Various tax jurisdictions have established preferential regimes in relation to the taxation of income from patents and intellectual property. Multinational groups have therefore been able to consider where intellectual property is held in order to mitigate their global tax liability.
Over time various anti-avoidance measures have been implemented to attempt to mitigate this position – both at a national level and in consequence of the Organisation for Economic Co-operation and Development (OECD). A brief overview of the key anti-avoidance measures is provided below.
UK Withholding Tax On Intellectual Property
Income tax at the basic rate must be withheld from most payments in respect of the use of patents and on royalties from intellectual property by a UK resident to a company outside of the UK. Although, exceptions arise when the payments are made in respect of works that have been exported from the UK for distribution outside the UK, or when a relevant double taxation agreement (DTA) applies.
Consideration for the complete sale of intellectual property represents the disposal of an asset, rather than a payment for its use. Under these circumstances, and subject to careful consideration of the relevant legislation and case law, the payments for the asset by a UK company is not subject to withholding tax.
Controlled Foreign Company (CFC) Rules
An overseas company holding intellectual property which is a subsidiary of a UK company may be regarded as a CFC, which can cause the profits of the subsidiary to be subject to taxation in the UK.
Base Erosion Profit Shifting (BEPS)
BEPS Article 6 was implemented to prevent ‘DTA shopping’, where an entity is created in a state for the purpose of obtaining benefits under the tax treaty, which would not be available directly to the individual or company.
For example an overseas company (co. A) making a loan to a UK company (Co. B) channels funds through a company in Luxembourg (Co. C) – if the loan interest were paid directly from A to B it would be subject to withholding tax, however the UK-Luxembourg DTA eliminates this charge there for the interest would have been paid from A to C then from C to A.
The BEPS rules seek to eliminate these arrangements by requiring that existing DTAs are amended to implement a limitations of benefits provision and principle purpose test.
Many crown dependencies, including the Channel Islands, have introduced new presence rules in response to the European Union’s recent threat to blacklist Jersey and Guernsey if they did not address concerns that their tax regimes facilitate offshore structures which attract profits without real economic activity.
The effect of the changes is to implement new economic substance requirements for companies that are resident in those locations. The rules require certain companies (including those holding intellectual property) to demonstrate that they have substance in the island by:
- Being directed and managed
- Conducting core income generating activities
- Showing that they have adequate people, premises and expenditure
When a company in a relevant sector cannot demonstrate whether it has adequate substance in the island during an accounting period it will be subject to sanctions including the exchange of information with competent authorities in other jurisdictions, financial penalties and, ultimately, striking off the companies register.