As nations around the world seek to compete in a global marketplace, governments are considering new ways to use the tax system to incentivise business to innovate.
Innovation is an important driver of economic growth and produces real societal benefits such as high-value jobs, exports and tax revenue. The trouble is, genuine innovation involves genuine risk and this risk is not always rewarded by the market.
Tax incentives are often used by governments to fill this gap between risk and reward. For example, many nations use research and development (R&D) tax credits to encourage businesses to take risks they may not otherwise take. These programs are generally focussed on supporting the front end of the innovation cycle – the development of new technology, products, processes, services or ideas.
There are far fewer incentives provided by governments to encourage businesses to see new technologies from the R&D stage through to commercial enterprise. This lack of back end support can mean that when businesses look to commercialise their technology they move to locations where labour is cheap, tax rates are low or the regulatory environment is more favourable. As a result, the jurisdiction that incubates the technology often doesn’t reap the societal benefits that innovation can provide.
As nations around the world seek to compete in a global marketplace, governments are considering new ways to incentivise high-value industries to set up commercial operations under their dominion. Against this backdrop, the role of tax incentives in encouraging innovation is changing.
Encouraging commercialisation with Innovation Boxes
A number of European nations use innovation or patent box programs that provide a lower corporate tax rate for intellectual property (IP) income. The definition of ‘IP income’ varies but can include income from the sale of patented products, royalty income and other income sourced from IP.
The rationale for innovation box polices is that if IP income is taxed at a lower corporate tax rate, businesses will protect, hold and exploit their IP in the taxing jurisdiction. It follows that businesses may choose to co-locate other activities such as manufacturing or administrative functions to maximise IP income that can be said to have a source in the country (and thus benefit from the reduced tax rate). Where successful, these programs can benefit the taxing nation through the creation of high-value jobs and the generation of non-IP income that would not be eligible to be preferentially taxed.
The interest in these programs is spreading rapidly as countries look to attract smart businesses to their shores. In July 2015, the United States Finance Committee Bipartisan Tax Working Group released a report as part of their own tax reform process stating that “concurrent with the increase in these discounted rate regimes around the globe, the United States will continue to experience an increase in the migration of intellectual property out of the country.”
Consequently, the working group declared that an innovation box regime should be part of a bipartisan framework for international tax reform in the US.
“The co-chairs agree that we must take legislative action soon to combat the efforts of other countries to attract highly mobile U.S. corporate income through the implementation of our own innovation box regime that encourages the development and ownership of IP in the United States, along with associated domestic manufacturing.”
What does a good Innovation Box look like?
Good eligibility criteria for innovation boxes have been the subject of great debate internationally. This has recently come to a head with the OECD endorsing a number of appropriate eligibility criteria for:
Forms of IP covered by the program – the preferred approach is that innovation boxes apply only to registered IP
A nexus standard that links the benefit of the innovation box to R&D, manufacturing and production conducted in the state providing the benefit
Mechanisms for providing the benefit for IP that is repatriated from offshore.
While these criteria should result in a fair, equitable and effective tax incentive program, the merits of adopting an innovation box in the US have been the subject of debate. While industry is generally supportive of an innovation box, some see it as a tax dodge for multinationals and question its effectiveness in fostering new innovation or commercialisation. The same was the case when the UK implemented the patent box program in 2013.
We are yet to see how adoption of an innovation box in the US could influence other governments to consider the idea. However, as more nations implement innovation box programs, this will place pressure on their trade partners and global competitors to provide an equally as attractive environment for both innovation and commercialisation.
Matthew McLeanis a Senior Manager at Griffith Hack Patent and Trade Mark Attorneys and IP Law (Australia)