Governments around the world are grappling with the question of how to tax the income from intellectual property. One of the key issues is that firms can and do locate such income offshore in lower-tax jurisdictions as a means to reduce tax liability, leading to a potential erosion of a government’s tax base.
In response to these concerns a number of European countries have announced or introduced a sharply reduced rate of corporation tax for the income derived from patents – called a "Patent Box" (because there is a box to tick on the tax reform form).
- In 2007 the Netherlands and Belgium were the first countries to offer the tax break, followed by Luxembourg and Spain in 2008.
The exact details of the policies vary across countries, but the impact of all of them is to reduce the rate of tax on income related to the exploitation of patents.
- In 2010 the Netherlands made significant modifications to their scheme to make it more attractive.
They widened the policy to an Innovation Box which encompasses a broader class of intellectual property, has no limit on the amount of income that can be included and offers an effective tax rate of 5% – the lowest Patent Box rate available.
- The UK government announced in 2009 that it will introduce a Patent Box at a rate of 10% in 2013.
Yet before legislation for the policy has even been written, there have been moves to make the policy even more generous. The latest round of an ongoing government consultation announced that the UK Patent Box will be extended to all existing patents (not only newly granted or commercialised patents) (HM Treasury and HM Revenue and Customs 2011).
This is starting to look like an intensification of tax competition between EU countries. A handful of governments have designed policies to attract and retain intellectual property. If firms respond by moving real activities or taxable income, then this has costs for other governments, who may themselves now consider instituting their own Patent Box to prevent firms moving activity offshore.
Competition to what end?
The UK government estimates that the Patent Box will lead to a revenue loss of £1.1 billion a year when fully introduced (HM Treasury 2010). This is a significant amount, especially in the current climate of austerity; £1.1 billion is over a third of the UK Government’s total science budget (which was £3.2 billion in 2010-11).
In recent research together with Martin O’Connell (Griffith et al. 2011), we show that the introduction of Patent Boxes in the Benelux countries is likely to reduce the share of new patents held in the UK by approximately 30%. The additional introduction of a UK Patent Box would more than double the UK’s share of new patent holdings, more than offsetting this reduction. However, UK revenue from patent income is predicted to fall substantially, because the lower rate of tax more than offsets the higher number of patents.
Our research suggests that the same holds for the Benelux countries – despite attracting more activity, revenues from patent income are reduced. The results of this process of tax competition, in which governments introduce Patent Boxes, will be to lower tax revenues for all governments. The question is what benefits will it bring?
These calculations do not incorporate how UK government revenue would evolve in the absence of a Patent Box, given that other countries may go on to introduce similar policies. That is, in a world in which, say most European countries are expected to introduce some form of a Patent Box, it is possible that tax revenues would fall even more if the UK did not introduce the Patent Box.
The calculations also omit any of the possible benefits (over and above tax revenue) associated with operating a Patent Box. In particular, the Patent Box might attract not only income but also real activity, or discourage firms from leaving the UK. Indeed, one of the publically announced motivations behind introducing a Patent Box has been the desire to attract innovation and to strengthen the incentives to invest in developing and commercialising patented technologies.
This could increase the level of high-skilled activity taking place in the UK and potentially boost general corporate tax revenues. However, the extent to which the Patent Box will be successful in incentivising real activity to take place in the UK is highly uncertain, not least of all because the research underlying the creation of a patentable technology need not have been undertaken in the same country where the intellectual property is held for tax purposes; European law prohibits criteria which favour research undertaken in European one country over another (see Griffith and Miller 2010 for a discussion).
Better off cooperating?
The EU, via the EU Code of Conduct on business taxation, has been active in discouraging policies which are thought to open the possibility of harmful tax competition between EU countries. The commission has considered whether a Patent Box falls foul of rules on state aid, but is not objecting to their operation in principle. However, it is not clear that EU countries are better off in a world where they compete to attract intellectual property relative to one where there is some level of cooperation. In particular, there may be gains to European countries from coordinating tax setting if the income derived from intellectual property, which is seen as mobile from the point of view of an individual country, is less mobile between the block of EU countries and the rest of the world.
Relieving pressure on the main rate
Patent Boxes may have a positive effect on government revenues in the longer term through a more indirect channel. It has long been noted that mobile income, such as that derived from patents, exerts downward pressure on the main rate of corporate tax (see surveys in Wilson 1999 and Fuest et al. 2005); governments reduce corporate tax rates in a bid to remain a competitive location for mobile activities. Devereux et al. (2008) provide evidence that tax competition largely explains the downward trend in OECD countries’ statutory corporate tax rates in the 1980s and 1990s.
The Mirrlees review from the London-based Institute for Fiscal Studies noted that, in principle, it would be efficient to tax mobile activities at a lower rate than those which are relatively immobile – this would allow a higher rate of corporation tax to be supported on less mobile (location-specific) economic profits, while using a lower rate to reduce the deterrence to mobile income (Mirrlees et. al. 2011). Explicitly setting a different rate for mobile income carries considerable implementation difficulties, has been rare in practice and is explicitly discouraged by international agreements (including OECD initiatives on harmful tax competition). However, seen in this light, Patent Boxes may allow governments to maintain a higher tax rate, and therefore collect more revenue from other, less mobile, forms of corporate income than would otherwise be the case.
Devereux, M, B Lockwood, M Redoano, (2008), “Do countries compete over corporate tax rates?”, Journal of Public Economics, 92, 1210-1235.
Fuest, C, B Huber, J Mintz (2005), “Capital mobility and tax competition: a survey”, Foundations and Trends in Microeconomics, 1:1-62
Griffith, R and H Miller (2010), “Support for research and innovation”, in R Chote, C Emmerson, and J Shaw (eds.), The IFS Green Budget: February 2010, IFS Commentary 112.
Griffith, R, H Miller, and M O'Connell (2011), “Corporate taxes and the location of intellectual property”, CEPR Discussion Paper 8424
HM Treasury (2010), Budget 2010, June.
HM Treasury and HM Revenue and Customs (2011), Consultation on the Patent Box, June.
Mirrlees, J , S Adam, T Besley, R Blundell, S Bond, R Chote, M Gammie, P Johnson, G Myles, and J Poterba, (2011), Tax by Design: The Mirrlees Review, Oxford University Press for IFS.
Wilson, JD (1999), “Theories of tax competition”, National Tax Journal, 52:269-304.