Many countries have enacted a patent box regime in order to spur innovation and create domestic manufacturing jobs. Simply stated, a patent box regime provides a lower tax rate on income from the exploitation of patented goods than for other income. Among the countries that have patent box regimes are China, Belgium, the United Kingdom, France, the Netherlands, Italy and Belgium. See B. Knight & G. Maragani, It is Time for the United States to Implement a Patent Box Regime to Encourage Domestic Manufacturing, 19 Stanford Journal of Law, Business & Finance p. 39 (Fall 2013).
A patent box regime can incentivize both domestic and foreign manufacturers to set up manufacturing in a country to take advantage of a lower tax rate on profits derived from intellectual property. Many multi-national companies have relocated intellectual property sourced assets and manufacturing to foreign countries without previously having manufacturing activities in that country related to the intellectual property. See Countering Harmful Tax Practices More Effectively, Taking Into Account Transparency and Substance, the Organisation for Economic Cooperation and Development (OECD, 2014). Given how much U.S. workers have suffered over the last generation, anything that has the potential to reinvigorate manufacturing must be seriously considered.
The exact terms of a patent box will vary depending on what the drafter is trying to promote. For example, the tax preference could require that the profits be derived only from a patent secured in that country or that the patented product be the result of domestic R&D. I have suggested in prior articles that a patent box regime in the United States should include the following characteristics:
- A reduced tax rate of between 5 percent and 15 percent, compared with a regular tax rate of approximately 35% on corporate profits. This would allow the U.S. to compete with already-existing patent box regimes in China and the European Union. Otherwise, there is little incentive to locate the manufacturing within the U.S.
- A requirement that the patented product for which the corporation is electing to use the patent box be manufactured in the U.S. This is the cornerstone of any patent box regime. It ensures job creation and follow-on R&D. See Knight & G. Maragani (Fall 2013), supra.
- Apply only to patents issued by the USPTO. As a matter of patent policy, this helps to enhance the value of U.S. patents.
- No requirement that the patented product be the result of domestic R&D. This helps to promote the repatriation of foreign sited manufacturing to the U.S.
- Apply to all existing patents rather than only to patents issued after a particular date. This increases the immediate impact of the patent box.
- Apply to worldwide income attributable to the domestically produced patented product. This recognizes the global reach of many U.S. companies.
- Allowing deductions of losses and expenses attributable to the qualifying IP at the standard corporate income tax rate. This avoids penalizing companies that take risks when they commercialize IP. Innovation is risky and some inventions are not successful in the marketplace. This incentivizes companies to attempt to market their qualifying IP.
- Apply to a wide range of domestically manufactured patented products. For example, software should be eligible.
Provide the option for a company to use a standardized formula or develop its own method to determine its income from the domestically-produced patented product. Businesses must be able to determine with reasonable certainty what income will qualify for the patent box.
For a more detailed discussion of these characteristics, see B. Knight & G. Maragani, supra; See B. Knight & G. Maragani, As Part of Any New Patent Legislation, the New Congress Should Enact a Patent Box Regime to Bolster America’s Competitiveness for New Innovation and Increase Job Opportunities for the Middle Class, BNA Insights: Health :Law Resource Center (January 9, 2015).
Congressman Charles Boustany, Jr. (R-LA) and Congressman Richard E. Neal (D-MA) recently released a discussion draft of proposed legislation that would enact a patent box regime in the United States. Boustany’s press release states that “U.S.-based multinational corporations are under increasing pressure to move more innovative development and production activities offshore.” This is the product of lower production costs abroad, including lower foreign tax rates.
The Boustany-Neal draft legislation is called the “innovation box” and would impose an effective tax rate of 10% on all innovation box profits by creating a deduction equal to 71% of a corporate taxpayer’s innovation box profit. Simply stated, innovation box profit is gross receipts from the sale, lease or license of qualified IP property less the cost of goods sold and other expenses attributable to those receipts. One significant limitation in the availability of the deduction is that it is available only to the extent of domestic R&D expenditures to a company’s other defined costs. Consequently, a company with no domestic R&D would not be entitled to take advantage of the patent box. This is one difference with my proposed structure for a U.S. patent box regime. This limitation imposed by Boustany and Neal appears aimed at a concern in Europe with countries utilizing the patent box as a means of becoming a tax haven. Some believe that requiring R&D to be domestically sourced is a way to make certain that there is a sufficiently significant connection with the patent box country to justify the lower tax rate on innovation profits. Alex Parker highlights this concern in his article as an issue the Organization for Economic Co-operation and Development (OECD) is currently investigating, noting that the OECD will likely propose a similar R&D requirement in future policy recommendations. The draft bill also includes a provision that would enable a foreign subsidiary to repatriate appreciated intellectual property into the United States in a non-taxable event.
One of the tremendous advantages of a patent box regime, besides creating U.S. jobs and encouraging innovation, is that it should result in an immediate appreciation in the value of U.S. patents. Patents will be more valuable if the income derived from them is taxed at a much lower rate. The U.S. House of Representatives will be addressing international tax reforms this fall as part of a large tax overhaul effort. Congressman Paul Ryan (R-WI), who is the Chair of the House Ways and Means Committee, issued a press release praising the Boustany-Neal innovation box proposal and stating that it may be considered as part of the upcoming international tax reform.
The United States should consider a patent box regime as a component of any tax reform legislation in order to make American business more competitive, spur innovation and R&D, and enhance the value of U.S. patents.