Sunday's New York Times had an interesting story on how the Netherlands is becoming a tax haven for intangibles: The Netherlands, the New Tax Shelter Hot Spot:
But for earnings derived from intellectual property such as royalties, the Netherlands has become a tax shelter of choice. With celebrities lending their names and images to clothing lines, licensing their hit songs to corporate sponsors, seeking roles in Hollywood and engaging in other ventures that generate significant taxable income, the Dutch system, which does not tax royalties, offers a nifty shelter.
As they flock to Amsterdam, celebrities are taking a leaf out of the playbook of major corporations that also use Dutch tax shelters to help reduce or eliminate the royalty taxes on patents, another form of intellectual property.
Interestingly, there is a catch, at least when it comes to Americans:
Not everyone has access to Dutch shelters. Dutch tax benefits are typically available only to artists who are not citizens of the United States. While the Netherlands does not tax royalties going in or out of a Dutch company, the Treasury Department in the United States typically levies its standard corporate income tax rate of 35 percent on royalties coming into America from a Dutch entity.
Dutch holding companies set up to protect royalties often work in tandem with offshore Caribbean companies, shuffling money around to escape taxes, analysts say. For example, part of the Rolling Stones’ Dutch-run assets are funneled through the Netherlands Antilles, a Dutch protectorate and a classic Caribbean tax haven, according to company registration documents.
15 months ago, the Wall Street Journal ran a similar story about Ireland -- Irish Subsidiary Lets Microsoft Slash Taxes in U.S. and Europe:
Giant U.S. companies whose products are heavily based on their innovations, such as technology and pharmaceutical firms, increasingly are setting up units in Ireland that route intellectual property and its financial fruits to the low-tax haven -- at the expense of the U.S. Treasury.
The movement of intellectual property to Ireland has been good for the Irish economy. According to the Irish business information website, FinFacts Ireland, the lower tax rate on patent income has raised revenues that Ireland would not have raised:
Up to half of Irish corporate tax receipts may relate to taxes paid on profits transferred from other overseas units of US corporations, to its Irish subsidiaries.
In effect, the Irish tax exemption on patent income, could well fund over 5% of the Irish Government's planned total spending (current and capital) of €48.5 billion, in 2006.
The Irish would surely dispute that they are a tax shelter for IP. Rather, they see it as a tax incentive to locate R&D in Ireland. As the law firm of A&L Goodbody points out in their description, The Irish Patent Exemption:
The basic requirements for the patent exemption have always been that the work which went into developing and having a patent registered must have been carried out in Ireland, other than work which is ancillary to the main work carried out in Ireland. For a person or company to enjoy the exemption, that individual or company must be resident in Ireland for tax purposes. It is important to note that the patent itself does not need to an Irish registered patent. The determining factor for the grant of the relief is that the work in developing the patent is carried out in Ireland.
But, as the Wall Street Journal pointed out, there are ways to game the system:
A common device is to take successful, patented American ideas and then develop new generations of them -- with help from an offshore research division. The ownership of the new version (and profits on licensing it) can then legally be shared between the U.S. parent company and the offshore unit.
Suppose a U.S. company develops a new, easy-to-use computerized day planner, and it's a global hit. All the royalties must go to the U.S., where it was invented, and be taxed at the U.S. corporate income tax rate of 35%. But if the company builds a new and improved version, adding features created partly by its offshore R&D team, the intellectual property rights of day planner 2.0 can be shared between the U.S. and the foreign unit -- as can the profits. Day planner 1.0, of course, disappears.
U.S. law explicitly permits this practice. The controversy comes in valuing the contribution made by the offshore unit. Did it pay a fair share of the development cost? And did it pony up a reasonable price to the parent company to be able to share the rights to the original invention, a price an arm's-length party would pay?
U.S. companies seek to meet the test by creating "cost sharing arrangements" between them and the foreign unit. "R&D cost-sharing agreements within corporate structures can minimize the tax payable in the parent country," notes Ireland's government in a development paper.
In the I-Cubed Economy, we need to look carefully at factors that determine the creation and location of intangible assets. Intangible assets are both very localized (local tacit knowledge) and very foot-loose (IPR). Those that are foot-loose with flee to the most advantageous location. Every once and awhile there is a flurry of activity about offshore tax havens and the entire issue of international taxation of corporations. Maybe it is time for one of those flurries to re-examine the laws and regulations relating to the transfer and taxation of intangibles.
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