The Portuguese intellectual property box: issues in designing investment incentives

• DOI: https://doi.org/10.1108/JITLP-11-2017-0044
• Pages: 86-102
• Published date: 25 July 2018
• Date: 25 July 2018
• Author: António Martins
• Subject Matter: International business law,International economics,International trade

The Portuguese intellectual

property box: issues in designing

investment incentives

Ant

onio Martins

Department of Economics and CeBER, Universidade de Coimbra,Coimbra, Portugal

Abstract

Purpose –The purpose of this paperis to discuss tax and accounting issues related to the evolutionof the

intellectual propertybox in Portugal and present a preliminary view of its impact. In 2014, Portugal adopted

an Intellectual Property(IP) box, exempting from corporate taxationhalf of the gross revenue obtained from

selling IP rights. In 2016, the country adopteda new IP regime, in line with BEPS’recommendations, with

stricter rules for exempting income. The “modif‌ied nexus approach”, recommended by the OECD, was the

cornerstone of legal changes. The research questions addressed in this paper are as follows: was the

Portuguese IP box, set up in 2014, internationally competitive in terms of the scope of qualifyingassets and

the tax rate when compared to other EU countries? Could its legal design induce potential corporate tax

avoidance? Does the new IP box framework reduce avoidance opportunities and does it increase tax and

accountingcomplexity for companies and tax auditors?

Design/methodology/approach –The methodology used in this paper is based on the legal research

method combined with a case study analysis of the IP box in Portugal. The economic motivation for legal

changes, the interaction between the tax authorities and the policy makers in the wake of BEPS’

recommendations, and the economic crisis that Portugal faced, inf‌luenced legislative options. A

multidisciplinaryapproach is required to analyse the IP box modif‌ications, and the methodology follows this

line of enquiry.

Findings –The author concludes that the 2014 IP box was not competitive in terms of the scope of

qualifying assets and the tax rate. However, it couldbe a potential tool for tax avoidance, mainly linked to

transfer pricing strategies. Legal changes, introduced in 2016, by enacting stricter rules for granting tax

benef‌its, f‌it a worldwide trend of restraining prof‌it shifting opportunities linked to intangibles. The new

framework clearlyimpacts tax and accounting complexity, for companies and tax auditors. Preliminarydata,

for 2014 and 2015, showa negligible impactof the IP box on corporate taxation.

Practical implications –The “modif‌ied nexus approach”is not a def‌initive panacea for f‌ighting tax

avoidance. Multinationalsmay move resources (e.g. highly specialized persons)to entities that are developing

IP, curtailingthe restriction associated with acquiring services from relatedparties. Tax authorities may f‌ight

these schemes, but facea challenging task. The grandfathering option andnew accounting choices related to

expense allocation are delicateissues. Not all countries adopted BEPS’recommendations at the same time,

which may impact international prof‌it shifting activities and increase tax authorities’coststo control them.

The paper also providespreliminary and exploratory evidence that IP boxes, per se, do not suddenly raise the

R&D activityof f‌irms.

Originality/value –The analysis highlights legal, accounting and economic issues in dealing with

changes in investmentincentives and can or may be a useful remainder for countries in the processof setting

up, or amending,IP boxes.

Keywords Investment, Intangibles, Portugal, Intellectual property box, Tax incentives

Paper type Research paper

The author is grateful for the remarks of two anonymous reviewers, which were helpful in improving

the paper. The usual disclaimer applies.

JITLP

17,3

86

Received26 November 2017

Revised3 February 2018

9 April2018

Accepted22 April 2018

Journalof International Trade

Lawand Policy

Vol.17 No. 3, 2018

pp. 86-102

© Emerald Publishing Limited

1477-0024

DOI 10.1108/JITLP-11-2017-0044

The current issue and full text archive of this journal is available on Emerald Insight at:

www.emeraldinsight.com/1477-0024.htm

1. Introduction

Intellectual Property (IP) box tax regimes should cover a wide range of income, encourage

innovation and be easy to administer (McAlister, 2011). Investment in intangibles, seen as

crucial to economic growth, is the main focus of IP boxes. A desirable IP box should attract

real and substantial innovative activity and minimize tax avoidance opportunities (Evers

et al., 2015).

In 2014, Portugal adoptedan IP box, exempting from corporate taxation halfof the gross

revenue booked from selling IP rights. The purpose of the IP regime was to create a

favourable taxation for IP-relatedincome, aiming at fostering innovation[1]. The Portuguese

regime was potentially prone to tax avoidance, by allowing intercompany related

transactions as a prof‌it shifting strategy.The OECD (2013) developed the Base Erosion and

Prof‌it Shifting (BEPS) project and paid special attention to intangibles held by

multinationals.Much of their prof‌it shifting is linked to IP transactions (Kleinbard,2012).

The BEPS project addressed IP boxes and recommended preferential treatment only to

income derived from substantial innovative activities effectively carried out by taxpayers.An

European Union Directive[2]–laying down rules against tax avoidance practices affecting

the functioning of the internal market –also addressed the issue of f‌ighting tax avoidance

related to IP boxes. This is supposedly achieved through the adoption of the “modif‌ied

nexus approach”, which assesses whether there is substantial research and development

(R&D) activity effectively carried out by companies benef‌iting from IP boxes. In 2016,

Portugal adopted a new regime,in line with BEPS’recommendations, with stricter rules for

qualifying IP income (Ernstand Young, 2016).

The research questions addressed in this paper are as follows: was the Portuguese IP

box, set up in 2014, internationallycompetitive in terms of the scope of qualifying assets and

the tax rate when compared to other EU countries? Could its legal design induce potential

corporate tax avoidance? Does the new IP box framework reduce avoidance opportunities

and does it increase tax and accountingcomplexity, for companies and tax auditors?

Legal changes enacted in 2016, establishing stricter rules for granting tax benef‌its, f‌ita

worldwide trend of restraining prof‌it shifting opportunities linked to the use of intangible

income. The new framework also presents additional sources of accounting and tax

complexity for companies and tax auditors. Preliminary data show a negligible use of IP’s

tax benef‌its, in 2014 and 2015.

The “modif‌ied nexus approach”is not a def‌initive panacea for f‌ighting tax avoidance.

Multinationals may move resources (e.g. highly specialized persons) to associated entities that

are developing IP, curtailing the restriction linked to the acquisition of services from related

parties. Tax authorities may audit these schemes, but face a challenging task. Accounting

issues, emerging from the computation of intangibles’net income and expense allocation, are

now of greater relevance, as explained later when dealing with the new (2016) Portuguese IP

box. Not all countries adopted BEPS’recommendations at the same time, which may impact

international prof‌it shifting activities and increase tax auditing costs (Herzfeld, 2017). The new

IP box has a grandfathering clause, allowing the previous (2014) system to be applied until 2021.

It is not diff‌icult to anticipate corporate accounting policies being used to make imputations to

old IP projects (more favourably taxed). Tax authorities may f‌ight accounting/tax manipulation

schemes, but litigation will probably follow. The paper also provides preliminary and indirect

evidence that IP boxes, per se, do not suddenly increase the R&D activity of f‌irms. In 2015, only

three Portuguese f‌irms benef‌ited from the old regime, and 2m euro (a negligible amount in the

context of corporate income tax data) were deducted to the total tax base.

Literature about IP boxes has been mainly addressing their impact on investment

location (Dischinger and Riedel, 2011), avoidance strategies (OECD, 2013), impact on

Designing

investment

incentives

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