U.S. Tax Reform and BEPS Action 5 - the EU Spots the Missing Nexus


Last week, this blog suggested that part of the Senate’s tax reform bill, passed on December 2, might be in breach of BEPS Action 5. The relevant provision is one that seeks to establish a 37.5% deduction on part of a U.S. corporation’s “foreign-derived intangible income”. This would produce an effective rate of 12.5% on such income compared to the proposed new general corporate tax rate of 20%. In short, it is a patent box in all but name. It therefore falls squarely within BEPS Action 5 which requires such a regime to have a “direct nexus between the income receiving benefits and the expenditures contributing to that income”. And yet, as the blog pointed out, there is no sign of any nexus requirement in the Senate’s bill.

This has not escaped the attention of the finance ministers of the EU’s five largest economies – Germany, the UK, France, Italy and Spain. In a letter to U.S. Treasury Secretary, Steven Mnuchin, released on Monday, they wrote that the Senate’s proposal, “in deviation of the agreed nexus approach, . . . will provide benefits to income from IP assets that are in no direct connection with R & D activity”.

The finance ministers have other issues with the proposed regime. Its design, they complain, “is notably different from accepted IP regimes by providing a deduction for income derived from intangible assets . . . such as branding, market power, and market-related intangibles”. In addition, by providing preferential treatment for exports, the proposal “could . . . face challenges as an illegal export subsidy” contrary to WTO rules.

The ministers concluded their letter to Mnuchin by expressing their confidence that “you will find a wise and well-balanced compromise in your mission to create a modern and robust new U.S. tax code”. It remains to be seen whether that confidence is well-placed.

By Dr Craig Rose, Technical Editor, Bloomberg Tax

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