The Growing Concern of Substance for IP Companies

post Saturday September 10, 2011

Tags: ip management, tax/transfer pricing

In May 2011, Transfer Pricing Associates published an article entitled, “IP Companies and Substance: No-Fly Zones?” that explores issues surrounding substance requirements in IP host countries and gives guidance on how to achieve a balanced risk-return.  The article begins by noting the importance of placing intellectual property in low tax jurisdictions as intellectual property normally represents 40 – 80% of a MNE’s value-added.  The realization of this fact by some tax jurisdictions has created a ‘race to the bottom’ in terms of tax rates and substance thresholds in order to attract more foreign investment and tax revenue.  To counteract this opportunistic behavior, however, tax authorities have introduced stricter substance requirements and/or Controlled Foreign Corporation (CFC) legislation.    

Effective Place of Management

In deciding how and in what jurisdiction to tax IP, tax authorities must determine whether the incorporation in one country differs from central management and control in another country.  If the facts and circumstances are at odds with the legal set-up, anti-abuse legislation provides for a substance over form approach.

Substance Requirements        

Typically, in order to legitimately transfer IP to a particular jurisdiction, the MNE must satisfy certain threshold substance requirements to prove that the entity is acting as both a pro?t centre and an investment centre.  Such requirements generally include:

• payroll requirements/Number of FTEs;
• minimum capital requirements;
• minimum revenue thresholds;
• minimum amount of investments/spending;
• reporting requirements; and
• requirements in relation to activities/number of activities.

Control over Risk

In determining an IP holding location, the entity deemed to be the owner of the IP also needs to be in control of the management of the IP and have the ?nancial capacity to bear the risk of decisions associated with investing in IP. With-out these critical elements being established, tax authorities will raise questions over the commercial substance of the arrangement.

Tips on Physical Presence of an IP Company’s Management Team

The article presents the following ‘rules of thumb’ for MNEs seeking to centralize IP in key locations:

• The Director should make decisions on behalf of the IP company when physically present in the country of residence of the IP company and business travel should not interrupt decision making;
• Ideally, the CFO should make decisions on behalf of the IP company while physically being present in the country of residence of the IP company (except for registration of IP in other countries), but when travelling or working abroad can make a decision on behalf of the IP company.
• IP registration/patent applications should be signed in the name of the IP company, though governing law and physical presence will depend on the requirements of the registration of?ce; and
• Key decision makers (i.e. Director, CFO and IP Lawyer) should not make decisions which are legally binding on the IP company when they are not physically present in the country of residence of the IP company, except when compliant with a written authorization process.

To access the full article, please visit http://www.tpa-global.com/PDF/Publications/TPA-IPcompanies.pdf

Leave your comment

Comments on 'The Growing Concern of Substance for IP Companies' (0)