|Introduction to tax and IP|
by Andrew Casley – PricewaterhouseCoopers LLP
“The schoolboy whips his taxed top – the beardless youth manages his taxed horse, with a taxed bridle, on a taxed road – and the dying Englishman, pouring his medicine, which has paid seven per cent, into a spoon that has paid fifteen per cent – flings himself back upon his chintz bed, which has paid twenty-two per cent – and expires in the arms of an apothecary who has paid a licence of a hundred pounds for the privilege of putting him to death.” Sydney Smith
It is always worth distinguishing between a system of taxation and taxation itself. Taxation has been with us for a very long time and the basics haven’t changed much: the Romans taxed the movement of goods, the profits of businesses and the property and income of individuals. But in the last 100 years, systems of taxation have been growing increasingly refined and pervasive. In addition to customs and excise taxes, we now tax the provision of goods and services (value added taxes, sales and use taxes), we measure business profits rather better than the Romans did and our methods of collecting taxes on individual income are very much more sophisticated. We also tax the flow of funds (dividends, interest) and the accumulation of funds (wealth or capital taxes).
One huge development in systems of taxation is the use of tax as an instrument of policy. We apply special taxes to things we want to discourage (tobacco, the use of fossil fuels) and we provide relief (allowances, credits and exemptions) for things we want to encourage (capital expenditure, pensions).
A great web of bilateral tax treaties between countries governs the right to tax, the allocation of income and profits, the provision of credits and in certain circumstances allows governments the right to decide among themselves how much tax will be charged. The OECD has a Committee on Fiscal Affairs under which more or less permanent working parties steer the evolution of this web and the way in which the concepts used are to be interpreted and applied.
It would be very surprising if intellectual property managed to escape this broad net. It rarely does. From tax credits for research and development (R&D), through allowances for intellectual property assets and withholding taxes or VAT on royalties to capital gains taxes on disposals, the whole cycle of intellectual property creation and use is affected by our systems of taxation. The problem, as the Romans discovered with the taxation of business profits, lies in two areas: identifying the person and measuring the value. How much was actually spent on R&D? Who spent it? Who owns the intellectual property being used? Was it sold or licensed? What is it worth?
These are all areas of tension between taxpayers and taxing authorities – a tension exacerbated by the inherent difficulty of measuring something that is, by definition, intangible. The Roman solutions to the same tension in business profits, until the Emperor Constantine abolished them, were imprisonment and torture. Today we use accounting and valuation. Unkind people have been known to draw unflattering parallels.
The tensions today are, if anything, worse because the creation and use of intellectual property within a multinational group are generally poorly measured and difficult to track. This is the subject of the next chapter, which also highlights some of the specific tensions by reference to recent tax cases reported in various parts of the world.
A responsible approach to tax on intellectual property is about three things: complying with your obligations; paying what you should without overpaying; and taking the relief that is available. The following chapters provide some insight into these areas, dealing with transfer pricing, tax valuation as it affects the transfer or use of intellectual property and R&D credits.
The point about systems is that they can be understood, applied and dealt with. One of the best ways to deal with tax systems is to have a system of your own to deal with them. Call this a policy. Then the people that apply the policy – the managers, the lawyers, and the business people, do not need to know the detail of how something is taxed, the rates that apply or the minutiae of why the policy works. They can get on with their jobs.
For intellectual property within a multinational group the issues can be complex but the policies can be relatively straightforward. “We deal with R&D so; marketing expenditure is treated thus; and the use of intellectual property is covered in this or that way.” Consistency of treatment reduces administration and is attractive to tax authorities, it helps make things easier to explain.
Properly prepared, a good policy will link into other areas such as the legal department – “patents and trademarks are registered by this or that company which licenses their use”; and will match the commercial operations of the group – “R&D budgets are agreed by these people and the costs are charged on such and such a basis.” Exceptionally, but growing more common, policies will take disclosure requirements into account to ensure that what is reported for financial and fiscal purposes draws on the same information systems.
All of this requires a degree of discipline, some foresight and a willingness to tackle what has always been recognised as a difficult area. As reporting requirements become more detailed, the additional visibility and transparency that brings to the area of intellectual property make it more likely that the effort required will be repaid in terms of managing tax audits, fewer tax adjustments or less interest and penalties. As the next chapter shows, good policies are no guarantee of an easy ride but they serve to smooth the road, reduce the cost and increase the chances of winning.
In short, there is an answer to the rather daunting picture painted at the beginning of this chapter. It depends on being prepared, on recognising intellectual property for what it is – an integral part of the value chain for most businesses – and building a policy around that.
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