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Yves here. We are delighted to welcome two world-recognized tax experts as writers on our site. They also happen to fall in the minority that believes that paying taxes is the price of civilization.
One of the things that has worked in the favor of corporate and individual tax gamesmanship is that tax, and particularly cross border tax, is so complex as to induce MEGO (My Eyes Glaze Over) among just about anyone other than serious professionals. I’ve noticed, for instance, that attorneys in specialities other than tax seem if anything to have more of an antipathy to tax issues than mere mortals.
And that suits everyone on the inside. Complexity assures limited entry into the discipline which in turn means high pay levels for those with expertise. It also helps lobbyists push for regulations that further lard up the tax code, since politicians can tell their constituents they’ve done something for them (“Tax incentives for the locally pottery kiln”). Those provisions also serve corporations and the wealthy generally, since they further the use of tax reduction as an illusory economic stimulus. In fact, the main effect is a race to the bottom on corporate taxes, which results in a shifting of the tax burden to regressive consumption taxes and not-very-progressive personal income taxes. In other words, tax avoidance has long been a means for redistributing income to the capitalist classes.
Heretofore, coverage corporate taxes has seldom gotten outside the business section of the paper. But cases of prominent US companies like GE and Apple paying zero or near zero taxes has galvanized public attention. And in the UK, a mass movement, UK Uncut, has emerged to opposed what amounts to tax scoff-lawing via clever use of loopholes, particularly by multinationals.
In the US, the issue of corporate tax avoidance via inversion deals (buying often inconsequential foreign companies in more favorable tax jurisdictions as the vehicle for moving the corporate tax domicile there) has become so controversial that the Treasury has roused itself to block this move.
This post gives a layperson-accesible description of a UK ruse in the international tax race to the bottom, that of the “patent box”.
By David Quentin, a UK tax lawyer and senior adviser to the Tax Justice Network, and Nicholas Shaxson, the author of Treasure Islands, an award-winning book about tax havens
With the UK’s “Patent Box” coming under renewed scrutiny, an explanation is in order of how nasty, disingenuous and hypocritical the thinking behind it is.
By way of background, The “Patent Box” is a tax incentive that reduces the effective UK corporation tax rate to 10% (as compared to 21%) on income attributable to patents, subject to certain conditions. Generally-speaking tax incentives like this seek to attract mobile capital to relocate to one’s home jurisdiction (or discourage it from migrating away), and the hope is that jobs and prosperity will follow (or remain, as the case may be). Other jurisdictions may try to follow suit, and the ensuing international jostling is a process that some call international tax ‘competition’. Others call it a race to the bottom. Whatever one calls it, the patent box must be understood in this context. Several European regimes have popped up in this terrain, notably in Ireland, Switzerland and the Benelux countries: Belgium, Netherlands and Luxembourg.
The UK government has been frank about the tax ‘competition’ aspect of it, expressly announcing the regime as an enhancement to the “competitiveness” of the UK tax system. In 2011, when the UK’s Patent Box regime was in development, PWC published a pamphlet entitled Is it time for your country to consider the “patent box”? which is equally frank about the realities of tax competition:
Intellectual property (“IP”) is highly mobile and can be easily separated from the jurisdiction where it was developed and migrated to low-tax jurisdictions. Over the last few decades, a greater proportion of IP (and the resulting revenue stream) has been moved offshore to minimize tax. In response, some countries have adopted the concept of a “patent box,” a tax regime that sharply reduces the rate of corporate tax applied to income resulting from qualifying IP.
Yet it would be a mistake to imagine that this is just about states being forced to reduce tax rates on intellectual property income because of the threat of migration. As PwC explain, the “Patent Box” regime may be a way to help states pander to the wishes of flighty corporate capital with a minimum of democratic fuss:
In general, most businesses would prefer general tax relief in the form of an overall corporate tax rate reduction. However, since in some countries incentives can be viewed politically as more feasible than reducing overall corporate tax rates, an alternative tax reform scenario could be the adoption of a patent box regime. Such a regime likely would encourage companies to locate the high-value jobs and activity associated with the development, manufacture, and exploitation of patents in-country.
Note that section in bold. Intellectual property, PWC suggest, is an opportunity for states to subsidize returns to capital, because it is possible to build a narrative of utility around intellectual property. PwC is not interested in demonstrating that the “Patent Box” in fact has these benefits of utility; the issue is the political feasibility of the tax cut for corporate capital. (It’s also worth noting that tricky tax subsidies are much less visible to democratic populations than headline corporate tax rate cuts are.)
While the social and economic utility narrative is weaker for some forms of intellectual property (trademarks, for example, or copyright), it is stronger in the case of patents, which are associated – at least in the minds of policy-makers and the public – with technology-driven economic growth and advancements in medical science.
The UK has carefully targeted this intersection between mobility and apparent utility. Its Patent Box, in contrast to, say, Luxembourg’s more generous approach, is restricted specifically to patents rather than applying to a broad spectrum of intellectual property assets, and it requires that there be some activity associated with the patent.
No doubt it is this careful targeting which emboldened David Gauke, Financial Secretary to the UK Treasury, to describe the Patent Box as having been introduced to “spur innovation”.
But this is disingenuous, for several reasons:
The targeted sectors are already in the business of developing new technologies: it is hard to imagine there are dormant research projects, from which latent research capacity is currently being withheld, which will be roused into action because of the prospect of the resulting profits being taxed at 10% rather than 21%. In any event, technology-driven sectors are already lavishly subsidised in the UK through enhanced tax deductions and tax credits attributable to expenditure on research and development. The patent box is therefore an further subsidy supplementing the eventual profits, in addition to the subsidies already available for product development.
The Patent Box rules are not structured to reward the creation of new technologies; existing patents can be brought in from outside and the new owner can nonetheless benefit from the relief, provided that some activity is undertaken in relation to the exploitation of the patent.
Perhaps most importantly, it is the very existence of intellectual property rights that spurs innovation, so there is no need for them to have a special extra subsidy. However socially useful a patented technology may or may not be, a patent is a privately-held and transferable monopoly over the commercial exploitation of an idea, and that monopoly only exists because the state chooses to enforce it. Bringing into being and protecting such privately-held monopolies is a way for the state to reward human creativity. Owning such an asset is not something the state needs to subsidize with a tax break; simply owning it should be enough.
It is also worth remarking that cutting a firm’s tax bill by one means or another does not directly achieve anything in terms of genuine innovation: it is merely a wealth transfer to capital owners. It is probably fair to say that these facilities lure corporate bosses into taking their eye off what they do best, as they focus instead on the next tax-driven sugar hit.
Mr Gauke makes no attempt to disguise the fact that the underlying driver here is not to foster innovation at all, but the dynamic of international tax ‘competition.’ His ‘spur to innovation’ speech, delivered to a City of London audience, opened with the proposition that UK tax policy is determined by “market forces,” not by the UK government:
Because in a global business environment, it isn’t politicians – even those politicians like me, who are responsible for national tax policies – that make the ultimate call about which tax systems are the most competitive or the most attractive. It’s businesses like yours, and you vote with your feet.
That is an extraordinary statement, if you think about it.
There is no recognition here of even the possibility that cooperation between governments could protect tax bases worldwide in respect of the more mobile forms of income. It fully embraces the downward pressure on the corporate tax take that market forces impose.
The UK’s Patent Box regime is therefore best understood as an instance of unalloyed complicity on the part of the UK government with the global dominance of corporate capital over the state power to tax. That complicity on the part of a jurisdiction like the UK is extremely harmful to the corporate tax system worldwide and completely undermines the UK’s standing to push for multilateral tax reform.
Not only that, but there’s early evidence that the gross benefits to the UK itself – much paper-shuffling, with few jobs – come with associated tax costs which may be high. Let’s also not forget that a race to the bottom is a race: Ireland, which introduced its patent box in 1973, is now smarting from the UK’s recent moves, and the lawyers and accountants, some of the biggest beneficiaries of the patent box gravy train, are even trying to get the United States to join in.
Essentially, the “Patent Box” is an if-you-can’t-beat-them-join-them attitude to tax havenry, which is why its existence on the UK’s statute books marks the UK out as a rogue state in the world of corporation tax.
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It would be better to charge a usage based license fee based on value for the service of upholding patent protection rather than the current set-up of a fixed fee. Large volume and large IP revenues in a jurisdiction should provide more revenue for the public services that protect the patent. That would reduce the benefits of transferring IP rights to low-tax jurisdictions.
IP-rights are only worth anyhing if they are protected. In some countries the IP-rights aren’t protected much by the government, might be a good idea to incentivise the protection by charging a small license fee per usage instead of the ridiculously low one time cost. Set the current cost of patent as a floor and then charge an additional fee (0.1% or less/more?) of every IP-value charged out to low-tax jurisdictions.
Actually, most countries charge periodic maintenace fees to keep issued patents “in force”. The problem with basing any patent-related fee on “value” is that valuing patents is a fool’s errand in most cases (see my post below). And many countries use compulsory licensing schemes that set minium royalties to reduce or eliminate infringement actions.
My alternative would be to charge much higher maintenance fees for older patents, since most patents don’t really become valuable until long after they’ve been issued. I would also institute “use-it-or-lose-it” defenses to keep patent holders honest about actually working their inventions and not speculating on trapping someone else.
My proposal would be getting the IP-value straight from the profit and loss accounts filed with revenue :-)
The higher the intercompany charge for use of IP the higher the IP fee to maintain the legal protection of the IP. The result would be the closing off a bit of the tax-minimising.
& to keep companies honest in their estimations of their arms length valuation then maybe accept their estimations when they sell the IP rights to low-tax jurisdictions but then also calculate the actual value based on the received license/royalty-fees and if the initial estimation was wrong then recalculate tax-liability based on actuals. A bit of back-taxes to be collected.
Companies “lease” their own patents in these offshore locations. They pay a hefty fee, which they take off their taxes. The patent earns its income in the offshore location from this rent, and royalties once they start coming in.
It’s droll that Americans can accuse any other country of being a “Rogue State”, particularly for the Terrible Crime of not having a corporate taxation system as stupid as the Imperial American one.
Wow, a twofer in the reading comprehension fail category.
1. Your comment is a straw man. The post makes no claim that the US system is better than the UK one. It is sternly criticizing a bad feature of the UK regime as illustrative of a general philosophy. It does not say the US system is superior.
2. Did you manage to miss the Anglicized spellings? Quentin is British, specifically, a UK tax barrister, formerly of the Queen’s own law firm Farrer & Co. Shaxson is also British. This critique comes from your countrymen, not outsiders.
It is remarkable how critiques of dodgy policies often evoke knee-jerk jingoistic defenses.
The music is going to keep on playing on until someone gets angry enough to start throwing some chairs around.
It should be clear why the UK has been on the fence on exiting the EU. The ideologues running the UK see the EU as too meddlesome and don’t want Brussels bureaucrats getting in the way of the
mafiathe City. Naturally, Cameron and Osborne see it as a win. Another way to look at it as a declared tax war and citizens around the world should take notice. Yes, rogue fits the description.One can view the UK empire as the ultimate tax haven — Gibraltar, Jersey, Guernsey, BVI, Bermuda (even former ones like Singapore, HK, Nevis) — all are complicit in one way or another in corporate and private race to the bottom tax schemes.
I agree with you John and the present policy might work if UK still had the economic clout it used to but that’s from the ‘what if’ school of history.
My particular fear is for the rather valuable income we squeeze out of the EU in pensions business. That will all become available to SwissRe, MunichRe and Allianz if the right-wing tories get their way.
A great post covering multiple levels of abuse—intellectual property, tax law; economics, and society. That takes real genius and arrogance. Who says we don’t live in a meritocracy!
Having practiced patent law for about 25 years, including stints at biotechnology companies and law firms, and being one of those who hasn’t been afraid to talk to tax attorneys about patent-based tax shelters, I have a few thoughts to add. (And we have plenty under U.S. law. I learned this first-hand from one colleague tax attorney at a large biotech who explained how he moved our patents into an off-shore Caribbean based holding company, and a CFO who bragged to me how he played off-shore technology development of U.S. patents to get a 3% tax rate.)
Perhaps a few preliminaries for those not too familiar with patent law.
You can read about the history of patent law here. Modern patents are really an exchange between the inventor and the government. The inventor provides a sufficient description of the invention and how to make and use the invention. In return, the inventor gets a limited time in which to the use the patent as just described. The definition of the “invention” of course, is the key. The invention is defined by one or more claims, which act and function somewhat analogously to the description of property boundaries. But, importantly, multiple claims can encompass an invention.
Although originally a patent (“Letters Patent”) served as a state grant of monopoly, a positive right in legal parlance, by end of the 18th Century patents became rights that only allowed a patent owner to stop others from essentially making or using the patented invention. Modern patents are thus negative rights, in that they allow the owner only to prevent an action by another; they do not enable the patent holder to practice their patented invention. For example, multiple patents held by different owners can cover (“read on” in patent jargon) the same invention (see below). Thus patents don’t really create monopolies by themselves. (Of course, patent rights can be abused. In fact, several important anti-trust provisions apply to using patents to bully competitors and create monopolies.)
For example, Jane obtains a patent for a chair having a seat, four legs, and a back. Bill obtains a patent for a rocking chair having a seat, four legs, a back, and two runners (a new twist). Although Bill has a patent, Jane can stop Bill from making and rocking chairs because the act of making rocking chairs would infringe Jane’s patent, the claims of which are said to “dominate” Bill’s.
Typically, and what is the basic idea, Jane and Bill will work out a licensing agreement so that they both profit. In fact, in the pharmaceutical world, dozens of patents held by multiple owners often cover the same drug leading to “stacking royalties”.
Examining patents is a very difficult proposition. Examiner’s are given very little time to review and understand often highly complex technologies presented in a highly “legalized” document. (I often describe the style of patent writing as “Charles Dickens-meets-Scientific American”.) The patent laws and regulations are complex. In order to decide what’s sufficiently “new” to justify a patent grant often requires multiple levels of inference and abstraction. Thus, not surprisingly, many patents are often ruled invalid in courts and on appeal. In fact, the rate of invalidation by the U.S. Court of Appeals for the Federal Circuit, the last court for patent holders before the Supreme Court, runs about 50%.
Enforcing patents is also a long and expensive process. Because few countries outside the U.S. and Commonwealth provide for any sort of real discovery, different cultures have very different views about the scope of patent rights, and domestic accused infringers often have a strong home-field advantage in the courts (historically, Japan has been notorious on this), it’s rarely viable to obtain patent protection outside the U.S. and Europe for most inventions.
Valuing patents is a fraught exercise. Because a patent is really only as valuable as its ability to stop third parties, one cannot simply add up sales of a product or service, or assign R&D costs, to a given patent. First, because more than one patent can cover an invention, even a valid patent may be worthless without a license from a dominating third party patent holder. Second, one has to discount the value based on the likelihood of subsequent invalidation by a court. Third, if a patent can’t be enforced effectively an infringer has no fear of the patent holder.
All of these points only emphasize the outrageousness of Musses. Quetin and Shaxson’s article. Because patents are really highly complex rights that are often subject to revision or complete invalidation, because the inventions described by the patent themselves are subject to multiple claims, and because patent enforcement is often impractical, the idea of assigning a simple tax value to a patent is a sham.
The view of the authors that the “Patent Box” is just a give-away is really an understatement.
Fabulous exposition, David. Thank you.
Thanks David. Very interesting.
“I’ve noticed, for instance, that attorneys in specialities other than tax seem if anything to have more of an antipathy to tax issues than mere mortals.”
Consider this reply a wholehearted endorsement. I can’t stand tax law and I avoid it like the plague. My personal feeling is that when a client seeks tax advice, they are seeking tax avoidance advice. If they want advice on how to pay taxes, a CPA will do just fine. Therefore, a client isn’t really looking for my professional judgment, they are looking for my professional justification of their predetermined desire.
I thought tax avoidance was legal, but tax evasion was not.
You are correct. There is a Supreme Court decision on just this point, written by Louis Brandeis, IIRC.
Wouldn’t it be nice if the Conservatives (actually Labour too) admitted that their only real constituency is the City of London, and began a campaign to separate it from the UK. I’m sure everybody who works in the City would be happy to constitute it as another Luxembourg, with the Isle of Man and the other dependencies John mentioned upthread (Gibraltar, Jersey, Guernsey, BVI, Bermuda) as part of it – there’s nothing impossible about a distributed, non-contiguous polity. Then we would all know where we stand.
‘Heretofore, coverage corporate taxes has seldom gotten outside the business section of the paper’
Well it almost made it to page 1 here in Australia this week, but fortuitously we had a ‘burqa scare’ which lorded it over front pages and invaded op-ed territory too. Now Abbott’s democratically elected government can go about its work imposing austerity on the ‘leaners’ – those of us too dim or lazy or insignificant not to have offshore tax arrangements – while enriching the ‘lifters’, you know, the ‘job creators’ who prosper through government preference and tax avoidance. Some guys have all the luck eh? And some make their own luck too.
‘The burqa is a terrible threat to Australia. Who’d a thunk it? But I can put a hard currency value on that threat if you want. Eight billion dollars a year. That’s not the cost of new security measures at Parliament House to prevent al-Qaeda or ISIS transvestites sneaking past the front desk in their cunning murder frocks.
No. It’s the cost of being distracted from the politics of real things – like broad scale tax avoidance by more than half of the top listed companies on the ASX – and instead devoting our attention and energies to ridiculous BS.
After Monday’s revelations that most of Australia’s biggest companies – the miners, the banks, the property moguls – pay laughably little tax, and multinationals pay virtually none, Muslim Fashion Week was actually a gift for Tony Abbott.’
http://www.smh.com.au/comment/tony-abbott-hides-real-issues-under-the-burqa-20141002-10p5zi.html
Excellent review and analysis as usual. Thank you Yves for posting this.
So, where does it all end? Will it be when some country is no longer taxing business at all, only employees? Can much more be squeezed out of employees? In UK it looks very doubtful although we could revert to the former practise of deeming income from self-employed chaps – that was quite lucrative at least as long as they could continue trading.
I suppose the end game of the moneymen is the shrinking of government to an inconsequential size leaving capitalists as the only power centre still standing. Welcome to Ferenginar.
The tax collection process is bizarre and enormously wasteful. Countless resources are spent by governments on the simple and very unproductive process of extracting money from the private sector and by the private sector to avoid it. Rather than tying those resources up with complex calculations, tedious collection and monitoring efforts, and costly administration, why can’t they be freed up to better effect? Far better ways of taxation must exist!
To me, a universal transaction tax seems to make the most sense. Money flows through banks. Every time money enters an account, a fraction should be withheld as tax. For example, for every dollar moved from any one account to any other account, one thousandth could be withheld as tax. Cash should be taxed at a different and much higher rate based on the average number of times that cash changes hands before being returned to a bank. All other taxes should be abolished. The more economically active a person or entity is, the more times money would be transferred from one account to another, and the more taxes they would pay. Generally speaking, as the velocity of money increases, so will taxes. Thus, with a universal transaction tax, taxation is not based on wealth, but on economic activity. Consider too that a transaction tax is highly egalitarian – everyone pays exactly the same rate. Large amounts of money sitting in a mattress are no more useful to the owner than a pea sitting in the same mattress. The only advantage over a pea is the potential that money may embody (though permaculturists may have a different view…). Since everyone has the same basic needs (e.g. food, water) and must spend similar amounts of money to satisfy these needs, everyone is taxed equally on the basis of essentials. In contrast, those more active economically, especially speculators, would pay much more than the economically less active.
I agree that the complexity is a feature that suits everyone on the inside. Complexity as utility. But, if we’re not willing to change it, we must put up with it.
“paying taxes is the price of civilization”
Paying taxes is the price of political bureaucracy. The extent to which civilization prospers or suffers is governed by operation of Parkinson’s Law.
Wellie when you get that time machine going, you can stop the climatic change that brought us the Egyptian civilization.
Skippy…. ahhh…. back to the savanna…