|International taxation of IP and goodwill|
Adrian Gregory, Brett Boshoff
Globalisation, new technologies and e-business have led to new business models in which information, IP and knowledge have become core business assets and key drivers of competitive advantage.
IP rights are increasingly amongst the most valuable assets owned by companies and their exploitation can produce significant profits. For example:
The tax treatment of IP rights is dependent on the territory in which the rights are owned. Since there is great variability in the tax treatment of IP rights between territories (see below), the territory in which the rights are owned will affect the earnings of a MNC.
Goodwill is an intangible asset that comprises a significant part of most M&A transactions and, as such, the tax treatment of goodwill will often also be central to the earnings of a MNC.
International comparison of the taxation of IP and goodwill
Since IP rights are portable assets, it is, in principle, possible to locate these rights in a territory that has a favourable regime for the taxation of IP and the profits derived therefrom. The portability of IP rights derives from the fact that they are a distinct property right that can be legally owned and protected separately from the operating assets and goodwill of a business that uses the IP. This makes possible the transfer and subsequent franchising / licensing of IP rights independently of any sale or other dealings in the tangible goods to which they relate.
In so far as the choice of territory in which to locate IP is concerned, there are two principle tax considerations: the rate at which profits realised in the territory will be subject to tax; and whether tax relief will be available for the acquisition cost of IP and goodwill.
The acquisition of IP and goodwill as part of the acquisition of a business as an asset deal may also give rise to the following considerations:
The tension between asset and share deals
Typically, the effective tax rate of a business acquired in an asset deal will be lower than a business acquired pursuant to a share deal. This is principally because the cost of goodwill will qualify for tax relief on an asset deal, but not on a share deal.
However, in many cases a seller may prefer to dispose of shares to minimise its own tax costs. If the deal is structured as an asset deal, it will be important for both the seller and purchaser to understand the impact of this deal structure on the business's effective tax rate and any consequent impact on price.
Amortisation policy Standard accounting practice typically requires that a company write off the purchase price of intangible assets over the useful economic lives of those assets. In practice there will often be a range of reasonable estimates of an intangible asset's useful economic life. In circumstances where the tax treatment of intangible assets follows their accounting treatment, the decision regarding the length of useful economic life will involve a trade-off between cash flow and earnings. A long useful economic life will enhance earnings. But it will also reduce annual tax deductions relating to the intangible, and therefore reduce net cash flow.
It should be noted that non-tax considerations will be central to any decision on where to locate IP and tax considerations should not be allowed unduly to influence these commercial considerations. For example, IP protection and enforcement are fundamental to the preservation of the value of IP and, as such, it is vital that appropriate legal protection is afforded to the IP owner by the legal system of whichever territory is chosen for the location of the IP.
The remainder of this chapter describes in broad outline the tax treatment of IP and goodwill in various jurisdictions and highlights particular issues that should be considered if IP is to be located in those jurisdictions.
The tax treatment of IP and goodwill does not follow standard accounting practice. Rather, the treatment of these assets is set out in the Australian tax legislation with the treatment varying depending on the nature of the intangible asset involved (see Table 2.2).
Costs of internally generated IP are typically fully tax deductible as revenue items on an accrual basis. However, one of the main issues when dealing with IP and goodwill in Australia is that capital allowances are not available with respect to the acquisition cost of trademarks and goodwill.
Whilst Australia is not a particularly high tax jurisdiction (corporate profits being taxed at a rate of 30%) the fact that capital allowances are not available in respect of acquired trademarks and goodwill means that Australia is not typically considered a favourable jurisdiction to locate the IP assets of a MNC.
Typically, the two main issues when dealing with IP and goodwill in France are: trademarks and goodwill cannot be amortised for tax purposes; and France is a relatively high tax jurisdiction with the standard rate of corporate income tax in 2002 being 35.42%.
Aside from the exceptions noted above with regard to trademarks and goodwill, the tax treatment of intangible assets typically follows standard accounting practice (see Table 2.1).
A reduced rate of corporate income tax (20.19% in 2002) is applicable, under certain conditions, to profits derived from patents and patentable discoveries. Relative to other intangible assets, the tax treatment of such patents and patentable discoveries is particularly favourable - amortisation over the useful economic life of the asset (subject to a minimum amortisation period of five years) is deductible for tax purposes and profits derived from the exploitation of these assets is taxed at the lower rate.
The tax treatment of IP and goodwill follows standard accounting practice and, as such, amortisation of these assets over their useful economic life will give rise to charges that are deductible for tax purposes across the full range of these assets (see Table 2.1).
The main issue when dealing with IP and goodwill in Germany is that Germany is a relatively high tax jurisdiction with profits being taxed at a corporate income tax rate of between 38% and 40% in 2002.
Generally, no tax deductions are available in respect of acquired IP and goodwill - the exceptions being patents and software (see Table 2.2).
However, despite the fact that tax deductions are not generally available for acquired IP and goodwill, the enactment of legislation reducing the standard rate of corporation tax to 12.5% with effect from 1 January 2003 has enhanced Ireland's attractiveness as a territory in which to locate IP. The reduced rate of 12.5% only applies to active trading income - investment income and capital gains will continue to be taxed at higher rates (see Table 1, below).
If IP assets are to be located in Ireland it will therefore be important to structure the IP exploitation activities where possible such that they constitute a trade for Irish tax purposes.
It should also be noted that there is a special regime in Ireland that applies to income from Irish developed patents. Irish legislation provides for a tax exemption for income derived from such 'qualifying patents' where the holder of the patent is tax resident in Ireland.
The tax treatment of IP and goodwill is prescribed by Japanese tax legislation, which provides for tax amortisation at specified rates across the full range of intangible assets that have been recognised for accounting purposes (see Table 2.1).
The main issue when dealing with IP and goodwill in Japan is that Japan is a high tax jurisdiction with profits being taxed at a corporate income tax rate of 42% in 2002.
There are no special Dutch tax rules regarding IP and goodwill and, as such, the Dutch tax treatment of these assets generally follows standard accounting practice, which means that: costs of internally generated IP are generally fully tax deductible on an accrual basis; and acquired IP and goodwill is capitalised and amortised over its useful economic life (see Table 2.2).
Whilst the Netherlands is a relatively high tax jurisdiction (corporate profits are currently subject to tax at a rate of 35%) the fact that tax deductions are available for development costs / acquisition costs across the full range of intangible assets (other than internally generated goodwill) means that the Netherlands is often considered a favourable jurisdiction to locate the IP assets of a MNC.
The tax treatment of IP and goodwill is prescribed by Spanish tax legislation, which provides for tax amortisation at specified rates across the full range of intangible assets that have been recognised for accounting purposes (see Table 2.2).
The main issue when dealing with IP and goodwill in Spain is that Spain is a relatively high tax jurisdiction with profits being taxed at a corporate income tax rate of 35% in 2002.
There are no special Swiss tax rules regarding IP and goodwill. Swiss tax law generally follows standard accounting practice, which means that: costs of internally generated IP are generally fully tax deductible on an accrual basis; and acquired IP and goodwill is capitalised and amortised at rates agreed by the federal and cantonal tax authorities (see Table 2.2).
Corporate profits are subject to combined federal and cantonal (incl. communal) profit taxes at an effective rate of between 15% and 29 %.
However, preferential rates of cantonal tax are available in circumstances where a Swiss company receives mostly foreign source income. In such cases, royalty income from foreign (group) companies may be taxed at an effective rate of tax as low as 10%. It is for this reason that Switzerland is typically considered a favourable jurisdiction in which to centralise the ownership of the IP assets of a MNC.
In recognition of the increasing importance of IP to business, the UK government has recently introduced a new regime for the taxation of IP, goodwill and other intangible assets (together 'intangibles') as part of its UK competitiveness agenda. The new regime complements new rules that have been introduced for the taxation of research and development expenditure.
The new intangibles regime applies to intangibles acquired by a company on or after 1st April 2002 from a third party. The tax treatment of these assets, so far as possible, follows standard accounting practice with income, expenditure and amortisation relating to intangibles being treated as revenue items (see Table 2.1 above).
The new regime does not apply to intangibles acquired before 1st April 2002. Such assets are 'grandfathered' and their tax treatment will continue to follow the 'old' regime for the taxation of intangibles, so long as these assets stay in the hands of their existing owners or in the same 'economic family'.
Under the 'old' regime, the taxation of intangibles is complex and inconsistent with different types of intangible asset being taxed on a different basis eg tax deductions being available for the amortisation of the acquisition cost of a patent but no similar tax deduction being available for amortisation in respect of a trademark or goodwill.
The end result is a complicated set of tax rules for intangibles due to the fact that two parallel tax regimes will continue to operate for the foreseeable future.
Under the new intangibles regime, deductions will be available for the full range of IP assets and acquired goodwill. This, together with the fact that the UK is not a particularly high tax jurisdiction (corporate profits are currently subject to tax at a rate of 30%), would appear to make the UK a relatively favourable location in which to locate the IP assets of a MNC.
However, the new regime will not apply to 'grandfathered' assets. The new regime includes anti-avoidance rules aimed at preventing companies from artificially trying to convert 'old' assets into 'new' assets (eg through intra-group disposals) and, as such, the benefits of locating IP in the UK will not be available to existing IP assets of a MNC.
The tax treatment of IP and goodwill does not follow standard accounting practice. Rather, the treatment of these assets is set out in the US tax legislation with the exact treatment varying depending on the nature of the intangible asset involved. However, deductions are available for US tax purposes across the full range of IP assets and acquired goodwill (see Table 2.1).
The US is a high tax jurisdiction with corporate profits typically being taxed at a rate of around 40% (depending on the states in which the company operates). This is a principal reason why the US is not typically considered a favourable jurisdiction in which to locate the IP assets of a MNC, albeit that deductions are available across the full range of IP assets and acquired goodwill.
In many respects, the taxation of IP and goodwill in the US and the Netherlands is fundamentally the same, particularly in regard to the range of assets in respect of which tax deductions are available. Yet the Netherlands is often considered a favourable jurisdiction in which to locate IP, whilst the US is not. This has more to do with other attributes of the US and Dutch tax systems (particularly in regard to the taxation of branches, the availability of tax rulings, breadth of tax anti avoidance provisions and the relative ease of corporate reorganisations) than any fundamental difference in the taxation of IP and goodwill.
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