Talks Under Way to Add Patent Box to U.S. Tax Code

Some businesses would win, some would lose, under proposals lawmakers are drafting to impose a lower tax rate on income generated from intellectual property housed in the U.S.

U.S. lawmakers are exploring a new corporate tax break that would benefit companies already adept at avoiding taxes.

The idea—known as a patent box or innovation box—would impose a lower tax rate on income generated from patents and other intellectual property housed in the U.S. This would aid technology and pharmaceutical companies trying to maintain low tax rates that they’ve achieved by booking income in overseas tax havens.

The so-called innovation box also is attractive to lawmakers in both parties who are worried that companies can easily move income outside the U.S. and chase low tax rates around the world. The break could help preserve the domestic tax base threatened by tax inversions and takeovers by foreign companies, said Representative Charles Boustany, a Louisiana Republican who is working on innovation box legislation.

"If you're a retailer or other firm that's not benefiting from this, you're going to go ballistic. Once the revenue estimate comes in, that's going to be a cold slap in the face of reality." --Marty Sullivan, Tax Analysts“Using the patent box approach with international tax reform might be a slim window through which we can actually start phase one of full tax reform,” he said. “We need to do something on international tax reform to put us on a competitive basis.”

Still, the appeal to technology companies looking abroad for lower taxes also is what makes the benefit problematic. Any break designed to attract income that’s mobile to the U.S. will soak up revenue that could be used to lower tax rates on income that can’t be moved.

Retailers and electric utilities would have trouble getting their income inside the innovation box so it could qualify for lower rates, and they would have little if any guarantee that Congress would come back and cut their tax rates.

“If you’re a retailer or some other firm that’s not benefiting from this, you’re going to go ballistic,” said Marty Sullivan, chief economist at Tax Analysts, a nonprofit publisher. “Once the revenue estimate comes in, that’s going to be a cold slap in the face of reality and the patent box won’t be as attractive any more.”

Talks still are in the early stage, and the idea hasn’t been fully endorsed by any of the key players—Senate Finance Chairman Orrin Hatch, Ways and Means Chairman Paul Ryan, or Treasury Secretary Jacob J. Lew. Even if they reach an agreement, they won’t have much time to act before election politics distract lawmakers.

Senator Ron Wyden of Oregon, the top Democrat on the Finance Committee, hadn’t included an innovation box in his previous tax plans. He said Tuesday that he is open to the idea, though he has technical concerns about how the rules would be written.


Innovation Box Rules Being Written

Boustany is trying to revive and revamp a proposal he wrote with former Democratic Representative Allyson Schwartz. And two senators—Republican Rob Portman of Ohio and Democrat Charles Schumer of New York—are working on their own idea.

“Democrats, I think, are a little more open to it because it’s tied to innovation; it’s not just a corporate tax cut across the board,” said Robert Atkinson, president of the Information Technology and Innovation Foundation, a Washington group whose board of directors includes technology company executives. “Republicans like it because it’s a tax cut.”

The details aren’t settled yet, and they’re important. A box that offers lower rates for trademarks, copyrights, and other intangible property would generate broader political support than one focused only on high-tech patents. It would also deprive the government of much more revenue.

A group of Silicon Valley tax directors suggested a rate of 10 percent to 15 percent in an April letter to lawmakers, compared with today’s 35 percent top corporate rate and the 25 percent rate that Republicans are seeking.

The executives, led by Jeff Bergmann of NetApp Inc., said the U.S. should act quickly to develop a box with a broad definition of qualifying income so it can be “first in line” to tax its companies’ income from intellectual property.

An innovation box could become part of a larger international tax deal that has eluded Congress. Many Republicans and President Barack Obama agree broadly on a plan that would impose a mandatory one-time tax on about $2 trillion in U.S. corporate profits overseas, use that money for highways, and make structural changes to the international tax system. The U.S. House is holding a hearing Wednesday on the idea.

U.S. lawmakers are examining the innovation box—which could mimic one in the U.K.—as industrialized countries develop rules to crack down on corporations’ use of cross-border structures. Companies including Starbucks Corp., Google Inc., and Apple Inc. are facing scrutiny in Europe.


Tax Rates

The U.S. can’t compete with the single-digit tax rates some companies can now achieve abroad. But if those rates rise above 10 percent or 15 percent in Europe, a U.S. innovation box could provide a reason for companies to locate intellectual property—and potentially more research jobs—at home.

“What the advocates for a patent box want is something that will substitute for their current tax planning,” Sullivan said.

Critics say innovation boxes don’t necessarily create incentives for new investment. And companies relying on older intellectual property—cartoon characters, for example—could gain windfall benefits.

Also, the rules could be tricky for the Internal Revenue Service to administer.

“You get people jumping through all kinds of hoops and playing all kinds of games to get their income into that box,” said Rebecca Wilkins, executive director of the Financial Accountability and Corporate Transparency Coalition. “You can bet the tax attorneys are figuring out how they can play the patent box rules, even though they haven’t been drafted yet.”

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