The Clock Is Ticking On American Innovation

8/20/2019 The Clock Is Ticking On American Innovation

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The Clock Is Ticking On American Innovation

Hamilton Place Strategieswww.hamiltonplacestrategies.com

202-822-1205

Patrick SimsElliott OwensbyAditi Srinivas

America’s status as aninnovative beacon forthe world could be dashedbecause of little-understoodchanges to international taxlaw. These changes, if leftunanswered by Congress,

could lead to severe and ir-reparable economic harm tothe U.S. economy.

It started two years agowhen G20 finance ministerscalled on the Paris-based Or-ganization for Economic Co-operation and Development(OECD) to develop an actionplan to address the issueof base erosion and profitshifting (BEPS), specifically asit relates to intellectual prop-erty (IP). InOctober of2015 G20 Fi-nance Min-isters metto discussthe OECD’s

new rules.

The OECD’sintention isto help countries harmonizetax law across internation-al jurisdictions. Apart fromresolving tax avoidance, theOECD hopes that multilat-eral tax policy cohesion will

provide businesses withcertainty and predictabilityin decision making.

However, certain rules, likeAction 5 and the ModifiedNexus framework, will likely

create what the businesscommunity refers to as“material impact.” By re-quiring companies to locateactivities like research anddevelopment (R&D) whereIP income is taxed, firms areforced to make tough choic-es about where they locateinvestment and jobs, dras-tically altering the structureof their businesses and thebroader economy.

The U.S. hostsmany of theworld’s largestand most inno-vative firms, butthe new OECDregulations –

which go in toeffect in 2016 –combined withrelatively high

U.S. rates, incentivize U.S.firms to relocate innovativeactivities abroad, placinghundreds of billions of dol-lars in U.S. investment andthousands of high-skilled

Findings:

• Countries competing

with the U.S. or innova-

tive investment and jobs

have put in place preer-

ential tax rates or Intel-lectual Property.

• These preerential rates,

combined with a rela-

tively high U.S. corporate

rate, has contributed to

the two trillion dollars in

assets held by U.S. multi-

national irms abroad.

• The OECD’s Modiied

Nexus rule requires mul-

tinational irms to locate

IP creation in the same

jurisdiction where IP-re-

lated income is taxed.

• I Congress ails to imple-ment reorm, billions o

dollars o investment and

thousands o high-skilled

jobs are at risk.

October 2015

The new OECD regula-tions, combined withhigher U.S. corporatetax rates, incentivizeU.S. irms to relocate

innovative investmentand jobs abroad.


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American jobs at risk.

If firms do not relocate, theleast economical choice,they will be taxed at higherrates all over the world andbe forced to cut investmentand lay off workers here inthe U.S.

For the U.S. economy, this isa lose-lose situation unlessCongress acts to adopt rules– that many of our econom-

ic competitors have alreadyput in place – to keep inno-vative companies and jobs. The clock is ticking on U.S.innovation. The OECD dead-line to adopt innovation-pro-tective rules is June 30, 2016.

U.S. Multinational Compa-nies Are Incentivized ToRelocate

Base erosion occurs whenfirms locate taxable assetsin lower tax jurisdictions,avoiding the higher rateswhere these assets wereoriginally created. Globally,the OECD estimates that$100 to $240billion in taxesare not going

to the jurisdic-tions wherethey are owed.1

Fixing this problem, as therules are intended to do,could cost the U.S. economybillions. U.S. critics of inter-national tax reform fail torealize the implications of

these rules and the econom-ic pressure they place on U.Sfirms to remain competitive.

U.S. firms are competing ata global level and IP is moreimportant than ever. Patentsgranted by the U.S. Patent& Trademark Office havemore than doubled in thepast decade alone. Over half

of these pat-ents originatedabroad – a dra-

matic increasefrom yearsprior (Fig. 1).

According to estimates,over two trillion dollars areheld by U.S. firms overseas.2 There are many reasons forthis.

U.S. irms are com-peting at a global

level and IP is moreimportant than ever.

Fig. 1: Total U.S. Patent Grants Have Doubled In The Last Decade As Firms Have Become

More Information-Intensive And Foreign Competition Has Increased

Source: U.S. Patent & Trademark Office

157,718

326,033

67,964

1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

+106.7%

74% 62% 53% 55% 50% 49%

26% 38% 47% 45% 50% 51%

2010 2014

100%

200019801970 1990

Foreign US

Total Number Of U.S. Patents Granted

Percent Of Patents Granted In U.S. (U.S. versus Foreign Origin)


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First, U.S. firms are generat-ing more and more revenuefrom abroad as emergingmarkets show promisinggrowth for U.S. products andservices. Moreover, repatri-ating foreign revenue backto the U.S. costs firms more

than if they simply investedit abroad due to the rela-tively high U.S. corporate taxrate.

Second, U.S. firms are in-creasingly locating IP assetsabroad as foreign countriesoffer tax incentives for inno-vation-based business activ-

ity.

These preferential tax ratesare known as Innovation orPatent Boxes (InnovationBox) and they are a big rea-son why many intellectu-al-capital intensive firms, likeinformation technology andhealthcare companies, holdlarge amounts of overseas

assets (Fig. 2).

Innovation Boxes Now ComeWith Red Tape

Unlike tangible assets, intan-gible assets are not limitedby geography. A companythat develops IP assets inCalifornia can offer that ser-vice to hundreds of millionsof people around the world.Holding these assets inlower tax jurisdictions keepsU.S. companies competitiveas global rivals often benefitfrom favorable rates in theirhome countries.

Innovation Box rates oftendiffer dramatically from

tries and many have alreadyimplemented or are planningto respond with changes toattract innovative firms (Fig.3).

According to the OECD’stimeline, countries with IPregimes that are inconsis-tent with the BEPS’ frame-work must start amendingtheir legislative process bythe end of 2015. Companiescannot receive tax benefitsfor IP income that does not

meet BEPS criteria after June30, 2016. The OECD has found16 IP regimes to be partly orwholly inconsistent with theproposed framework.4

Countries Rush To StayCompetitive In Advance ORegulatory Shifs

overall corporate tax ratesaround the world. For in-stance, Belgium’s InnovationBox rate is 6.8 percent, whileits overall corporate incometax rate is roughly the sameas it is in the U.S., at 34 per-cent.3

The OECD does not seek toend preferential tax treat-ment for IP, but to specifywhether preferential ratesare deserved. The OECD’sModified Nexus approach

only allows a firm to benefitfrom a preferential IP rate tothe extent that it can showthat it incurred costs, likeR&D expenditures, that add-ed real value to the creationof an IP asset.

This approach was endorsedby all OECD and G20 coun-

Fig. 2: Industries With Information-Intensive Assets

Have Higher Overseas Holdings

$1

$7

$89

$122

$152

$194

$217

$270

$445

$601

Materials

Discretionary

Financials

IT

Industrials

Consumer

Healthcare

Telecomms

Utilities

Energy

Source: Bloomberg

Overseas Assets Of U.S. Multinationals ($ In Billions)


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While the BEPS Project maybe well-intentioned, newregulations will force bothcountries and companies tomake difficult choices. Look-ing to get ahead of the OECDrules change, some coun-tries are proactively lower-ing corporate tax rates andincreasingly offering prefer-ential Innovation Box rates.

Many major economic com-petitors of the U.S. havealready lowered their corpo-

rate income taxes or plan toin the near future. The U.K.slashed corporate taxes to20 percent in 2014, with aspecial 10 percent tax rate by2017 for income from IP. Ja-pan’s business tax rate wasreduced from 34.62 percentto 32.11 percent, with addi-tional cuts planned for 2016.

far the highest in the OECD),or relocate these activitiesto a tax jurisdiction commit-ted to protecting IP with anupdated tax code.

The Outdated U.S. CorporateTax Code Risks American Jobs And Economic Growth

The U.S. corporate tax rateis significantly higher thanother developed economies.

Combinedwith the lack

of comparableprotections forIP, this createsa dramaticallyuncompetitivetax landscape.

Bipartisan proposals havebeen put forth in both theHouse of Representatives

Overall, the number of OECDcountries with dividend ex-emption systems has grownfrom nine in 1986 to 28 in2011, reflecting the increaseddesire to remain econom-ically competitive in theinformation economy.5

It is easy to see how theOECD’s attempt to regulatethe location of business ac-tivity createsa perverse

incentive forbusinessesthat have theU.S.-basedR&D opera-tions. Compa-nies can con-tinue to do R&D in the U.S.and suffer wildly uncompet-itive corporate tax rates (by

Hamilton Place Strategies 4

High corporate rates

combined with the lacko comparable protec-tions or IP, creates adramatically uncom-petitive tax landscape.

Fig. 3: The United States Lags Competitors In The Implementation Of An Innovation Box

3538

28

20

28

19

34

13

29

25

13

35 35

1514

1010107665

30

0

5

10

15

20

25

30

35

40

H u

n g a r y

F

r a n c e

I t a l y

P e r c e n t

I r e l a n d

U . K .

S p a i n

M a l t a

U . S .

B e

l g i u m

L u x e m b o u r g

N e t h e r l a n d s

C

y p r u s

Fully Phased-In Patent Box RateStandard Corporate Rate

Source: Senate Finance Committee, International Tax Reform Working Group: Final Report

Corporate Versus Innovation Box Tax Rates By Country


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and the Senate seeking tolevel the playing field forAmerican companies andworkers.

The final report from theSenate Finance Committee’sInternational Tax Reform

Working Group, co-chairedby Senator Charles Schumer,(D-New York) and SenatorRob Portman (R-Ohio) pro-posed the adoption of anInnovation Box for U.S. firms,in order to encourage “thedevelopment and ownershipof IP in the United States.”6

While U.S. multinationalfirms are increasingly globalplayers, they still have sig-nificant business operationshere at home that could bejeopardized by the BEPS Proj-ect’s treatment of IP.

By some estimates, U.S.multinationals have “70 per-cent of their value added, 66

percent of their employment,73 percent of their capital in-vestment, and 84 percent oftheir R&D” still located in theU.S. (Fig. 4).7 The R&D invest-ment for U.S.-based multina-tional enterprises, and the23 million high-skill jobs itsupports, totaled $230 billionin 2012.8

This is precisely the econom-ic activity at risk of leavingas businesses are forced tomigrate towards countrieswith competitive tax rates.

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Notes:

1 OECD, “Reforms to the international tax system for curbing avoidance by multinational

enterprises,” Press Release, 5/10/2015

2Richard Rubin, “U.S. Companies Are Stashing $2.1 Trillion Overseas to Avoid Taxes,”

Bloomberg Business, 3/4/15

3Quantria Strategies, “Patent Boxes, Technological Innovation and Implications for Corpo-

rate Tax Reform,” American Action Forum, 8/24/15

4OECD, “BEPS - Frequently Asked Questions”

5Washington National Tax Services, “Opportunities and challenges ahead: 2015 Tax Policy

Outlook,” PricewaterhouseCoopers, 1/15

6US Senate Committee on Finance, “International Tax Bipartisan Tax Working Group Re-

port,” 7/15

7 Dr. Laura D’Andrea Tyson, Finance Committee, U.S. Senate, Testimony, 2/24/15

8Ernst & Young, “Buying and Selling: Cross-border mergers and acquisitions and the US

corporate income tax,” Business Roundtable, 3/15

Fig. 4: U.S. Multinational Firms Have Significant

Business Activity In The U.S.

Source: E&Y

84%Research &

Development

$230billion

R&D Supported

66%Employment

23 MillionJobs

The Clock Is Ticking On American Innovation

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