What Is Intellectual Property?
According to World Intellectual Property Organization or WIPO, intellectual property refers to creations of the mind, such as inventions, literary and artistic works, designs and symbols, names and images used in commerce. It is protected in law by, for example, patents, copyright and trademarks.
Operational and IP Restructuring
Operational restructuring is a fixture of all business strategies. This does not only happen during tough times but is practiced all throughout the life cycle of a business to keep it healthy and with the current trends.
Sustainability is every organization’s priority so it may remain competitive. Effective risk management, efficient and effective management controls, improved operational systems, continued innovation, better products and services, and increasing profitability are key focuses for top management. At some point a key organizational restructure will look to where and how to effectively manage the organizations IP and the systems and structures that are used to hold and use this IP to make sure there are still deemed appropriate.
Intellectual property is considered a dominant asset of most businesses, thus it is most often overlooked as a profit centre. More and more multinational companies are using intellectual property rights to maximize profits by means of geo arbitrage. Moving intellectual property offshore is now a common strategy. Google, Yahoo, Uber, AirBnB and McDonalds are only a few of the companies who are moving and holding their IP or even their head offices to jurisdictions with relatively low tax rates, which in turn allows for the utilization of IP as a profit centre to maximum benefit.
Because of its intangibility, IP is very efficient to optimize specially in terms of structure and value in an offshore environment. Strategic IP planning is very important from the outset in a modern global focused corporation.
Kelvin King of Valuation Consulting Co. identifies two steps in valuating IP: Determining capital values and extraction of profit.
He specified three approaches in determining capital values: the income approach, market approach and cost approach. The income approach measure the value of an asset by the present value of its economic benefits while the market approach looks at the analysis of recent sales or offering of comparable property. The cost approach measures the value of an asset by the cost to create and asset.
Extraction of profit is when one considers the highest (if appropriate) defendable royalty rate for the charge by IP HoldCo reducing taxable profits elsewhere in the Group.
The valuation of IP in addition to the total value of all other assets will be used as the basis to determine the necessary rate of return. Consequently, this will also provide the data on the royalty rate the principal company should collect.
Restructuring of Royalty Fees
Following the proper valuation of your IP rights, determining the correct royalty fee structure is necessary. Jurisdiction disputes commonly arise on the grounds of which gains more from the IP sale or outsourcing deals. For example, Country A finds out that the royalty payments it makes to Country B is excessive or Country A does not receive full value of for Country B’s use of its intellectual property.
Audits and Advanced Pricing Agreements (APAs) are two major methods that are encouraged to be practiced among companies engaging in IP dealings to ensure the observation of arm’s length pricing.
Companies restructuring IP ownership through the centralization in a tax efficient location. Popular examples are Switzerland, Ireland and Malta.
Cost sharing agreements (CSA’s), buy-in payments and sale are three commonly used methods in migrating intangible assets like IP.
A CSA is an agreement between two parties wherein they will define the cost of contributions and the benefits to be returned to each party. Effectiveness of a CSA will rely on business and economic sense and the provision of arm’s length prices.
Buy in and buy out payments are another way to migrate IP. This requires a party to buy in or buy out of a CSA. Payments should also represent arm’s length prices and subsidiaries need to pay fair market value to be able to buy in.
Lastly, selling of IP to offshore affiliates could save on tax costs as the profits derived from this sold asset will be taxed in the offshore jurisdiction and not the principal location where the IP originated. Then again, parties involved in this kind of transaction must observe the arm’s length prices. A Comparable Uncontrolled Price method is used to determine the appropriate pricing for this kind of sale.
Partnership is also another way to migrate IP offshore. Although it sounds easier at first thought, it is considered to be legally challenging and may not even provide optimal results.
Centralizing IP ownership and management is not easy. This will most likely involve relocation of manpower and equipment that will cost the company a great deal of money.
Other Considerations in Restructuring IP
Choosing the right location
Choosing a jurisdiction must not only be based on which location has the best taxation system but must also include legal framework, available human capital, standard of living and infrastructure for systems.
Cost of doing business
Looking at tax incentives alone of one country is not enough to finally decide that it’s the one. Check the accessibility to a good tax treaty network. This is your way to reduce withholding tax and prevent double taxation.
As with any business deals, make sure that all your agreements are well documented. Your legal team must also see to it that you are engaging in an entirely legal arrangement. Arm’s length prices are very relevant.
As with any cross-border restructuring, careful consideration should be given to ascertaining and documenting the arm’s length transfer price of the resulting related party transactions – substantiating the value of the IP in the case of a sale, the basis of royalty charges in the case of a license arrangement, etc. All comprehensive transfer pricing documentation must be kept.
Restructuring IP offshore may be easier said than done and perceived as more complicated than it sounds but when successfully established, it can turn around your future. Study your options and decide.