Patent Boxes Benefit MNEs Rather than Governments, say EconPol Researchers

Research from EconPol Europe into the use of so-called ‘patent boxes’ by multinational enterprises (MNEs) reveals an increase in pre-tax profits of 8.5% for the MNEs. However, there is little evidence to suggest governments which operate the system receive any benefit, and could even experience a reduction in revenues.

The use of patent boxes, which grant preferential tax treatment for the income earned from successful innovations and related intellectual property (IP) rights, has increased rapidly in the European Union in the last decade. Critics of the system, including the OECD, say the unregulated practice is harmful as it offers profit-shifting opportunities for MNEs.

Researchers Marko Koethenbuerger, Federica Liberini and Michael Stimmelmayr (ETH Zurich) have disentangled the effects of the preferential tax treatment of IP income in European countries. They provide a comparison of pre-tax profits of firms in patent box countries - before and after the introduction of patent boxes – and provide the comparison for two types of firms: affiliates that belong to a MNE and those that belong to domestic conglomerates. Only the former is able to use the patent box for international profit shifting. Changes in pre-tax profits of the latter are indicative of productivity effects of patent boxes.

The research shows that 3.5% of the increase in pre-tax profit is due to productivity effects through the usage of IP, while the remaining 5% of the increase relates to profit shifting and combines two counteracting behavioral responses: MNEs shift profits into the patent box country, which increases pre-tax profits by 15.2%. However, 10.2% of the increase in pre-tax profit does not remain in the patent box country and is shifted out of the treated affiliate through interest payments among affiliates of the MNE.

The net tax revenue effect of the overall profit shifting response, therefore, could be negative. In-shifted profits are taxed at the lower patent box tax rate, while the out-shifted profits get subsidized at the regular corporate tax rate.

“Surprisingly, the profit shifting effect includes an unintended, reversed profit shifting out of the affiliate,” say the report’s authors. “Contrary to expectation, the overall tax base adjustment might lower tax revenues collected from MNEs.

“The shifting behavior of MNEs has a possibly surprising influence on corporate tax revenues. Albeit only a fraction of the incoming profits leaves the patent box country again via internal debt arrangements, the type of ‘round tripping’ is costly for the patent box country. It certainly lowers corporate tax revenues and might even lead to a reduction in revenues that the patent box country collects from MNEs.”

See the full paper: http://www.econpol.eu/publications/working_paper_29

For further information about the research, contact Prof. Dr. Marko Köthenbürger at  koethenbuerger@kof.ethz.ch

For further information about EconPol Europe contact Juliet Shaw at shaw@econpol.eu, or 0034 686481877/0044 7837 360470