In other legislative news, earlier this week Senator Carl Levin, Chair of the Senate Permanent Subcommittee on Investigations, introduced S.506 - the Stop Tax Haven Abuse Act. A companion bill -- H.R.1265 -- was introduced yesterday in the House by Congressman Lloyd Doggett and has 56 co-sponsors.
In his statement on the bill, noted a tax avoidance technique using intellectual property:
Here's just one simplified example of the gimmicks being used by corporations to transfer taxable income from the United States to tax havens to escape taxation. Suppose a profitable U.S. corporation establishes a shell corporation in a tax haven. The shell corporation has no office or employees, just a mailbox address. The U.S. parent transfers a valuable patent to the shell corporation. Then, the U.S. parent and all of its subsidiaries begin to pay a hefty fee to the shell corporation for use of the patent, reducing its U.S. income through deducting the patent fees and thus shifting taxable income out of the United States to the shell corporation. The shell corporation declares a portion of the fees as profit, but pays no U.S. tax since it is a tax haven resident. The icing on the cake is that the shell corporation can then "lend" the income it has accumulated from the fees back to the U.S. parent for its use. The parent, in turn, pays "interest" on the "loans" to the shell corporation, shifting still more taxable income out of the United States to the tax haven. This example highlights just a few of the tax haven ploys being used by some U.S. corporations to escape paying their fair share of taxes here at home.
(The issue of these IP passive investment companies - both foreign and domestic - was covered in our report Intangible Asset Monetization: The Promise and the Reality.)
While the legislation does not specifically target these IP transactions, it does strengthen the "economic substance doctrine" which basically states that tax benefits are not allowable if the transaction does not have economic substance or lacks a business purpose -- i.e. if they are done for the purpose of avoiding taxes. The bill also expands tax reporting requirements for these passive foreign investment corporations. In addition, the bill also takes away patent protection for tax planning techniques.
According to the Wall Street Journal, "At a House hearing Tuesday, Treasury Secretary Timothy Geithner said the Obama administration supports the tax haven legislation, which is similar to a bill Mr. Obama co-sponsored as a senator."
As we noted in our Intangible Asset Monetization report, the issue of the use of IP in tax havens needs to be addressed. If the use of investment companies for IP is seen as a mechanism for tax avoidance, this creates a serious barrier to positive policymaking. As suggested in the report, it might be time to look at tax incentives for the creation of intangibles. But, that is not going to happen as long as the tax abuse issue is not addressed. The Levin bill may be a way of putting the tax abuse issue behind us - and moving on to other policy ideas.
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