Secrets — Tax authorities worldwide are slowly but surely bringing new tax laws into force which should stop or at least reduce certain tax-minimizing behaviors by multinationals related to the management of intellectual property assets, such as trade secrets. As Secrets has previously explored, the times they are a changin’ at least on the tax front.
This short paper explains a little at a very high level how multinationals have used intangible assets and intellectual property and associated structures for aggressive tax avoidance purposes. There are, of course, many valid reasons to establish an IP holding company, apart from the tax reasons discussed here.
BEPS (Base Erosion & Profit Shifting)
Base erosion and profit shifting (BEPS) refers to tax avoidance strategies by multinational companies that basically exploit differences in tax rules between different jurisdictions to artificially shift profits to low or no-tax locations.
Multinational companies have long had complicated tax structures, many of which are entwined with the innovative assignment of intangible assets and intellectual property and the use of IP holding companies in these low or no-tax locations.
Intangible Assets & Intellectual Property
An intangible asset is an asset that is not physical in nature. It includes items such as patents, trademarks, copyrights, designs, domain names, social media handles, know-how, trade secrets, data, business methodologies as well as goodwill and brand recognition.
Intangible assets exist in opposition to tangible assets which include land, buildings, vehicles, equipment, inventory, stocks, bonds and cash.
A subset of intangible assets, known as legal intangibles, can be formally protected through intellectual property rights such as patents and trademarks.
However, this is not the case with other intangible assets such as trade secrets, know how, training systems and business methods, technical processes, customer database, distribution networks, etc. These assets may be equally or even more valuable but substantially more difficult to identify and valuate.
IP Holding Companies
An IP holding company exists to hold the intangible assets and the intellectual property rights on behalf of the multinational. The IP holding company does not itself necessarily manufacture products or supply services based upon the IP held.
Given the intangible nature of intangible assets, it is relatively easy to establish an IP holding company and move the intangible assets into that entity wherever it is located.
The IP holding company then grant licenses to use that IP it holds back to the different operating companies within that multinational.
Aggressive IP-Based Tax Avoidance Schemes
Tax avoidance techniques for multinational companies are generally all about location. Such techniques are all about where a company chooses to open offices and create subsidiaries, and where it chooses to allocate its profits and expenses.
Aggressive tax avoidance schemes using intangible assets typically involves three elements.
One: Establish an IP holding company and locate it in a low or no-tax location. Transfer the intangible assets from across the multinational company into that IP holding company.
Two: Have the IP holding company grant licenses to those intangible assets and IP it now possesses back to the operating companies within the multinational. Many of these operating companies within the multinational company will be located in high tax jurisdictions but with good rates of tax relief.
Three: Set up the terms and conditions and especially the fee and fee structure within these inter-group licenses to maximize the tax benefits to all of the companies involved. Ignore arms-length arrangements and instead work to ensure that the IP holding company generates lots of profit while the operating companies have lots of expenses.
The New OECD BEPS Rules
We have previously discussed the new OECD BEPS rules that are likely to come into force worldwide in the next few years.
These rules alter current practice in one simple but fundamental manner. Current multinational tax practice is conducted primarily on the basis of paper agreements signed between multinationals and their various subsidiaries. Thus, current regulations are complied with – on paper.
The new OECD rules shift tax treatment from an assessment of these paper transactions to the concept of genuine arm’s length transactions. In other words, would the parties have actually concluded such an agreement if they were truly separate entities? Put in this light, many of the current inter-company agreements would probably not pass muster.
Hazel Helps Companies Identify Rank & Protect Their Trade Secrets
The Hazel Trade Secret Asset Management System may help your company manage its trade secrets and trade secret processes. Hazel can keep track of your corporate trade secrets and help you determine an appropriate level of protection for each trade secret recorded. Hazel can record who in your organization is responsible for a given trade secret, who is responsible for protecting the trade secret, and who has access to the trade secret, among other things. Hazel can also help with tax issues by noting where a trade secret asset is legally held and what agreements pertain to it. Contact the Hazel Team today to learn more.
For Secrets, I’m Donal O’Connell.
Cover by Pieter Brueghel the Younger – Bonhams, Public Domain, Link
The trickster by https://upload.wikimedia.org/wikipedia/commons/0/04/Zacharie_Noterman_-_The_trickster.jpg
Tax collector by Anonymous – Hausbuch der Mendelschen Zwölfbrüderstiftung, Band 1. Nürnberg 1426–1549. Stadtbibliothek Nürnberg, Amb. 317.2°, via http://www.nuernberger-hausbuecher.de/, Public Domain, Link