On 11 November 2014, the UK and Germany made a joint announcement about a proposal they had developed to address some of the concerns raised over the OECD's suggested approach to dealing with preferential IP tax regimes. These regimes will close to new entrants from June 2016, and will be abolished in June 2021 but there is a long grandfathering period, under which benefits can continue to be claimed until June 2021.
OECD BEPS Project
One of the Actions in the OECD's project to counter Base Erosion and Profit Shifting (BEPS) is on Countering Harmful Tax Practices More Effectively (Action 5). In September 2014, the OECD published a report on Action 5, stating that its Forum on Harmful Tax Practices (FHTP) would be focussing on "substantial activity" in the context of IP tax regimes (such as the UK Patent Box or the Dutch Innovation Box). The OECD's preferred approach, supported by a majority of OECD member countries, was to require a direct nexus between the income receiving tax benefits and the expenditure contributing to that income. This "Modified Nexus Approach" would require substantial economic activities to be undertaken in the jurisdiction in which the preferential regime exists, by requiring tax benefits to be connected directly to R&D expenditures.
The UK, Spain, Luxembourg and the Netherlands did not favour this approach. The nexus approach was also criticised on the basis that it would create a major compliance burden in tracking the relevant expenditure.
There is a G20 summit meeting taking place in Brisbane on 17-19 November, and the disagreement over the Modified Nexus Approach was threatening to impede progress in agreeing measures to counter harmful tax competition, and in other areas covered by BEPS. The UK and Germany's joint proposal will be put on the table for discussion at the FHTP's meeting at the summit. If agreed, it will form the basis for future negotiation and finalisation of the Modified Nexus Approach for Action 5.
UK and Germany joint proposal
The aim of the proposal is to address the concerns that were raised over the Modified Nexus Approach. There are 4 key elements:
Uplift of qualifying expenditure: Where related party outsourcing or acquisition costs are incurred, a maximum uplift of 30 percent of qualifying expenditure, capped by reference to actual outsourced expenditure, will be available, although it is not yet clear exactly how this will apply in practice.
Closure and abolition of existing IP regimes: All existing IP regimes to be closed to new entrants (products and patents) from June 2016 and abolished by June 2021.
Grandfathering: IP within existing regimes can retain benefits until June 2021 to allow for transition to new regimes which will be based on the Modified Nexus Approach.
Tracking and tracing: The FHTP will agree by June 2015 a practical and proportionate approach (for companies and tax authorities), including transitional mechanisms for IP from existing into new regimes and special rules for previous expenditure. This remains an area of significant complexity.
What should businesses be doing?
Given the long grandfathering period, businesses should try and maximise benefits available under current regimes, plan for the transition to the new nexus-based regimes and anticipate the likely impact, as well as reviewing other opportunities which governments may offer to encourage inward investment.