Seeking Tax Savings in Troubled Times
Though the current downturn in the global economy has had a dramatic impact on several industry sectors, the reeling technology sector has suffered disproportionately. High-technology economies throughout the United States, from Austin, Texas to Silicon Valley, from Washington State to Washington D.C., are struggling to remain profitable during this economic turmoil. The rise of Asian economies such as China and India as "hubs" for technology based corporations, has put tremendous cost pressure on North American technology companies to compete along cost lines.
This new economic environment makes it understandably difficult for companies to contemplate the implementation of long term tax strategies, when the focus is strictly on meeting profitability targets. Given that a corporation must function as a going concern, corporations owe it to their shareholders and other stakeholders to engage strategies which maximize short term operations and long term value. One such relatively inexpensive strategy which serves to minimize the level of global taxes a corporation must pay, involves intangible migration, including technology transfers.
Migrating Intangibles: What Does it Entail?
Many technology firms have incurred or will incur this coming year business losses that can be carried forward 20 years or back 3 years. Such loses, if not utilized, eventually expire and can serve no future benefit, and if carried forward the company may need to wait several years to see the refund. One strategy that Canadian corporations should consider when such losses exist, and where valuable intangibles (such as patents, copyrights, trade marks and trade names) are present, is migrating such intangibles to low tax jurisdictions such as Barbados.1 While many considerations are relevant when deciding to which country intangibles should be migrated, the key benefit to consider is that profits generated from such intangibles will be taxed at a lower rate.
The sale of an intangible asset from one tax jurisdiction to another will result in exposure to capital gains taxes. The benefits of migrating intangibles during these difficult times is that you may be able to offset the capital gain, on the sale of the intangibles, by your operating losses. In the future as the economy improves the revenues derived from the intangibles will be reported offshore at a much lower rate. Consideration should be given to the capital gain that will be created versus the losses carried forward, and those expected for the current year, to ensure they are sufficiently high to offset capital gains that will result from the sale of intangible assets.
Many countries including Canada and the U.S. require that intangible transfers, along with most intercompany transactions, occur at arm's length prices. Generally speaking, approaches to valuing intangibles include the Comparable Uncontrolled Price (or Market Approach), the Cost Approach, and the Income Approach. Technology companies must illustrate what the fair market value of such intangibles are in order to justify what the related party in the lower tax jurisdiction will pay for such intangibles. Valuation is generally performed by commissioning an expert report, and by reference to industry comparables.
In these tough economic times technology companies should consider migrating intangibles to lower tax-rate jurisdictions as future profits that such intangibles generate would then be taxed at a significantly lower tax rate. The usually contentious issue of valuation is reduced since the availability of operating losses allows the transferor to be conservative towards the source country in valuing the intangibles. It is important to note, however, that intangible transfer prices must represent arm's length consideration.