By John Gimigliano, Principal in Charge, Federal Legislative & Regulatory Services, Washington National Tax, KPMG LLP
Jun 30, 2017
From the Tax Governance Institute
As Congress explores new options for tax reform, the so-called “innovation box”—first introduced in 2015 by Ways and Means members, Charles Boustany (R-LA, retired), and Richard Neal (D-MA)—could play a central role.
The concept of the innovation box—also referred to as patent box or intellectual property (IP) box—is to apply a preferential tax rate to income derived from certain intangibles. The rationales behind the concept include:
- Intangible-related income tends to be highly mobile, making it easy for IP owners to locate IP and source income in low-tax jurisdictions. Lowering taxes on this income will encourage them to keep these intangibles, and their income, in the United States.
- Research and development activities associated with creation of IP are highly desirable, and tax incentives would encourage the location of those activities here.
Building a better (innovation) box
We wrote about the innovation box idea when it was first proposed. A key sticking point for the original Boustany-Neal proposal was that it was both expensive and not particularly effective. Congressional revenue estimators found that the bill would cost several hundred billion in lost revenue over the 10-year budget window. And the way it was structured didn’t sufficiently reward innovators or encourage domestic R&D.
Interest in the innovation box concept faded as the Ways and Means Committee focused on a different approach that ultimately became the House Blueprint. But today the innovation box concept is getting another look as many in Congress seem to be gravitating toward a minimum tax on foreign earnings as part of an overall tax reform plan. (For more details, see Tracking Tax Reform, The ball is in the Senate’s court?)
A potential problem is that if the foreign minimum tax rate is significantly lower than the overall corporate rate, taxpayers would still have an incentive to move mobile IP-related income out of the United States and into the lower tax foreign jurisdictions. This leaves Congress with the challenge of developing a new anti-base erosion mechanism that can be coupled with a foreign minimum tax. Some possible options:
- A more effective innovation box regime: Unfortunately, “more effective” means more generous tax incentives for innovators. So it may be even more expensive than the original innovation box proposal, a difficult trade-off in the context of revenue neutral reform.
- A virtual innovation box approach: This would apply a tax rate on domestic intangible income equal to the foreign minimum tax rate (similar to what was done in the 2014 Tax Reform Act). This would theoretically provide a level playing field. But the current Congress may prefer one tilted in favor of domestic investment.
- A modified BAT: The original border adjusted tax (BAT) was the ultimate carrot (0 percent tax rate on exports) and stick (no deduction for imports) approach. But the BAT ran into major opposition from parts of the business community and in Congress. Modifying the BAT by limiting it to intangible income alone could give the Senate its minimum tax and the House a partial implementation of its BAT.
Each of these approaches has its own set of complications, and there’s no guarantee that Congress will adopt any of them. But we can assume that Congress will be considering all of these problems over the summer.
This article represents the views of the author only, and does not necessarily represent the views or professional advice of KPMG LLP.
The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.