Politicians and the public were outraged when New York-based Pfizer announced its plan to merge with Dublin-based Allergan and move its headquarters to Ireland. Pfizer was accused of being “unpatriotic” and the move was called a “disgrace” and a “travesty.” But Pfizer said the move made sense. It would enable huge drug maker to take advantage of Ireland's lower corporate tax rate.
Pfizer's plan is an example of one of several legal tax schemes employed by U.S. companies seeking to lower their tax burden. But it is hardly the only one. Corporations have found ways to park billions of dollars in earnings offshore to avoid the high U.S. tax rate. And while lower taxes may be good for a company's bottom line, it is not good for the U.S. Treasury. In fact, this has become such a big problem that and even before Pfizer announced its plan, members of Congress had started to draft legislation that would give companies an incentive to keep their profits at home and make the U.S. a more attractive place to do business.
So these lawmakers are looking into the feasibility of establishing a tax incentive policy commonly known as the “patent box” or “innovation box.” This system would subject companies to a much lower tax rate on income earned from intellectual property. Instead of the U.S. rate of 35 percent, a company might, for example, pay between 5 and 15 percent on all income derived from patents, trademarks, copyrights and any other IP.
“It's a mechanism to reward innovation and to keep high-tech companies in the U.S.,” says Lori Johnson, a partner at Chamberlain, Hrdlicka, White, Williams & Aughtry who specializes in intellectual property.
For years, U.S. manufacturers have been migrating overseas, lured largely by lower labor and production costs. The government has tried to stem this flight, fearing the loss of industry could lead not only to the loss of tax revenue but also to the demise of future innovation. Government tax breaks, offers of free or low-cost land and other incentives are frequently used to encourage companies to build factories in the U.S. and stay put.
But labor costs are only part of the equation. The high corporate tax rate in the U.S.—the highest in the industrialized world—has become a major factor behind corporate flight.
To be sure, many U.S. companies find plenty of other loopholes and don't pay close to the oft-quoted 35 percent tax rate. Pfizer, which earned $9 billion in profit in 2014, paid a tax rate of about 26 percent on those earnings, according to its own reported financial results. General Electric Co. employs a number of aggressive—and legal—strategies that have greatly reduced the company's corporate tax burden. And even trying to figure out the tax rate Apple Inc. pays is not easy. Two years ago, Apple CEO Tim Cook estimated it was about 30.5 percent, whereas The New York Times put it at closer to 8.2 percent.
But increasingly, U.S. companies that operate globally are tempted to relocate some of their business overseas. Many, especially in the technology sector and pharmaceutical industry, have moved their intangible assets, including patents that have come out of research done in the U.S., to countries that already have patent box regimes, including the United Kingdom, France, China, Spain, the Netherlands, Italy and Belgium.
Lawmakers now want to create a patent box, or innovation box system in the U.S., one that would count the value of all intangible assets, including trademarks and copyrights, and tax them at a lower rate. The goal is to give corporations more incentive to keep research and the innovation that follows at home.
This summer, Reps. Charles Boustany Jr. (R-La.) and Richard Neal (D-Mass.), both members of the House Ways and Means Committee, introduced the “Innovation Promotion Act of 2015.” The draft bill introduces the concept of an innovation box system that, through a complex formula, would lower the effective tax rate on innovation box profits to around 10 percent by allowing a large deduction on profits derived from qualifying intellectual property.
House Speaker Paul Ryan, the former chairman of the House Ways and Means Committee who is seeking a broader overhaul of the tax code, has praised the innovation box proposal, saying it “can help us stem the tide and protect good American jobs.” Bipartisan support for such a measure also exists in the U.S. Senate, where Sen. Charles Schumer (D-N.Y.), and Rob Portman (R-Ohio) are advocating for the innovation box concept.
“If we don't change our tax laws, companies abroad are going to keep pulling the rug right out from under the United States, taking our intellectual property and thousands of jobs right along with it,” Schumer said when Boustany and Neal introduced their draft bill.
At some level, establishing an innovation box regime in the U.S. is a defensive measure. Patent boxes that already exist overseas are expected to attract even more U.S.-developed intellectual property in the future. And to make matters worse, some European countries are expected to start requiring U.S. and other corporations to also move research jobs to within their borders to qualify for their patent boxes.
“This means U.S. jobs would be lost—good jobs that support the middle class,” says Bernard Knight, a partner at McDermott Will & Emery who was formerly general counsel for the U.S. Patent and Trademark Office and has written extensively about patent boxes.
Supporters of an innovation box in the U.S. say such a system would ensure that future innovation spurred by existing industry remains in the U.S. “Studies have shown that when manufacturing moves, follow-on innovation moves too,” Knight says.
Case in point: The U.S. lost its lead in battery innovation in the 1980s, when it stopped making consumer electronic devices. In a 2013 article Knight co-wrote for the Stanford Journal of Law & Business, he describes how the countries that made the batteries after that gained the exposure and relationships needed to learn to supply the more demanding laptop PC market, and eventually the even more demanding automobile market. The U.S. is now at a disadvantage when it comes to manufacturing batteries for hybrid and electric cars.
But just what a U.S. innovation box regime would look like is still unknown. It could have geographic or other limitations, says Johnson. It could enable a foreign subsidiary to repatriate IP into the United States without paying a huge tax bill. And It could involve changing current tax rules to ensure that a company's income from intangible assets that have already been moved overseas are taxed at some minimal rate.
Whatever shape a U.S. innovation box takes, proponents say that in addition to creating jobs and encouraging innovation, such a system would make patents worth a lot more. “They will be more valuable if the income derived from them is taxed at a much lower rate,” says Knight.
But the draft legislation is still a long way off from becoming law. And how appealing a U.S. innovation box will be if it gets through Congress is anybody's guess.
“In the end, it will depend what the legislation looks like,” Johnson said.