Australia must break the shackles of intellectual property in FTAs

Last week some of Australia’s biggest and richest companies voluntarily fronted up to a senate inquiry on corporate tax avoidance.

Bigwigs from big brands, including Apple, Google, Microsoft, Rio Tinto, BHP Billiton and Fortescue Metals, squirmed under the spotlight as they were grilled about how they (legally) shift profits offshore to avoid paying tax here.

Clearly more needs to be done to improve Australia’s current tax laws and the workings of the Australian Taxation Office.

However, missing from the current debate (and moral outrage) on multinationals and tax is how intellectual property functions as a double-edged sword against consumers.

Today, multinational companies use patents, copyrights, trademarks and other legal privileges to extract profit from consumers, pushing states to police consumer behaviour on their behalf (as in the case of criminalising downloading). At the same time, multinationals also use these legal privileges to avoid paying taxes on their profits.

The global profit-shifting games are underpinned by long-standing rules in the trade, intellectual property and tax regimes.

Back in the 1980s, a small group of incumbent United States and European Union multinationals drafted a set of rules for intellectual property that ended up in the World Trade Organisation. Known as the Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS) and binding on all WTO members, it contains an important rule: any free trade agreements following TRIPS cannot set lower standards of protection for intellectual property, and where one WTO member grants more of these privileges to another state it must grant them to all WTO members.

Each new FTA has in turn a rule about not being able to go backwards on intellectual property. This creates a huge incentive for multinationals to push for the inclusion of intellectual property in FTAs.

The US and EU lead this bilateral agenda because their efforts to do so in the WTO have been blocked by Brazil, India, China and South Africa. In effect, each FTA increases the taxing privileges of intellectual property owners. FTAs that, for example, increase patent or copyright terms mean more private taxes can be collected in the form of fees and royalties.

The problem is that the ownership of intangible assets (including movies, music and patents on medicines) can be easily moved around. This is because intellectual property assets exist as electronic documents. A report by JPMorgan in 2012 pointed out that many multinationals had centralised their key intellectual property assets using offshore subsidiaries located in tax jurisdictions such as Bermuda, Cayman Islands, Ireland and Singapore. The spread of intellectual property rules to virtually all of the world’s jurisdictions, along with bilateral tax treaties means multinationals have lots of options about routes and combinations of intellectual property assets.

Basically, the parent company develops the intellectual property – not much research and development takes place in tax havens like the Cayman Islands – and then through a subsidiary locates some or all the intellectual property rights in a jurisdiction that best fits the parent company’s tax strategy. It may also be made to look as if the subsidiary has contributed to the cost of developing the intellectual property.

The subsidiary, operating as an assignee or licensee of the intellectual property, generates income through a re-licensing strategy that is carefully planned by its parent company and that fits with the parent’s global production and supply chain needs.

In theory these kinds of intra-company transfers of assets should be subject to arms-length pricing. But in practice tax offices have had trouble following these arrangements, let alone finding ways to price these kinds of asset transfers. It is not a case of, for example, one patent, one technology. Multinationals apply for hundreds or thousands of patents each year, surrounding particular technologies with patents.

Information technology companies like Microsoft and Google have come in for public criticism for this behaviour, but all multinationals are playing the same game. Patents have become an integral part of a win-win game for pharmaceutical companies in which they obtain high prices for their patented medicines, but use patents to shift their profits into tax havens.

What is to be done? While seeking the co-operation of other states through the OECD and the G20 is one option, Australia should also consider unilateral action. The incentives to fix the problem through international co-operation vary. The incentive for the US is to let its multinationals use intellectual property to extract profits from consumers around the world and fix up the problems in its tax code to make sure it captures more of this corporate income.

For countries like Australia avoiding intellectual property chapters in FTAs that increase the private taxing power of multinationals is one option. Certainly, Australia should implement the recommendation of the Harper Competition Policy Review (2015) that “an independent and transparent analysis of the costs and benefits” be undertaken of intellectual property in any new trade agreements.

Each country can invest more in definitional games around transfer pricing rules, but in a legal arms race the multinationals will likely win. One might look at the possibility of some simple rules such as deeming rules that render ineffectual transfers of intellectual property for tax purposes.

The tax advisers who draft intellectual property licensing strategies for multinationals have created fictions. It is a fiction to say that the research and development of intellectual property by high technology multinationals occurs in places like Puerto Rico or the Cayman Islands. It is also a fiction to say that billions of dollars of income are earned in these places.

There is no reason why these fictions cannot be deemed away.