Enterprises are constrained in a number of ways when considering where to lodge operations. For the usual activity of siting a manufacturing operation, the company has to determine the availability of land for the facility, access to transportation, a ready workforce, sourcing of materials, and so on. Research and development (R&D), however, faces those challenges as well as the protection of the IP from infringement, ease of exploitation within the jurisdiction, and access to a more specialized workforce required for the R&D activities. The advent of the patent box regime—when income earned from IP is taxed at a rate below the statutory corporate income tax rate, to encourage local research and development—has added tax considerations to the mix.
The OECD’s Pillar 2 proposal, a global minimum tax rate of 15%, will be adopted into regulation in many countries in 2024. The use of Patent Box systems will present challenges in many countries. Lowering tax rates for the development and retention of IP within a jurisdiction contradicts the concept of Pillar 2. Patent box rates may be as low as 2.5% in Cyprus and as high as 10.5% in Slovakia, but they all share the same drawback: They are all below the proposed magic number of 15% effective tax rate.
Some countries have moved away from having a preferential tax rate on IP and have taken a different approach by creating super deductions—most recently Italy has gone this route by allowing a deduction of 230% of the IP development expenses. Such an intersection with the general tax rate will complicate the definition of the effective tax rate of the multinational entity as the local entity with enhanced deductibility will reduce the enterprise tax liability within the jurisdiction.
Depending on how qualifying income is defined, and what adjustments are allowed/required will impact the overall result as its starting point. When the final result is obtained, and the resulting imposition of a top-up tax is encountered, the schema and rational for a patent box may be defeated. The final laws and regulations for Pillar 2 will define how this plays out for multinationals and will complicate an already complex tax calculus.