Intellectual Property Taxation Viewpoints and Globalization Strategies

In July of this year (2007), Philips mounted a multinational intellectual property challenge against Acer, citing patent infringement. From the manpower invested by the two sides, the sky-high compensation sought, and the ups and downs of each side's competitive posture, it is not hard to see how governance of intellectual property (IP) can reach the level of operational strategy.

IP governance involves professional integration across departments, has a fundamental influence on the operations of today's corporations, and is truly a key management issue in the knowledge economy era. Taiwan's corporations, too, have been putting remarkable amounts of effort and resources into R&D work and patent applications, with annual spending having reached an estimated NT$200 billion, and their innovation and technology-led development strategy is quite explicit. But limited by the characteristics of patents, a defensive mindset, and immature IP governance technology, the tangible benefits being created are estimated to be only about NT$2 billion.

In terms of IP governance at Taiwan's companies, the considerable gap between resources invested in IP and the benefits produced highlights how much progress could be made by correcting the imbalance between offense and defense and achieving tighter cost control.

For discussion, one may divide IP governance into its strategic, tactical and cost aspects. The strategic aspects are the backbone of IP governance, and they must be attuned to one's market presence, competitive posture, etc. The tactical aspects emphasize the application of legal tools, and one must consider the basic laws and accounting systems of different countries simultaneously. As for cost aspects, the greatest emphasis should be put on R&D management, and – the subject of this article – tax arrangements in Taiwan and globally.

Establishing a R&D environment with greater cost advantages: Make the most of tax incentives

In order to encourage enterprises to invest in high value-added R&D work and go through multiple channels to acquire intellectual property, Taiwan allows qualified enterprises to claim R&D investment tax credits and other tax preferences, and is open to technical know-how capital contributions (i.e., "technology appraised as capital stock", where the contributor receives an equity stake in a venture in exchange for technical knowledge). Additionally, to encourage enterprises to introduce advanced technology from abroad, it was also stipulated that in technology licensing situations where certain requirements are met, royalties paid to foreign licensing organizations are exempt from income tax. As a result, if each of the R&D tax reductions and exemptions can be fully taken advantage of, tax costs for local companies engaged in R&D remain low.

In practice, however, Taiwanese enterprises applying for the above R&D tax preferences often find themselves fighting the tax authorities over each item in tax audits, and the tax preferences eventually agreed to still get deeply discounted, leading to constant legal disputes between the two sides. Examining the main reason, one finds that Taiwanese taxation in practice tends to be formalistic, whereas different R&D models and forms have proliferated. It is difficult for single legal provision to make general inferences about them, which makes the governing authorities often weigh the applicability of regulations more conservatively (so if it is not possible to determine with certainty the substantive nature of a transaction, tax collection is safeguarded first and foremost). Then again, although the tax laws give the tax administration the substantive authority to levy taxes, R&D work is beyond the professional expertise of internal revenue/tax personnel. Nonetheless, "substantive determinations" are often left to the tax authority to decide, leaving both tax collectors and taxpayers perplexed.

Another part of the picture is that enterprises in Taiwan generally conduct business first and perfect the financials later: That is, priority is given to effective business timing and flexibility, but that makes it hard for corporations to control tax risk. Because tax collection in Taiwan in practice still emphasizes formalism, when a firm fights for R&D tax preferences, the return will be two-fold if the documentation that must be provided has been produced in advance through the firm's information security management system, and internalized in its routine operations management. If, in talks over technology transfer or licensing deals, the financial, tax and legal departments are first instructed to review the contract documents, ambiguous wording and unclear rights and obligations can be avoided, thus lowering risk in tax filings. Also, before executing different IP arrangements (including licensor/licensee agreements, transfers of ownership or full/partial usage rights, agency, consignment or joint R&D), one can avoid double taxation and increase tax benefits by first giving consideration to the domestic and foreign tax implications.

Continuous control of transnational taxation cost: Deploying intellectual property globally for greater efficiency

When an enterprise undertakes transnational intellectual property transactions (including technology transfers, patent licensing, technology investments, international joint R&D projects, etc.), the tax issues become more complicated. This is because tax systems in different countries may not share the same approach to recognizing and valuing intangible assets, the same definitions of royalties or technical service fee income, or the same principles for determining the jurisdictional sources of income, and there are differences as well in how countries apply taxation agreements and in how their internal revenue organs think about taxation. The tax issues involved in transnational IP transactions may therefore be called quite complex, and the risks are also high.

In consequence, when a corporation considers the tax risks of its transnational IP transactions, it is necessary to thoroughly understand how the transactional substance and income classification for each transaction is determined within different tax jurisdictions, whether there are applicable taxation agreements, and administrative remedies for when tax disputes arise. If a group enterprise wants to reposition its IP rights (by, for example, establishing group-wide or regional IP centers), then a careful tax assessment process is all the more unavoidable if it wants to be effective in increasing tax efficiency and avoid tax risk.

Given its relative importance, the tax risk borne in the course of IP management should not take a back seat compared to litigation risk. Western multinationals have become accustomed over the years to facing the high cost of back taxes, fines and double taxation due to tax authorities in different countries questioning the reasonableness of their transaction amounts for intangible asset assessment, licensing and transfers. Hence, the principle that needs to be scrupulously taken to heart, as enterprises carry out transnational IP tax management, is this: Invisibility does not mean risks do not exist; it means the risks are harder to identify.

To summarize, in order to carve out a R&D environment with more tax cost advantages, if enterprises can look carefully at the economic aspects – the domestic or foreign nature of income, the rights and obligations – and match them with suitable information security management mechanisms, and if they can seek a globally integrated business model with greater tax benefits, then compared to being exhausted responding after the event to audits by tax bodies in different countries, such preemptive and comprehensive tax planning no doubt represents the correct way of thinking as it offers both economic efficiency and tax benefits.

This article was completed with assistance from Wendy Chiu.

Yishian Lin is a partner at PricewaterhouseCoopers Taiwan. Please send your comments and questions to: Yishian.Lin@tw.pwc.com