Should India explore IP-focussed tax incentives?
By R. Subhashree
Recently, the United Kingdom released draft of the proposed legislation on ‘Patent box’ – a scheme of tax incentives to corporates that domicile and exploit their patents in UK. The objective is to encourage setting up of manufacturing facilities in UK and creation of jobs. It also aims to improve UK’s competitiveness as compared to other EU countries. Countries like Netherlands, Belgium and Luxemburg provide tax benefits to companies in respect of income generated from ‘qualifying’ intellectual property (IP). Belgium provides for ‘Patent Income Deduction’ in respect of patents but does not impose a condition on location of R&D activities. Netherlands provides for preferential rate of 5% tax on patent income. Luxemburg taxes only 20% of qualifying IP income and covers trademarks, design and domain names.
In India, the Income Tax Act, 1961 provides certain concessions to individuals in respect of income from patents and copyrights. Under Section 80QQA, deduction of 25% of income from royalties earned by authors of textbooks in Indian languages (subject to conditions) is available. As regards royalty income from books other than textbooks, a maximum deduction of Rs.3 lakhs is allowed. A maximum deduction of Rs. 3 lakhs is also allowed from royalty earned from patents. All these provisions are applicable to individual assessees alone. Corporate assessees do not get any preferential treatment in respect of intellectual property (IP) income.
Research and development qualifies for deduction under the Income Tax Act, 1961 as provided in Section 35 in respect of scientific research. The Indian tax regime currently provides for a weighted deduction (twice) on the research expenditure. However, the incentives are not on the basis of revenue generated out of such R&D activities. From 1st April, 2010, this deduction is extended to any manufacturing company. Finance Act, 2009 extended the benefits to any company engaged in the ‘business of bio-technology or in any business of manufacture or production of any article or thing, not being an article or thing specified in the list of the Eleventh Schedule’ in contrast to certain restricted industries like pharmaceuticals and computers prior to the amendment. Acquired patents and copyrights can be written off over a period as per provisions of Section 35A. Thus, while provisions exist to incentivise innovation, no special provisions are envisaged for incentivising commercialisation of innovation, notably patents. It is perhaps time for India to consider incorporating such IP-focussed provisions.
The concept of patent box - so called because it is to be opted for by ticking in a box - has been in vogue since 1973 when Ireland first introduced it. It provided that any person claiming accordingly in the prescribed form ‘shall be entitled to have any income from a qualifying patent arising to him on or after the 6th day of April, 1973, disregarded for all the purposes of the Income Tax Acts, and of the enactments relating to corporation profits tax’. Ireland has subsequently introduced caps to exemption from patent income. Post 2007, the BENELUX countries have put in place some form of a patent box regime.
The discussion paper released by UK in 2010, while making a case for reform and patent box states that IP is mobile and multinational groups have a choice as to where to locate its ownership. But, debate on the real and positive impact of such an incentive scheme continues.
One of the main opposing arguments is that companies already benefitting from monopoly rights do not need further incentive by way of tax breaks. Also tax treatment alone is not a determining factor in deciding where a firm will locate its operations. Further, notwithstanding such concessions as in UK, the state of source of the royalty will have the right of taxation, based on local law and tax treaties. Though generally the treaties provide for a lower of rate of taxation in the state of source of the royalty, an entity will have to structure its operations carefully. A study by Griffith, Miller, and O’Connell (2011) on the relationship between location of intellectual property and tax credits showed that, tax credits affect location decisions. The study also concluded that the revenue lost by way of tax breaks is not offset by increased taxes from increased incomes. The Bio Science Industry Report for 2010, by NZBIO (New Zealand) calls for amending the current tax regime in New Zealand which treats income on sale of patents as part of revenue and not capital gains. It is felt that such treatment is a disincentive to attracting capital into New Zealand companies and also new entities prefer to locate their operations overseas, ‘potentially taking their staff, jobs, activities and assets with them’.
Another argument against singling out patent income for preferential treatment is that calculating the exact income attributable to patents is difficult. In case of a parent and subsidiary (where the latter is working the patent) payments made to the parent would include a host of items like payments for brand name, marketing support etc. Such cost would also push up the value of goods sold. What would form part of cost and how much of income is actually attributable to patents could be subject of much debate between the tax authorities and the assessee. Again where an assessee undertakes production himself as well as licenses patents or, the value of his own brand is included in the cost of goods, complex calculations would be required to arrive at the qualifying income.
The argument of an amalgam of subsidies or incentive schemes distorting the tax structure is loaded against a patent-box like regulation. Profit being a reward for risk-taking should get equal treatment across different sectors of business. It is unfair to discriminate between a patented product and non-patented product when both contribute to economic activity, jobs and earn profits.
But, a patent box like provision does find favour in the ripple effect it creates. Tax breaks to entrepreneurs working patents, help to create jobs and increase productivity contributing to the economy. It should be possible to devise a differential tax structure which incentivises commercialisation of patents without being a tax cut favouring only a few.
[The author is Manager, Lakshmikumaran & Sridharan, New Delhi]