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Aug. 17 — Draft legislative language intended to offer a sharply discounted 10 percent tax rate on money U.S. firms make from foreign sales of their most innovative products is written so broadly that it could apply to nearly anything sold.
The innovation box plan released by Reps. Charles Boustany Jr. (R-La.) and Richard E. Neal (D-Mass.) covers more industries than previous efforts to incentivize companies to base their intellectual property stateside and the effect could be that it would be hard for the IRS to draw the line between what gets the lower rate and what doesn’t.
“My guess is that it’s the intent of the authors that it be broad,” says Joe Kennedy, a senior fellow at the Information Technology and Innovation Foundation.
Released in late July, the proposal from the two Ways and Means Committee members would create an effective 10 percent tax rate for certain income arising from patents and other qualifying intellectual property, and allow for the repatriation of certain IP tax-free until it is sold.
The draft is still in its infancy, and lawmakers—including Senate Finance Committee ranking member Ron Wyden (D-Ore.)—said they plan to dive into its details during the summer break.
However, some issues are already emerging that will likely draw consideration from the Ways and Means Committee when work starts on crafting a final bill. Namely, members must make the hard choice of clarifying what intellectual property qualifies for the deduction.
The Boustany-Neal draft says that qualifying gross receipts for determining innovation box profit would include income from a patent, invention, formula, design, pattern, know-how or any product made by using such properties. Additionally, under the draft, companies can include income from motion picture films, videotape or computer software.
That is a much broader approach compared to the patent box plan released in 2012 by Boustany and former Rep. Allyson Schwartz (D-Pa.). The Manufacturing American Innovation Act—which failed to advance out of committee—limited the reduced tax rate to patents only.
A wide range of industries likely would make the argument that their product falls into the patent box calculation, Kennedy said.
Peter Merrill, principal at PricewaterhouseCoopers LLP, put it more bluntly. “There is no product that I can think of that isn't produced using either a patent, invention, a process, a formula, a design, pattern or know-how,” Merrill said.
And lawmakers should expect pressure from anxious stakeholders.
“No doubt they will get lobbied to make it narrower and make it wider and get approached from industry as to whether it will apply to them,” Kennedy said.
Despite the potential for broad interpretation, some software may slip through the draft's generous legislative language and not qualify. Cloud-based software isn't sold or otherwise disposed of in a way that the draft would cover; the product is sold as a service. Software industry representatives say that the language appears to rely on an outdated notion of how the digital economy operates.
Boustany and Neal are aware of the broad definition of qualified property in the draft. In fact, this is question No. 1 in an eight-part request for feedback released by the committee to stakeholders.
• which costs or expenditures for innovation not mentioned in the draft should be included;
• how expenses allocable to innovation profits should be determined;
• how compliance burdens could be minimized;
• how an innovation box deduction should coordinate with the research and development credit and the deduction under Section 179;
• if transition rules would be necessary to implement the innovation box deduction;
• whether an innovation box would help U.S. companies remain competitive globally; and
• the extent to which gross receipts from services related to a product that uses qualified property would be determined in the patent box calculation.
The definition of qualifying property was expanded in the new plan, but two other sections were narrowed in the Boustany-Neal legislation compared to Boustany's 2012 effort.
Gone under qualifiable IP profit are “routine profits,” defined by the 2012 bill as a taxpayer's cost of goods sold for the taxable year allocable to patent gross receipts minus the sum of the cost of raw materials, cost of items purchased for resale and costs of intangible property right such as royalties, all multiplied by 15 percent.
Also left out of the new innovation box plan is the requirement that “more than a substantial percentage” of a qualified property's value be derived from the use of qualified patents in order for its income to be considered gross receipts.
Kennedy said a budget score of any patent box proposal will be highly anticipated by the Ways and Means Committee.
And a U.S. patent box wouldn't come cheap. George Callas, a Ways and Means staffer who has worked for both Chairmen Dave Camp (R-Mich.) and Paul D. Ryan (R-Wis.), said at a May 8 conference that a U.S. regime could potentially cost “hundreds of billions of dollars” as scored by the Joint Committee on Taxation.
However, thanks to a congressional Republican policy change at the beginning of the year, some federal scoring will include dynamic results as well, meaning government analysts will take into account a bill's effect on the market and individuals' behavior when calculating economic impact.
A patent box measure is ripe for dynamic scoring, Kennedy said.
“This would be one particular provision where you would expect a significant dynamic factor in which you can argue there is a record of dynamic results,” he said.
Early reports indicate that research and patent application have increased in some countries with patent box regimes, Kennedy said.
“So I think CBO would have to attach some positive dynamic effect to it,” Kennedy said. “How big? Nobody knows yet and that's one of the things the committee is going to look for.”
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Text of the Boustany-Neal request for feedback is at http://waysandmeans.house.gov/wp-content/uploads/2015/07/2015-07-29-Boustany-Neal-Innovation-Box-Questions.pdf.
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