IP companies and substance: no-fly zones?

By: Steef Huibregtse, Mark Peeters, Louan Verdoner and Steven Carey.

Intellectual Property (“IP”) generally represents between 40 percent and 80 percent of ‘value-add’ of MNEs, therefore making it attractive for MNEs to reduce their global effective tax rates by locating IP in a low tax or tax advantaged jurisdiction. This has created a ‘race to the bottom’ mentality amongst some tax jurisdictions with regard to tax rates and substance thresholds in a bid to attract investments and tax revenue. Fast running out of patience with this opportunistic behaviour, the OECD and many tax authorities are now taking significant steps to address this.

Although many favourable jurisdictions have put substance requirements in place and, under increased pressure from the OECD, are adopting exchange of information rules, substance in light of transfer pricing risk management should more appropriately be addressed by MNEs from a corresponding country/OECD perspective, to achieve a balanced risk-return.

With this balanced approach as the end goal, this paper sets out:

• Key tax reference points in relation to how this will be viewed from a tax residency/CFC perspective; substance requirements in general terms;

• OECD transfer pricing references, which can be regarded as a common denominator when assessing the substance thresholds applied by its members;

• Practical guidance to consider when setting up an IP management company in a favourable tax jurisdiction as well as some practical steps to manage the related tax and transfer pricing risks; and

• Country survey of various popular IP holding host destinations: Hong Kong, Luxembourg, Madeira, Mauritius, Singapore, Switzerland and United Arabic Emirates.

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