When it comes to assets, perhaps none are more mobile than intellectual property. Patents, copyrights, trademarks and other so-called “intangible” assets bring tremendous value to the corporations that own them, but they don’t exist in a physical form, making them easy to move from one country to another. For decades, U.S. corporations have taken advantage of this mobility to move their IP assets to jurisdictions with lower tax rates, such as Ireland and Luxembourg.
But last year’s Tax Cuts and Jobs Act included provisions to incentivize U.S. companies to change their approach to IP. The corporate tax rate under the act dropped from 35 percent to 21 percent, but the tax rate on foreign profits generated by IP assets owned by U.S. companies—known as foreign-derived intangible income, or FDII—is subject to an even lower rate: 13.125 percent. Under the law, that rate will remain in effect until 2026.
“If you have a U.S. company that owns the IP and exploits it by selling products or licensing the IP to foreign customers, subject to certain limitations, you can get the reduced rate,” explained Natan Leyva, a V&E partner whose practice focuses on international tax planning. “It’s an additional carrot the government put in to either keep IP in the U.S. or, if companies have moved IP offshore, to bring it back.”
But with the carrot comes a stick. Previously, U.S. companies that owned foreign IP in offshore subsidiaries could generally defer U.S. tax indefinitely on the income generated by that IP—at least until that income was repatriated via distributions or loans to the U.S. parent company. However, now U.S. companies that continue to house foreign IP assets offshore will be subject to a new U.S. tax on income generated by those assets, whether they repatriate that income or not. This new global intangible low-taxed income, or GILTI, regime will subject foreign earnings that exceed a certain threshold to a minimum tax rate of 10.5 percent.
“It makes it even less attractive to keep your IP offshore,” Leyva said.
For many companies, these tax changes come as a relief. As easy as it may be to move IP assets offshore, it can be cumbersome and costly to meet a country’s requirements for housing those assets, which typically entail setting up an office or entity in that country. Nor do corporations relish having to regularly fly their U.S.-based employees to those jurisdictions to take care of business.
“In some jurisdictions, much of the tax savings may be lost due to high foreign registration and filing fees and other local compliance costs,” says V&E tax partner David Cole. “A lot of people who set these structures up found them to be more expensive than they thought and an on-going administrative headache.”
Nevertheless, the decision to move IP assets back to the U.S. isn’t exactly a no-brainer. Companies seriously considering such a step should keep the following five things in mind:
- The current FDII rate won’t last forever: As noted earlier, the 13.125 percent rate on profits from IP assets will expire in 2026. After that, the rate will increase to just over 16.4 percent. If congressional policy preferences change, that rate, along with the general corporate tax rate, could rise again. “If there’s a change in political governance or increased revenue pressure, the rate could creep up,” Leyva said.
- Transferring IP assets could trigger new costs: Countries may levy taxes on corporations seeking to move their IP assets out, what’s commonly known as a “toll charge.” The tax could be based, for instance, on the built-in gain in the assets at the time of the transfer. A government could say, “That asset’s value exceeds its basis and there’s a certain amount of gain,” Leyva explained. “If you were to sell it to somebody else, that gain that would be taxable in our country, so we’re not going to let that gain escape our tax system by letting you remove the asset with no tax cost.” Further, depending on the method of transferring the IP back to the United States, that gain could also be subject to U.S. tax at the time of the IP transfer.
- Transfer pricing disputes may arise: In order to levy a toll charge on an IP asset, the taxing authority in a country must determine that asset’s current value . . . and it may not take the corporate owner’s word for it. The government may hire its own expert to assess the asset’s value, and that person’s findings might not match the corporation’s own assessment. Such disputes, Cole said, frequently end up in court or in government-to-government proceedings known as “competent authority.”
- Tax benefits may be lost if associated tangible assets are moved: In some cases, a company may decide to move an IP asset to the U.S. and also move or build a physical asset in the same location. Imagine, for instance, a company that moved medical device patents to the U.S. and also built a manufacturing plant domestically. Income generated by the plant would be subject to the 21 percent corporate tax rate instead of the 13.125 percent FDII rate. If, however, the plant was built offshore, a new change under the Tax Cuts and Jobs Act allows a 10% return on the plant’s depreciable assets to permanently escape U.S. tax—even when that income is repatriated to the United States. That means a company may still find it less expensive to house its plants outside the U.S., when possible.
- Going abroad in the future could also trigger toll charges: “One point to consider is what happens if you bring your IP back to the U.S. and then the world changes yet again,” notes Cole. While U.S. tax rates may rise in the years to come, it’s possible that tax rates in other countries could decline. Rates could drop low enough to tempt corporations to return IP assets to those offshore jurisdictions. But doing so could leave companies open to U.S. toll charges, as well as transfer pricing disputes.
Once a company has determined that it does make sense to move IP assets back to the U.S., it will have to be meticulous in planning those transfers, not only to minimize transfer pricing disputes but also to ensure that it is eligible for the FDII tax rate.
“You want to be very careful in how you structure your operations so that you don’t inadvertently lose the ability to get the lower rate,” Leyva said. “You either get the rate or you don’t. There is no middle ground.”