Domiciliation of Intellectual Property

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When trying to understand the motivation behind the choice of jurisdiction in which companies wish to exist and operate, we may need to look further than the obvious reasons. As Tamás Szabados puts it, the answer to the question on such motivation is simple: „It depends”[1].

Indeed it depends on many factors: legal, economic, personal reasons may shape such decision making, in an ever more connected world, where physical presence is almost a non-issue. In the era of internet based service, the notion of good old corporate status becomes less and less important. In practise however, favourable economic environments will always attract business, the Litmus test of which will always be the given tax system of that country.

Despite the globalising world, a growing legislative focus is being put on the actual domiciliation of corporate entities. Not only the European Union, but the US and other Organization for Economic Co-operation and Development (OECD) countries remain trusted opinion leaders and are kingmakers par excellence as to which jurisdiction is considered acceptable and which is black listed. Such ranking is based almost exclusively on taxation matters, which are still under the sovereign competence of individual countries.

As for the ever harmonising EU the same can be said: no pan-European tax system is yet imposed, as all Member States keep that monopole for themselves. It is not surprising therefore, that EU companies are often on the search for a more attractive tax residence within the Union. Such migratory movement of corporate entities between the Member States of the EU however, is also subject to complex rules, in the absence of codified law, based mainly on jurisprudence.

In one of the earliest cases of EU case law, that of the Daily Mail[2], the UK tax authority imposed “exit rules” for the corporation by restricting their relocation to the Netherlands, where the company wanted to benefit from more advantageous tax rules. Governments and their tax authorities never like to let go of well-paying customers.

Whether the Daily Mail, or other verdicts in later similar cases, which in many instances have been over-written by history, are contrary to the Articles of 49 and 54 of TFEU on the Freedom of Establishment, is not the question we intend to look at in this tour d’horizon.

What we wish to examine, is a very special type of company: let’s call them the SPVs. From the outset these are identically set up to any other corporation – irrelevant of the form of corporation – differing only in their actual activity: the management of intellectual properties. These Special Purpose Vehicles own or manage under assignments or complex license agreements very specific assets, sometimes the entire oeuvre of a creator or just a single element of it. In other cases they domicile among others the full spectrum of patents of market leading drug companies, IT technology rights, trademarks and manufacturing know-hows. In the European Union many awarded subsidies for film production or other cultural development are required by law to be segregated into such SPVs or Project Corporations in order to protect the state investment in the creation of intellectual property ‘goods’.[3]

Today, over 40% of the market value of American companies is intellectual capital[4]. Similar numbers are true for the EU and Japan. Hence it is a major priority for every economy in the world to have a firm grip on these assets, through corporate laws, taxation laws or Double Taxation Treaties between numerous countries. On the opposite side we have the creators, owners and their heirs as the ultimate beneficiaries of such intellectual properties, who wish to keep these assets safely away from the tax collector or the ripple effects of our volatile economies.

Such personal worries are not new. As early as 1841, when Alphonse de Lamartine, the politician, who later in 1848 proclaimed the Second Republic in France, presented his concept of a bill on literary property as it defined intellectual property at the time, stirred up a heated parliamentary debate, one that is still remembered today. Mainly trying to define the ownership notion of intellectual property versus conventional property, the debate soon evolved around how to keep the debt collectors, divorced wives and taxmen away from the poor creators, their families and possibly heirs.[5]

Not much has changed in a few generations: authors and creators want to protect the creations of their minds, corporations the intellectual goods they have researched and developed at substantial cost for decades. Such protection should include the economic proceeds as well, bien entendu! The first step then is to segregate intellectual property goods into corporations, which enjoy a certain protection by the mere fact that responsibilities are limited.

In the relentless search for higher profits and lower taxes, companies have learnt as a second step, in an era of one economic crisis after the other, to creatively find alternative solutions to their ‘existence’ among the accounting standards and rules, thus being within the perimeter of legality, regardless of their ‘nationality’.

That being so, is the much talked about cross-border migration and/or conversion of companies still really essential? If other methods of legal existence permit tax efficient operation, does the actual domicile of a company really matter? Especially when the activity of that company is the world-wide exploitation of intellectual property, making it difficult to connect to any single jurisdiction in particular? When looking at the legal connecting factors, do the nationalities of the ultimate natural person beneficiaries of a company, still matter, something which was an important issue in the Centros[6] case?

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So called ‘Profit-shifting’ between the mother companies and their subsidiaries anywhere in the world has increased even as corporate tax rates have fallen in OECD countries, from an average of 32.6% in 2000 to 25.4% in 2011.[7] In America corporate profits as a share of GDP have been at record levels in recent years, but the corporate tax take as a proportion of federal revenues has been near historic lows.

‘Transfer pricing’ also allows substantial room for maneuver between mother and subsidiary, becoming an essential tool in corporate entities tax planning. Many carefully chosen domiciles for subsidiaries are essentially shell companies or SPVs, which exist only to hold intellectual property rights and charge other parts of the group for their use or provide other “services” at above-market rates.

The end result is that there is little connection between where the economic activity takes place, where the company is incorporated and where the profits are booked from an accounting and taxation standpoint.

The heart of the problem is that tax regulation has failed to keep pace with business as it has globalized overnight. The main pillars of the international tax system were built nearly a century ago. It’s a system, which treats multinational companies as if they were loose collections of separate entities operating in different jurisdictions, giving companies huge scope to move income around the world to minimize their tax liabilities. Cross-border corporate taxation is fiendishly complex, the lobbying around it furious.

The ability to shift profits to low-tax countries by locating intellectual property in them, which is then licensed to related businesses in high-tax countries, is often assumed to be the preserve of high-tech IT, drug companies or music and film production corporations. Yet the famous coffee company Starbucks demonstrates, that current tax rules make it easy for all sorts of firms to generate what Edward D. Klein[8] calls “stateless income”: profit subject to tax in a jurisdiction that is neither the location of the factors of production, which generates the income, nor where the parent firm is domiciled.

In Starbucks’s case, the firm has in effect turned the process of making an expensive cup of coffee into intellectual property.

A similar set-up was used by SABMiller, a giant brewer, through a variety of devices, including holding valuable trademarks for African beers in low-tax European countries. The Rolling Stones musical oeuvre is managed through Dutch companies, so was the Maurice Ravel estate until it became public domain. Ikea, the well-known furniture supplier is actually a Dutch non-profit foundation. Many of the world’s multinational corporations, like Coca-Cola, Nike, Gucci have set up holding companies in the Netherlands to take advantage of tax shelters nearly identical to the ones that the Rolling Stones and U2 use, structured on the exploitation of intellectual properties. Entertainment companies and others that benefit handsomely from the Dutch shelters include EMI, the giant record label, and CKX Inc., the entertainment company which owns stakes in “American Idol”, the Elvis Presley estate and the soccer pin-up idol David Beckham.

The Netherlands is home to almost 20,000 “mailbox companies,” Dutch shorthand for corporate SPVs or shells set up by foreign companies and wealthy foreigners who use them to relieve taxes on royalties and patents, according to the Centre for Research on Multinational Corporations (SOMO)[9].

The cross-border tax system has become so complex that a completely new approach is needed. One intriguing proposal, unitary taxation, would aim to tax activities where they actually occur, not where some tax adviser has shifted them. Agreeing on where exactly business takes place in a world of services and intangible assets is tricky. Looking at the domiciliation of the corporation does not always help either.

Bono may front one of the world’s most popular rock bands, but the U2 singer did not earn many new fans among legislators when he defended Ireland’s controversial tax policies, known as the “Double Irish”, which allows companies to shift their profits from high-tax countries to havens typically used for transferring royalty payments for intellectual properties.

Ireland is now under pressure from America, the OECD and the European Commission to re-regulate its tax rules, especially after the Apple case[10], in which investigators from America’s Senate accused the company of using “stateless” subsidiaries for their tax arrangements, which are now being probed by European Commission, suspecting they could even amount to illegal state aid.

Dublin however, wants to keep its customers happy, specifically those many foreign firms, who moved to Ireland mainly for its flexible tax policies and regulation. On the same day it sounded the death knell for the Double Irish, it handed corporate tax planners a new tool: a “knowledge development box” that will allow companies to pay a lower rate on profits from intellectual property booked in Ireland[11].

The question to ask is whether the harmonization of world-wide corporate laws on company domiciliation or harmonization of universal tax rules should have priority on the legislative agenda. Should we redefine the purpose of company domiciliation in light of tax-law?

Can the legislator ultimately stop the creativity of the human mind, not in creating intellectual property, but in keeping it safely locked away somewhere in the world; not least from the taxman.

 

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