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Publisher : Elsevier - Science Direct (الزویر - ساینس دایرکت)
Journal : Journal of International Economics, Volume 88, Issue 1, September 2012, Pages 176–185
Corporate patents are important assets in the modern economy, where knowledge is highly valued. In many multinational enterprises (MNEs), they constitute a major portion of the business's value. The intra-firm transfer pricing process for patent-related royalty payments is moreover often highly intransparent and patents thus represent a major source of profit shifting opportunities between multinational entities. For both reasons, MNEs have an incentive to locate their patents at low-tax affiliates to minimize the corporate tax burden. The purpose of our paper is to empirically test for this relationship by exploiting a unique dataset that links information on patent applications to micro panel data for European MNEs. Our results suggest that the corporate tax rate (differential to other group members) exerts a negative effect on the number of patent applications filed by a multinational affiliate. The effect is quantitatively large and robust to controlling for firm size and unobserved heterogeneity between the entities. The findings moreover prevail if we account for royalty withholding taxes and binding ‘Controlled Foreign Company’ rules.
Anecdotal evidence suggests that multinational companies strategically locate ownership of their intellectual property at tax-havens, with the intention of minimizing their corporate tax burden. For example, the Wall Street Journal reports that Microsoft, a company which earns three-fourths of its revenue from license fees, is “increasingly setting up units in Ireland that route intellectual property and its financial fruits to the low-tax haven” (Wall Street Journal, 2005). In the UK, the Guardian writes that “three FTSE 100 companies have quietly transferred their valuable intellectual property to low-tax locations”, meaning that “they can reduce their UK-based profits and hence their British tax bills” (The Guardian, 2009). The rationale behind locating intellectual property at low-tax affiliates is two-fold. First, intangible assets are increasingly perceived to be important value-drivers within multinational enterprises (MNEs) (e.g. see Hall, 2001 and Zingales, 2000). Locating them at low-tax affiliates is thus an attractive tax saving strategy as it implies that the intangibles' profits become taxable at a low corporate tax rate. Second, the common good nature of intellectual property involves that it is used as an input factor by several operating affiliates within the multinational group which then pay a royalty or license fee to the intangibles-owner (see e.g. Markusen, 1995). As arm's length-prices for these firm-specific royalty payments are commonly not available to tax authorities, MNEs can distort royalty prices in order to shift profit between the operating entities and the intangibles-owner. Consequently, it pays for the MNE to locate its intellectual property in a low-tax country as this establishes a profit shifting link between all operating affiliates and a tax-haven subsidiary (see also Dischinger and Riedel, 2011).2 Tax authorities have raised increasing concerns about the relocation of intangible assets to low-tax countries and the associated reduction in their country's corporate tax base (see Hejazi, 2006). Nevertheless, studies which go beyond anecdotal evidence and investigate the link between corporate taxation and the location of intellectual property in a systematic empirical framework are scarce as information on intellectual property ownership is commonly not available in standard firm data sets. In the following, we will investigate this relationship by exploiting a new and unique data source that connects accounting and ownership information for a large panel of European multinational affiliates with data on patent applications to the European Patent Office (EPO). Thus, our analysis focuses on the location of corporate patents as a particular form of intangible property. The data is available for the years 1995 to 2003. To identify the impact of corporate taxes on multinational patent location, we additionally merge information on various aspects of the corporate taxation system. Following our argumentation above, we account for the host country's corporate tax burden (as measured by the statutory corporate tax rate) and the relative attractiveness of an affiliate's corporate taxation scheme compared to other firms in the multinational group (as measured by the corporate tax rate differential between the entities). Moreover, our analysis takes into account that the effective tax burden on patent-related royalty income may be affected by withholding taxes on royalty payments and so-called Controlled Foreign Company (CFC) rules. The latter are designed to refrain MNEs from avoiding taxes in their residence country by making passive (patent) income earned at low-tax subsidiaries taxable at the parent location. We assess the link between corporate taxation and the number of patent applications in various empirical specifications. Our most preferred model is a negative binomial framework which controls for affiliate fixed effects. The results suggest that both, the corporate tax rate and the tax rate differential to other group affiliates, exert a negative impact on the firm's number of patent applications whereas the effects are robust against the inclusion of time-varying country characteristics and affiliate size controls. Quantitatively, the coefficient estimates are sizable, implying semi-elasticities of around − 3.5. Thus, the regressions indeed suggest that MNEs distort the location of patents in favor of affiliates with relatively low corporate tax rates. Moreover, we find that the negative effect of taxes on the number of patent applications prevails if we construct tax measures that additionally account for withholding taxes on royalty income and binding CFC legislations. Our study contributes to the literature on multinational income shifting. A growing number of papers have provided empirical evidence which suggests that MNEs transfer profits from high-tax to low-tax affiliates in order to diminish their corporate tax burden (see e.g. Devereux, 2007 and Huizinga and Laeven, 2008). Recent work has connected these multinational profit shifting activities to the ownership of intellectual property.3 The idea is that arm's length prices for intra-firm royalties charged for the use of firm-specific intangible assets are hardly observable to tax authorities and that multinationals can thus easily distort the associated transfer prices and shift profits to low-tax countries. This notion is confirmed by a set of empirical papers which show that profit shifting activities are larger in MNEs with high intellectual property holdings and high R&D intensities (see e.g. Grubert, 2003). However, in contrast to our work, these papers neglect that corporate taxation may distort the location of intangible assets itself as MNEs have an incentive to ensure that their patent returns are taxable at a low rate and that profit shifting channels to low-tax countries are available to operating affiliates worldwide. In this sense, our analysis is most closely related to two recent papers: Mutti and Grubert (2008) provide evidence that US MNEs structure their operation in such a way that royalty income accrues with foreign subsidiaries in low-tax countries. However, as they do not observe information on patent ownership or license agreements, their evidence is indirect. Dischinger and Riedel (2011) find that the corporate tax rate exerts a negative effect on the size of intangible property assets, as reported on company balance sheets. However, using balance sheet data has limitations as it does, for example, not allow for a disaggregation of the legal assets which constitute the reported intangible asset figure whereas our study focuses on a clearly identified form of intellectual property. Moreover, our paper is related to a small literature that investigates how the tax system affects the location of R&D activity within multinational companies. For the US, Hall (1993) and Hines (1994) study the responsiveness of corporate R&D to the Research and Experimentation Tax Credit and find significant R&D price elasticities. Similarly, Hines and Jaffe (2001) determine how US R&D expense deduction rules affect the location of R&D by US multinationals.4Bloom et al. (2002) confirm a significantly positive effect of R&D tax credits on the level of R&D expenditures using macro data for major OECD countries. However, all of the cited papers focus on the role of R&D tax credits and abstract from potential effects of the corporate tax system on the location of the legally protected output to R&D activities, i.e. the corporate patents. Our study fills this gap and assesses the impact of corporate taxation on the choice of patent location accounting for various tax incentives, including the statutory corporate tax rate, withholding taxes and CFC legislations. The paper is organized as follows. Section 2 presents theoretical considerations to motivate our empirical analysis. 3 and 4 describe the data set and the estimation methodology. In Section 5, we present the empirical results and Section 6 concludes. 2. Theoretical considerations This section explores how the international corporate tax system may affect patent ownership within multinational firms.5 The discussion then leads on to Section 3, where we construct the tax variables used in our empirical analysis. The value of a patent stems from its provision of a temporary monopolistic right to exploit the associated technology within a given geographic area. Any party that wishes to use the technology in that geographic area will have to pay a royalty fee to the patent owner. To avoid knowledge dissipation, MNEs have a tendency to sell the right to exploit a patented technology to affiliated companies only (see Introduction) whereas the latter are forced, by the transfer price system, to pay a royalty to the patent owner. While in many cases the inventor of the technology is also the owner of the associated patent, our data suggests that the location of R&D activities and the resulting patents can also be geographically separated within multinational groups, as the locations are split in a non-negligible number of cases.6 The MNE's decision where within the group to locate its corporate patents is expected to be influenced by a set of tax considerations. First, patents belong to the most valuable assets within many multinational firms (see e.g. Hall, 2000, Hall, 2007 and Hall et al., 2005) and as their income becomes part of the owner's corporate tax base, MNEs have an incentive to locate production and ownership of their patents in a country with a small corporation tax.7 This incentive is especially strong as patented knowledge (like other intellectual property) has a trade price of zero and the location of patents and output production can hence be geographically separated at low costs. It is moreover well-known that MNEs do not patent all new inventions but may opt for secrecy instead. A simple model presented in an earlier working paper version shows that the incentive to patent a technology decreases in the host country's corporate tax rate. Precisely, from a taxation perspective, the major difference between patenting and secrecy is that know-how within a firm is more difficult to observe and to evaluate for fiscal authorities than a patent. A patent immediately attracts taxable income as the know-how manifests and the subsequent users in the production chain have to finance the intellectual property. With an informal use of know-how within an MNE, in contrast, income related to intellectual property accrues with the operating affiliates, e.g. through increased prices charged to final customers (see Ernst and Spengel, 2011). Patenting is thus an attractive strategy in low-tax countries as it attracts income from operating affiliates in high-tax economies and reduces the MNE's overall tax burden. Second, not only the host country's corporate tax burden may be decisive for the location of multinational patents but also the affiliate's relative attractiveness as a patent location, in comparison to other firms within the same multinational group. We thus construct a tax variable which calculates the tax rate difference between the considered affiliate and other firms within the MNE. This variable is also expected to capture profit shifting incentives since locating a patent in a country with a low tax rate and then selling the right to use this patent from there to high-tax affiliates in the same group, opens up profit shifting opportunities between the high-tax locations and the patent-holding affiliate in the low-tax economy. 8 Third, if royalty income is paid across a national border, the country of the royalty paying party usually charges a royalty withholding tax on the income stream. To avoid international double taxation, royalty receiving countries commonly apply a tax credit for the withholding taxes already paid before assessing the income stream at their corporate tax rate. Consequently, the effective tax burden on international royalty payments is determined by the size of the corporate income tax at the royalty-receiving country in relation to the size of the withholding tax imposed by the royalty-paying country. If the receiving country's corporate tax rate is higher than the withholding tax paid at source, a credit will be provided for the tax already paid, meaning that the royalty income is effectively taxed at the statutory tax rate of the royalty-receiving economy. In this scenario the withholding tax rate does not affect the corporate after-tax income and consequently the patent location decision. However, if the royalty-receiving country's corporate tax rate falls short of the withholding tax paid at source, the tax rebate is commonly restricted to the corporate income tax due. In this scenario, royalty income is effectively taxed at the withholding rate which generates incentives for the MNE to locate patents in countries with favorable bilateral tax treaties in order to ensure low withholding taxes on the income stream. Last, our analysis accounts for so-called ‘Controlled Foreign Company’ (CFC) rules which intend to prevent companies from avoiding taxes in their residence country by diverting income to subsidiaries in low tax jurisdictions. CFC rules operate by imposing an immediate tax charge at the level of the parent company on income earned in a foreign subsidiary if a set of criteria is fulfilled. The criteria vary across countries but in essence include an ownership threshold (e.g. the parent must hold more than 10% of the equity in the subsidiary), a tax threshold (e.g. the foreign tax paid on the subsidiary income must be less than 60% of the tax that would have been paid had the income been generated at the parent's location), and a threshold which specifies that a certain proportion of the subsidiary's income must arise from ‘passive’ or ‘tainted’ sources (e.g. a fraction greater than 5%). In most national CFC laws, royalties are considered to be passive income. If the CFC criteria for a given subsidiary are satisfied, the passive income of that subsidiary is effectively taxed at the corporate rate of the parent location, even if the income is not repatriated. Summarizing, this section suggests that MNEs have an incentive to locate their corporate patents at affiliates which observe a low corporate tax burden relative to other group members and do not face binding CFC legislations. From a practical point of view, MNEs can exploit different organizational structures to achieve a (re)location of patents to low-tax economies. First, they may obviously shift whole R&D units to low-tax affiliates. As this, however, may involve considerable costs, practitioners claim that a more often applied structure is to engage in subcontracting agreements in which the R&D head office is located in a low-tax country and subcontracts research to operating R&D units at other affiliates. The latter earn a fixed margin on their costs while the head office bears the project risk, receives the associated patent rights and earns all residual profits. Apart from subcontracting agreements, affiliates may moreover also engage in cost-sharing arrangements in which several affiliates share the costs and benefits of developing a (later patented) technology. If appropriately structured, these cost sharing agreements allow MNEs to assign an overproportional amount of profits to low-tax affiliates. In the following, we will empirically test whether and to what extent MNEs engage in these relocation activities by exploiting information on patent applications of multinational affiliates.9 The next section will describe our dataset and the construction of the tax variables used in our empirical analysis.
نتیجه گیری انگلیسی
Anecdotal evidence suggests that patents and other intangible assets play a decisive role in profit shifting strategies of multinational enterprises. Several firms are known to hold their patents and trademarks in tax-haven countries like Ireland and Switzerland, famous examples are Vodafone, Pfizer and Microsoft. Although tax authorities in various countries have raised increasing concerns about these intangibles relocations, studies which test for the link between corporate taxes and the location of intangible assets in a systematic empirical framework are scarce. This paper exploits a new and unique data set which links company accounting data to information on patent applications to the European Patent Office in order to investigate whether and to what extent corporate taxation affects the patent location within multinational groups. Our results suggest that the corporate tax rate exerts a strong negative impact on a subsidiary's number of patent applications. The effect appears across a range of model specifications and is robust against controlling for affiliate size, firm fixed effects and time-varying country characteristics. Similar findings are reported if we account for the relative attractiveness of an affiliate's tax scheme by using the tax rate differential to other group members as explanatory variable. Moreover, the estimated effects prevail if we additionally account for the role of withholding taxes on royalty payments and CFC legislations. Thus, our findings indeed suggest that MNEs tend to distort the location of their corporate patents in favor of low-tax affiliates. As patented technologies are considered to be drivers of future profits and simultaneously constitute a major source of transfer pricing opportunities within multinational groups, their relocations are likely to shift relevant volumes of profit to low-tax economies. Consequently, governments have an incentive to compete for these mobile profits by reducing their corporate tax rates in order to attract multinational patents to their jurisdiction. The European Union currently appears to experience this type of tax competition behavior as the Netherlands, Belgium and Luxembourg have recently introduced special low tax rates on royalty income from patent holdings. Moreover, as the latest addition, the UK recently announced the introduction of a patent box from 2013 onwards. This in turn puts pressure on high-tax economies with large R&D activities to restrict the migration of patents and other intangible assets from their borders. One means of limiting this outflow is to introduce or tighten CFC legislations which make foreign royalty income taxable at the parent location. Examples of countries which recently introduced CFC rules are Spain and Italy. Furthermore, several countries currently consider the introduction of another anti-avoidance instrument which was implemented by the German government in 2008 and allows the German tax authorities to tax a fraction of the future income generated from patents and other (intangible) assets developed in Germany even after the relocation to a foreign country (see OECD (2009)). In the light of our results, such limitations appear beneficial as they hamper international profit shifting and tend to reduce tax competition behavior between countries.