Nick Shaxson ■ Patent boxes: progress, or more racing to the bottom?
We’ve written quite a bit about patent boxes in the last few days. A Patent Box is a tax incentive that reduces effective corporation tax rates on income attributable to patents, subject to certain conditions. We at TJN think they are generally a terrible idea.
In two patent box blogs last week (here and here) UK tax barrister David Quentin and others questioned a rather cryptic new Anglo-German deal (or should we call it a stitch-up?) which appears to get rid of patent boxes, but then may be opening the ground to bring them in through the back door. We briefly asked how this might fit in with a new global scheme by the OECD, a club of rich countries, to tackle corporate tax abuses and abusive tax systems. Quentin subsequently wrote in a blog entitled What will Son of Patent Box look like? noting that these supposedly “competitive” tax policy structures are harmful and result in “highly uncompetitive chaos.”
Now, developing these themes in more detail, we have a guest blog from Prof. Sol Picciotto, a Senior Adviser to TJN.
Progress on patent boxes?
The new communiqué from the G20 leaders generally welcomed the OECD’s reports on the first year of its BEPS project to tackle harmful tax practices in corporate taxation, including the “progress made on taxation of patent boxes”.
You would need to have been paying really close attention to understand what they meant by this.
The OECD’s BEPS (Base Erosion and Profit Shifting) project is, quite correctly, examining patent boxes as a species of what it calls “Harmful Tax Practices.” Indeed, the discussions in the BEPS committee(s) on harmful tax practices have been dominated by patent boxes in the past year.
The debates have focused on a proposed approach for defining which “substantial economic activities” can be accepted as relating to the income resulting from patents. The OECD’s report published in September admitted that agreement had not yet been reached on this, due to opposition from Luxembourg, the Netherlands, Spain and the UK.
The UK-German agreement on patent boxes
However, on 11 November the German Finance Ministry announced an agreement with the UK on a modified version of the proposals. This seems to be an agreed attempt to influence the OECD’s wider work in a way that suits these two countries best.
If this UK-German proposal were to be accepted by all 44 countries in the BEPS project, would that spell the end of patent boxes?
Far from it.
First, Germany has accepted UK proposals for “grandfathering” the proposed changes, so that companies could join the scheme up to 2016, and continue to benefit until 2021 from a tax break that the UK government itself estimated costs the UK taxpayer £1.1 billion per year.
This means that the UK will have to make significant changes to one of the corporate tax breaks George Osborne introduced only last year – though the changes only kick in after seven years.
Second, Germany has agreed to a 30% uplift of what counts as qualifying expenditure to cover related party acquisition and outsourcing expenditure. (So on qualifying expenditure of £10 million, you can call it £13 million for the purposes of the patent box regime.)
Third, work is still needed to define “a practical and proportionate tracking and tracing approach” to be implemented by companies and tax authorities (see more on this below.)
More importantly, although the joint UK-German statement promises the “closure and abolition of IP regimes”, this is untrue.
The proposals will, instead, have the effect of regularising them. Countries which already have patent boxes would be expected to bring them into line with the new standards. At the same time, those that don’t will be under strong pressure to introduce their own.
So expect plenty more patent boxes.
Ireland and Switzerland have already said they intend to do so, and as we’ve noted, media reports in September suggested Germany itself is also looking to get in on the game.
The result would be a general reduction of tax on companies which use patents.
Patent boxes: the mythical research justification
Some may claim that this is no bad thing, to encourage research, which is often the justification trotted out for patent boxes.
Countries already provide generous tax breaks for research, through deductions of actual expenditure. A patent box goes well beyond this, by providing a low tax rate for income associated with a patent, in relation to all the R&D expenditures associated with such income.
Companies generally spend far more on Development than they do on Research, and the UK patent box was specially designed to cover all such spending. As HMRC explained it to business advisers, if you have a patent for a printer cartridge, you can apply all the expenditure attributable to developing the printer in deciding the proportion of income from sales of the printer eligible for the low tax rate.
The compliance problem
It’s also interesting to consider how compliance with the OECD standards will be monitored. What’s happening here raises questions about how serious the OECD is about genuine reform.
The proposed criterion for “substantial economic activities” is quite complex and burdensome to apply for both companies and tax authorities. Companies will have to establish a system to “track and trace” spending, to be able to show which of it is “qualifying expenditure”. (The Germany-UK announcement also mentioned that they would work on details for the track and trace system.)
Corporate tax advisers are generally quick to complain about the excessive costs of compliance with tax rules, but we haven’t noticed any such rumblings against these requirements.
The approach adopted by the OECD also means that monitoring is needed to check that national rules comply with the agreed standard. This should apply to not only to national laws, but also to how effectively the tax authority actually applies the track-and-trace rules. Application of the OECD standards is supposed to be done through the Forum on Harmful Tax Practices. It seems that this will need to become a permanent body, engaged in a continuous process of monitoring. It would need to cover not only patent boxes, but any other wheezes that countries come up with to reduce company taxes. To be effective, it would also need to extend beyond the OECD and even the G20, assuming that other countries agree to sign on to these proposals.
This approach will mean that the OECD tax experts should scrutinise national tax laws, and their application in practice, to verify whether they are “harmful”. Yet the mandate to the OECD from the G20 stated firmly that reforms “must be designed to address the gaps between different countries’ tax systems, while still respecting the sovereignty of each country to design its own rules”.
Either the OECD has a strange notion of sovereignty, or it doesn’t intend to look too closely into how countries actually applies the standards it is proposing.
Much simpler in our view would be to just state clearly that low tax rates on patent income are bad and such schemes should be withdrawn.
Copa do Mundo das injustiças #43: the Tax Justice Network Portuguese podcast
Uncommon Wealth and the ‘boomerang effect’: the Tax Justice Network podcast, the Taxcast:
Taxing unearned profits
Ireland’s responsibility for the impacts of cross-border tax abuse on the realisation of children’s rights (2nd UN submission)
22 August 2022