EU Research Paper Supports Modified Nexus Approach
The European Commission has released a working paper that looks at how significant the introduction of the modified nexus approach will be for the tax affairs of multinational companies that use patent box regimes
Entitled Patent Boxes Design, Patents Location, and Local R&D, the paper suggests “that in the majority of cases, the existence of a ‘patent box’ regime incentivizes multinationals to shift the location of their patents without a corresponding growth in the number of inventors or a shift of research activities.”
The paper further finds that “the size of the tax advantage is negatively correlated with the local R&D. This suggests that the effects of ‘patent boxes’ are mainly of a tax nature.”
The findings are significant as countries have agreed on the application of the “modified nexus approach” to determine a company’s eligibility to patent box tax incentives, under the OECD’s work on BEPS Action 5 on harmful tax practices. Under the proposed change, which countries that offer beneficial tax schemes for research and development activities would be required to adopt, a taxpayer would only be entitled to claim the tax benefits from an IP regime to the extent that it can show that it incurred the expenditures in that country on activities, such as research and development, that gave rise to IP income.
The paper said: “Recent debates on the potentially harmful consequences of ‘patent boxes’ have addressed the possibility to link the advantages of ‘patent boxes’ to the requirement of a real research activity in the country of the patent. Our results suggest that it has the potential to decrease the still dominant tax effects of ‘patent boxes’ on patent location and to raise the level of local inventorship. The ‘nexus’ approach hence offers some potential to mitigate the role of ‘patent boxes’ as new tax competition tools.”
“Patent boxes’ are found to exert a strong effect on attracting patents mostly due to the specific favorable tax treatment that they bring about. However, this effect varies across sectors and with the specific characteristics of the patents. High-quality patents are shown to be more influenced in their location choices by the tax advantage offered by ‘patent boxes’ than patents of lower quality.”
The paper adds: “The possibility to grant the ‘patent box’ tax regime to patents that have been acquired, were pre-existing, or contain embedded royalties, seems to make patent location even more sensitive to the tax advantages offered by ‘patent boxes.’ The same can be said for ‘patent boxes’ broadening their scope to other rights such as trademarks, design and models, copyrights, or domain names.”
The paper concludes: “‘Patent boxes’ are a relatively recent development in the tools offered to companies to boost R&D activities. They have been criticized for offering additional tax advantages to income already profiting from an intellectual property protection and having potentially little effects on the level of R&D. Their development has raised concerns over the fact that they could exert a significant effect on patent location without a change in real research activity, aiming only at the tax benefits. Our results confirm these fears, with the tax attractiveness of ‘patent boxes’ being larger the broader their scope.”
