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Germany and UK agree patent box compromise

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Germany and the UK have agreed a compromise proposal on patent box regimes. The agreement is based on the OECD's modified nexus approach requiring tax benefits to be connected directly to R&D expenditures, but seeks to address concerns with revised elements, including:

  • uplift of qualifying expenditure for related-party outsourcing or acquisition costs;
  • transition to closure of existing IP regimes by June 2016 with grandfathering until June 2021; and
  • further work on a tracking and tracing method.

The move comes just days before the G20 leaders’ meeting this weekend in Brisbane, Australia. Germany and the UK will present the proposal to the OECD forum on harmful tax practices and seek formal approval by the OECD and G20 at the January meeting of the OECD’s Committee on Fiscal Affairs.

In a statement, HM Treasury said: ‘Both Germany and the UK remain fully committed to the successful conclusion of the BEPS negotiations by the end of 2015, and to making the necessary progress on all actions within this project in order to do so. The proposal was developed through bilateral discussions between the two countries, seeking to achieve a balance between maintaining countries' ability to offer such regimes and preventing misuse of them.

‘The proposal seeks to achieve this through reinforcing the nexus approach to ensure substantial activity is undertaken in the jurisdiction offering the relief, whilst better reflecting the commercial realities of R&D investment by business. It also makes necessary provision for transitional arrangements between existing and new rules, and proposes further work to develop practical means of implementing the modified nexus approach.’

George Osborne hailed the move as ‘a great deal for Britain’ which protected ‘vital scientific research while making sure there are international rules that stop aggressive tax avoidance’, adding: ‘Our joint proposal balances the need to allow countries that wish to have these regimes to do so, whilst ensuring that they operate by rules that prevent abuse. This demonstrates the strength of our commitment to the BEPS project that we both helped initiate, and our determination to ensure that we conclude this by the end of 2015.’

Meanwhile, Germany’s finance minister Wolfgang Schäuble said: ‘Preferential tax treatment of intellectual property must be dependent on substantial economic activity. More and more countries are speaking out against allowing too much leeway for large multinationals to minimise their taxes. Just because something is legal, does not mean it is fair in tax terms. Multinationals must contribute their fair share to public budgets – just like any other company has to.’

The joint proposal is being viewed as leading to a significant watering down of the UK regime and follows earlier complaints that the UK’s patent box regime constitutes ‘harmful tax competition’.

The UK patent box was introduced as a measure to improve UK tax competitiveness, and was, as Ben Jones (Eversheds) observed, ‘in part in response to similar successful incentives in other jurisdictions such as the Netherlands and Luxembourg.’ The question now was whether ‘competing tax incentives in other countries will be similarly curtailed such that the UK is not ultimately disadvantaged by this change,’ Jones said.

Jonathan Riley, UK head of tax for Grant Thornton UK, said that the announcement played to the BEPS project and ‘sought to place the UK in the “good tax citizen” camp, even though it does have a negative effect on our tax competitiveness’.

Bill Dodwell, head of tax policy at Deloitte, welcomed the outline agreement and noted that it would need to be endorsed by other members of the G20 and OECD before it can be adopted. ‘It also seems that detailed rules on tracking and tracing research and development costs will need to be agreed, as well as details on how existing regimes are moved into the new approach,’ Dodwell said. ‘Focusing tax incentives on patents and equivalents may mean the withdrawal of some of the wider intangibles regimes adopted by other countries. Patent boxes have always been about incentivising the commercialisation of innovation, whereas R&D expenditure credits support the initial R&D. The UK has a good research record but a less strong commercialisation record – so we are pleased that this support can continue.’