However, the excessive complexity of the two methods of tax calculation, as well as possible anti-avoidance provisions that could leave companies vulnerable to unpredictable administrative decisions, are unattractive aspects of the system.
3. The Future
While this outline presents the current state of the patent box regime in the UK, the current system is about to undergo dramatic changes considering the OECD recommendations and the UK-Germany joint statement.64 It seems inevitable that the UK will implement regulations that live up to the original conception of an R&D stimulus. As a first step, patent boxes will need to have a nexus with local inventions. As from 1 July 2016, companies need to prove substantive R&D activities in the UK before being able to apply for patent registration and opt into the patent box regime. This modified nexus approach was phased in alongside the current transfer-pricing system, which companies could already opt into before 30 June 2016. For both paths, grandfathering provisions will preserve benefits until 2021.65
1. Current Regime
With a rate of only 2.5 percent,66 Liechtenstein’s patent box grants one of the lowest tax rates in Europe on IP-related returns. This represents a discount of up to 80 percent on Liechtenstein’s usual tax rate for trade income. At the heart of Liechtenstein’s overall approach is Article 55 of the Taxation Code.67 Its introduction dates back to 1 January 2011, when Liechtenstein completely revised its tax code and created several new passages concerning income taxation and IP-related tax relief.68 Promoted as a way of securing Liechtenstein’s market shares in R&D activities, the “IP-Box” was intended to encourage future growth in this economic sector.69
Due to the broad aim of promoting industrial growth and supporting R&D, the patent box regime in Liechtenstein is relatively extensive. It includes patents, trademarks, designs, software and scientific databases, as long as they are registered in any domestic or foreign registry.70 This scope constitutes the largest reach of eligible IP rights in all of Europe.71
58 Halsbury’s Laws (fn. 50), para 2035C; Tolley’s Tax Planning (fn. 51), pt 29 sub-s 29.57; Simon’s Taxes (fn. 51), vol 1 sub-s D1.1203 pt Qualifying IP Right; HM Revenue & Customs (fn. 51), ch CIRD210200 Qualifying IP Rights: Development Conditions A To D; HM Revenue & Customs (fn. 51), ch CIRD210210 Groups: Active Ownership Condition.
59 HM Revenue & Customs (fn. 51), ch CIRD220110 Patent Box: relevant IP profits: steps for calculating relevant IP profits of a trade (old regime) CTA10/S357C.
60 HM Revenue & Customs (fn. 51), ch CIRD230110 Patent Box: streaming: determining relevant IP profits CTA10/S357DA; an example for a fair and reasonable balance can be found here: HM Revenue & Customs (fn. 51), ch CIRD230150 Patent Box: streaming: example 1.
61 Cf. HM Revenue & Customs (fn. 51), ch CIRD220160 Patent Box: relevant IP profits: relevant IP income: overview CTA10/S357DA.
62 See section 357F to section 357 FB of the 2012 Finance Act; see also HM Revenue & Customs, The Patent Box: Technical Note and Guide to the Finance Bill 2012 clauses, 2012, 12 sub-s iv 1.32.
63 However, HMRC is restrained when it comes to putting these clauses in action: HM Revenue & Customs (fn. 63), 7 sub-s xvii.
64 S. Germany/United Kingdom (fn. 7).
65 HM Revenue & Customs (fn. 51), ch CIRD220550 Patent Box: relevant IP profits: profits arising before grant of right: how the relief is given.
66 Evers, Intellectual Property Box Regimes, 2015, p. 7.
67 Art. 55 Gesetz über die Landes- und Gemeindesteuern (SteG).
68 Wenz, 3 LiechtensteinJournal (2009), 87, 87.
69 According to the UN Data on Liechtenstein, 39 percent of Liechtenstein’s gross value-added was dependent on the production industry in 2010.
70 For guidance on qualifying rights that are registered see fn. 67.
71 Evers (fn. 67), 7.
2. Advantages and Disadvantages
The lack of double taxation treaties with other nations poses a mild problem for Liechtenstein and its IP strategy. Liechtenstein is a member of the European Economic Area, but is not an EU member state, and relies solely on separately negotiated agreements with EU member states. With only a few double taxation treaties in force, the major examples being those with Germany, Austria and the UK,72 Liechtenstein remains too unconnected to its European neighbours to take full advantage of its competitive patent box regime, a fact that might deter future investors wanting to utilise Liechtenstein as a principal hub for their IP holdings.
Additionally, there were concerns about the compatibility of Lichtenstein’s domestic approach with the interdiction of state aid under EU law. However, the European Free Trade Association Surveillance Authority settled this dispute and dismissed those claims on 1 June 2011.73 Therefore, the advantages of having a regulatory approach approved by European authorities and a steep discount on IP-related income might outweigh the relative isolation insofar as double taxation treaties are concerned in comparison with other European patent box regimes.
3. Target Audience
Liechtenstein’s variation on patent boxes seems to suit the needs of companies that want to protect their not yet sound assets from a first-time domestic taxation. Keeping in mind the current lack of double taxation treaties, very interconnected companies might face problems in this regard. These issues might arise in connection with outsourcing or spreading assets across various jurisdictions and/or entities, which might present those companies with a financial problem or the issue of reclaiming withholding taxes on royalty income from foreign jurisdictions.
4. The Future
As mentioned under B II. 2. and due to the findings of the BEPS commission on harmful tax practices, the current regimes pertaining to patent boxes will undergo significant changes in the next few years.74 Liechtenstein’s scheme does not deviate from this general trend. On 12 July 2016, Liechtenstein’s government released a statement confirming their willingness to change the current tax regime and implement the findings of the BEPS commission.75 As a result of this decision, the tax deductibility of IP-related income will be limited. In addition, measures for the efficient interchange of tax information will be put into action. Since the current legislation does not comply with these modifications, an appropriate transitional period will be granted to replace the old scheme.76
1. Current Regime
The “Knowledge Development Box” (“KDB”) was introduced by the Finance Act 2015 for companies whose accounting period started on or after 1 January 2016. The Act is designed to tax income arising from patents, copyrighted software and, concerning smaller companies, patent-like rights.77 Ireland was among the first countries to introduce a patent box regime in the 1970s. After abolishing it a few years later, it reintroduced in 200078, but abolished again tax incentives from 2011 to 2014.79 The new scheme covers a much smaller portion of available IP rights and focuses on patent and patent-like rights.
From 1 January 2016 until 1 January 2022, the box will offer a deduction of up to 50 percent on “qualifying profits”, leading to an effective tax rate of 6.25 percent.80 To calculate the qualifying profits (“QP”), it is necessary to determine the “qualifying expenditure” (“QE”), “uplift expenditure” (“UE”) and the “overall expenditure” (“OE”).81 QE and UE are added together and divided by OE. Ultimately, it is necessary to multiply this sum by the “qualifying assets profit” (“QA”).82 The result of the formula represents the profits that are related to R&D expenses (QP).83
The qualifying income includes any royalties and amounts received from a direct exploitation, as well as sums received from attributable sales.84 In comparison with other regimes, the Irish system is based on a narrow scope of qualifying income, especially compared with Liechtenstein’s approach.85 QE includes any R&D costs, expressly encompassing “costs of R&D that are outsourced to unrelated parties but excludes expenditure on R&D performed by related parties and the cost of acquired intellectual property”.86
Additionally, it must be pointed out that external experts can be appointed by the Irish Revenue Service to determine whether expenses qualify as R&D activities, or if IP rights are eligible under the Finance Act.87 Considering the importance of trade secrets, this situation could lead to possible confidentiality concerns on the part of companies.88
72 Fiscal Authority Principality of Liechtenstein, List of all Double Taxation Agreements (DTA) and Tax Agreements regarding Exchange of Information, https://www.llv.li/files/stv/int-uebersicht-dba-tiea-engl.pdf
73 See Decision EFTA Surveillance Authority, Official Journal of the European Community C 278/9.
74 Cf. OECD (fn. 6).
75 Fiscal Authority Principality of Liechtenstein, Regierung verabschiedet Bericht und Antrag zur Abänderung des Steuergesetzes (BEPS) (press release, 12 July 2016).
76 Hasler, Das neue liechtensteinische Steuergesetz, 2010, p. 22.
77 Office of the Revenue Commissioners, Guidance Notes On the Knowledge Development Box, 2016, s 1 sub-s 1; for additional information see: Minister for Finance, Minister for Finance publishes Finance Bill 2015 (22 October 2015, press-release).
78 Reddan (fn. 3), 1.
79 Graetz/Doud (fn. 2), 366.
80 Finance Bill 2015 – List of Items (Ireland), 5 ch “Corporation Tax” sub-s 30.
81 Finance Bill 2015 Explanatory Memorandum (Ireland), 7 s 30 para 3; Notes KDB, 3 ch 2.
82 Office of the Revenue Commissioners (fn. 78), 12 ch 2 s 2.2 sub-s 2.2.1.
84 Office of the Revenue Commissioners (fn. 78), 40 ch 3 s 3.2 sub-s 3.2.1 example 3.39.
85 S. C. II. 1.
86 Finance Bill 2015 Explanatory Memorandum (Ireland), 7 s 30 para 4.
87 Finance Bill 2015 Explanatory Memorandum (Ireland), 7 s 30 para 11; Office of the Revenue Commissioners (fn. 78), 77 ch 8.
2. Advantages and Disadvantages
Most advantageous for the KDB is Ireland’s already existing knowledge-based economy. Large corporations manage their European operations from Dublin and thereby provide a dense hub of information technology firms for Ireland. Furthermore, there are already numerous tax incentives for intangible rights, which could be combined with the KDB.89 Drawbacks include the narrow scope of eligible IP, the potentially high cost of tracking down every invoice item related to the relevant IP,90 and possible concerns about secrecy if external experts need to investigate.91 Nonetheless, with an exceptionally low rate of 6.25 percent and the promising future of a stable mechanism due to initial compliance with the OECD recommendations, Ireland’s KDB might be the perfect opportunity for eligible companies. Additionally, there are a great many double taxation treaties in place. Using Dublin as a hub for activities might therefore prove beneficial for MNEs.92
3. Target Audience
Ireland’s approach is at the forefront of OECD-compliant regimes: “For other countries, it’s only a matter of time before they follow,” said Kevin McLoughlin, head of tax at EY Ireland in an interview with The Irish Times.93 The implementation of the nexus approach constitutes a shift from targeting pure holding companies to entities that conduct real R&D in Ireland.94 Moreover, the current legislation is tailored to companies carrying out R&D activities in Ireland as well as those wanting to relocate significant R&D activities to Ireland.
4. The Future
Ireland’s approach has to prove itself over the next five years. The KDB is designed to comply with EU and OECD standards, and therefore is likely to stay relatively unchanged.95 What needs to be addressed are secrecy concerns arising from potential external investigations96 and the administrative burden, which obliges companies to clearly track all invoice items.
In a majority of cases, a detailed analysis allows for the conclusion that an existing patent box regime does have a positive impact on the growth rate in R&D.97 However, the core factor to predict the success of such a regime does not exclusively lie in the adopted tax rate.98 Various other elements, such as business environment, existing governmental policies and the scope of IP rights will more sufficiently determine the success of a patent box.99 It needs to be pointed out that the OECD and the EU recognise the effectiveness of patent boxes for encouraging R&D activities. However, these tax incentives came under scrutiny after the global financial crises, which led to the introduction of the nexus approach being the OECD’s method of choice.
Supported by the EU and the G20, the new OECD guidelines will need to be implemented internationally. Jurisdictions opposing this new global standard would risk economic sanctions, which could have a negative impact on vital branches of their economies. Countries which adopt the new standard will also need to redesign their global policies to attract substantial investment activities.
Ultimately, only time will tell if this orientation is fruitful and whether patent boxes are here to stay.100
89 Ernst & Young Ireland (fn. 102), p. 2; Deloitte Ireland, KDB – Adding to Ireland’s R&D incentives, 2016, p. 4.
90 Finance Bill 2015 Explanatory Memorandum (Ireland), 7 s 30 paras 5, 7; Office of the Revenue Commissioners (fn. 78), 3 ch 2.
91 Mason Hayes Curran LLP, Tax Update: Irish 6.25 percent KDB, 2015, S. 2 para 3.
92 The Office of the Revenue Commissioners, Tax Treaties, www.revenue.ie/en/practitioner/law/tax-treaties.html.
93 Reddan (fn. 3).
94 Department of Finance (Ireland), The KDB – Public Consultation, 2015, p. 3.
95 Department of Finance (Ireland) (fn. 108), p. 5.
96 S. fn. 110.
97 Cf. Graetz/Doud (fn. 2), 374 f.; Atkinson/Andes (fn. 1), 9 ff.; Knight/Maragani (fn. 5), 54 ff.
98 Exemplary for this conclusion: Merrill, 63 National Tax Journal (2010), 623, 627; Hemel/Ouellette, 92 T. L. Rev. (2013), 303, 347.
99 OECD, R&D Tax Incentive Indicators, 2017, sub-s “Changes in tax support for business R&D”.
100 Especially in light of criticism on tax breaks for IP, as IP is considered a prime vehicle for tax avoidance by some scholars: cf. Blair-Stanek (fn. 13), 14 ff., 58 f., 67 ff.