The Proliferation Of Patent Boxes

What's In a Patent Box?

In addition to differences in the types of IP that can be the subject of the patent box tax incentives, the tax rates and other rules for asset inclusion can differ significantly between nations. How and when the IP was acquired can be a factor in determining whether the IP may be included in a patent box. Some regimes allow existing patents to be included within the patent box assets, while others do not. For example, the UK, Spain, France and Hungary all allow the inclusion of existing patents in the assets that are the subject of the patent box, while the Netherlands and Belgium do not. Id. The argument for exclusion of existing patents is that they are already developed and the remaining R&D activities surrounding the technology of those patents may be nearing its end. The IP owner could take advantage of the tax incentive without providing any return to the nation in the form of monetary or social improvements.

Likewise, nations differ on their willingness to provide tax incentives for patents purchased from third parties. China allows acquired patents to be within their tax incentives, while The Netherlands does not. Others, such as France and Belgium restrict the types of acquisitions that can be included, for example, to those that have been held for a period of years or those that have been improved in some way.

Embedded royalties is another area where nations differ. Some nations, such as Belgium and the UK, allow profits to be attributed to qualifying intellectual property either in the form of separate royalties or as a royalty embedded in the sales price of the product. Other countries, such as France and Spain, do not allow embedded royalties, so if a royalty will form part of a product price, neither France nor Spain would provide a sufficient incentive to cause someone to locate their IP assets in those countries.

While many companies have taken advantage of the reduced tax rate, there are consequences of getting a tax break in a foreign jurisdiction. To take advantage of the reduced tax rate, a company must transfer its IP assets to the foreign jurisdiction. This is most often done by setting up a holding company owned or controlled by the parent company in the foreign jurisdiction. For pre-existing IP assets this transfer must be an arm's length transaction and therefore is a taxable event. Depending upon the size of the IP portfolio, the transfer taxes could be burdensome.

Patent Boxes In Litigation

While some holding companies can provide exclusive position on the IP assets to the parent company, not all companies can do so. If the multi-national has more than one division, for example a parent and a sister company that needs access to the same IP rights, this can create difficulties in enforcement proceedings. In most instances, because holding companies are set up to obtain patent box treatment, they have no manufacturing or other profit driving activities. Therefore, when assets held by the patent box are the subject of third party actions, for example, patent litigation, these assets have limitations merely by virtue of their placement in the holding company.

First, patent litigation must be brought by the owner of the patent, so the holding company may be the only one with standing to file suit to enforce the IP assets. Next, since the holding company that owns the IP generates no profit, there is the potential that the parent company will be unable to claim lost profits and may be limited to a reasonable royalty.

Another problem that arises when assets are held in a foreign holding company is if the parent company is sued for patent infringement and wishes to file counterclaims against the plaintiff based on its own IP, it may be unable to do so since the IP assets are not currently owned by the parent company. So, in order for the parent company to raise a counterclaim, it must first transfer the asset back to itself from the IP holding company, which is another taxable event. Further, since the parent company just obtained the asset, it will be unable to seek lost profits for the period before the reassignment.

The U.S.'s Innovation Box

The U.S. has recently suggested an innovation box regime for the purpose of incentivizing U.S. companies and multi-nationals to keep their IP and R&D dollars in the United States. This innovation box regime could put the U.S. on par with the tax rate found in some countries such as the UK and The Netherlands.

The proposed innovation box could also overcome the issues discussed above regarding holding companies. Since the innovation box is a reduced tax rate on profits from IP, companies would no longer have a reason to transfer their IP assets to an extraterritorial holding company. Companies could reap the benefit of the reduced tax rate, without any transfer of title, thereby obviating the issues of standing to sue, claiming lost profits, and asset reassignment in the context of a counterclaim.

For anyone who has already moved assets into a foreign patent box, one proposal eliminates transfer taxes for repatriation of IP assets to the U.S. If this proposal is adopted, the biggest obstacle to dismantling a foreign patent box will be predominately administrative.

But will a U.S. innovation box really cause companies to move their assets to the U.S. or cause U.S. companies that have already moved their IP assets abroad to repatriate those assets? Given the significant variations that exist between the current patent boxes, it's unlikely that the U.S. innovation box will be a one size fits all solution. For some companies, it will be the right answer and from the IP side, it will make portfolio management much easier. For other companies, the answer still may lie in one of the foreign jurisdictions.

Lori-Ann Johnson is a shareholder at Chamberlain Hrdlicka in Atlanta. A former USPTO patent examiner, Johnson counsels clients with the value management of their portfolios, aligning IP strategies to meet business objectives. She may be reached at 404-658-5496 or by e-mail at [email protected].