Building a patent box

This morning I attended an event at the Information Technology & Innovation Foundation on their new paper, Patent Boxes: Innovation in Tax Policy and Tax Policy for Innovation by Rob Atkinson and Scott Andes. A "patent box" is the name for a reduced tax rate for income derived from a patent. A number of countries, mostly in Europe, have various forms of a patent box -- with Ireland being the first back in the 1970s. As I noted in our 2008 report Intangible Asset Monetization: The Promise and the Reality, countries with a low tax rate on IP income are often seen as tax shelters with companies moving their IP to subsidiaries in those countries as a tax strategy. For that reason, the issue of transfer pricing -- how much a subsidiary pays the home country for the asset -- is such a large issue. In fact, OECD has an ongoing intangible transfer pricing project

The Atkinson and Andes paper make a good case for why having a lower tax rate on patent-related income is a good idea as part of an innovation strategy:

First, a patent box reduces the financial risk involved in innovation, better matching firm rewards with societal benefits, including the creation of high-wage jobs. If a patent box is designed in a way that links the incentive to the conduct of R&D and production of the patented product in the United States, it would go even further in spurring the creation and location of more innovation-based jobs in the United States. Second, a patent box would lower the effective corporate tax rate for knowledge-based establishments located in the United States, making it easier for them to compete against establishments in nations providing robust innovation incentives.

The twist that the Atkinson/Andes proposes is to condition the tax rate on the amount of R&D, commercialization and production done in the United States. That creates an incentive to keep the economic activity in the US along with lessening the incentive to move just the IP to a low rate country.

[A variation on this was presented in the recent testimony of Michael Rashkin at the Senate Finance Committee (see earlier posting).]

In our Intangible Asset Monetization report, I suggested that we should explore lowering the tax rate on intangible asset royalties, in conjunction with stricter regulations on international transfer-pricing mechanisms and cost-sharing arrangements and on passive investment companies:

Providing a more direct tax incentive to the licensing of intangibles by lowering the rate on intangible asset royalties, such as to the capital gains rate, is a more controversial proposal. This lower rate could be crafted to apply only to royalties for new licenses for a limited time, such as a sliding scale for three years. In crafting such an incentive, safeguards would need to be established to prevent the incentive from being used for simply transferring existing licenses to SPEs and to ensure that the incentive went to new licensing activities only.

In conjunction with such a tax incentive, the problem of tax havens should be addressed. Transfer pricing mechanisms and cost sharing arrangements need to prevent those transfers that, as the IRS describes, are "for inadequate consideration." The issue (some would say the abuse) of "passive investment companies" should also be handled.

The notion of tax havens and loopholes is often a matter of perspective. One person's loophole is another person's incentive. However, there is a growing concern that the tax code has become overly complex and that rates could be lowered in conjunction with the elimination of certain specific provisions. Any such tax reform, including the possibility of closing loopholes currently applied to intangibles and lowering the tax rate on royalties, should be looked at very carefully in the context of the impact on the creation and utilization of intangible assets.

As I noted in a posting early this year, President Obama's FY 2012 contains provision on taxation of intangible transfers. This provision would raise almost $22.5 billion over 10 years. That would be a good down payment for the Atkinson/Andes patent box proposal.