Transfer pricing issues

Stephen Labrum
Managing director, Alvarez & Marsal Taxand UK LLP
Email: slabrum@alvarezandmarsal.com
Tel: 020 7663 0443

The telecommunications, media and technology (TMT) sector faces numerous transfer pricing issues, the most contentious of which in coming years is likely to concern the treatment of intangibles.

The search for common transfer pricing issues faced by the TMT sector leads to a few key unifying themes. Arguably most significant are intangibles, including marketing intangibles as well as high-value intellectual property and market-access intangibles. These include purchased slices of the 3G and 4G radio spectrums, on which telecommunications companies have spent billions of pounds. Intangibles in these sectors may have very short lives, given the rapid and accelerating pace of technical evolution. Owners of technical intangibles may face considerable risks related to the potential recovery of their development investments.

A second theme is the supply chain. While much of the value lies in the intangibles, cost-efficient manufacturing, involving global procurement and outsourcing models, is highly relevant to parts of the telecommunications and technology sectors.

The theme of risk, particularly in respect of the acquisition or development and ownership of intangibles, is extremely important to the transfer pricing arrangements of companies in these sectors. As explored in greater depth below, the economic importance of risk related to intangibles presents some substantial challenges to transfer pricing professionals who must reconsider their approach in light of the guidance presented by the OECD in the revised draft chapter 6 of the Transfer Pricing Guidelines.

Applying the revised guidance to intangibles

In years past, many transfer pricing discussions related to intangibles focused on legal ownership and economic ownership (see, for example, para. 6.38 of the 2010 Transfer Pricing Guidelines which discusses the special circumstances under which a return would be payable to an entity other than the legal owner). Concerns over substance have always been relevant to the discussion, as tax authorities raised dependent agent, permanent establishment arguments when they believed that income was inappropriately finding its way to a brass plate company with a bank account and purported ownership of intangibles.

The revised chapter 6 has greatly expanded the scope of substance considerations, making them fundamental to the transfer pricing analysis, while reducing considerations of economic and legal ownership to the somewhat secondary status of a ‘starting point’. In the new guidance, four functions are key to the analysis: development, enhancement, maintenance and protection of the intangibles. To be even more specific, the guidance (paras 40 and 54 of the revised draft chapter 6) focuses on:

• which entity performs the most critical functions with respect to the development, enhancement, maintenance and protection of the intangibles;
• which entity bears and controls the risks and costs relating to developing and enhancing the intangibles; and
• which entity bears and controls the risks and costs relating to maintaining and protecting its entitlement to intangible related returns.

While this language is extremely important in the field of transfer pricing, it is somewhat technical in nature, and leads to questions about what it really means in practice to transfer pricing professionals.

The most immediate response to the revised guidance is to review the functional analysis of a business to consider whether the relevant functions have been identified and characterised appropriately. Reminiscent of the key entrepreneurial risk taking functions and significant people functions from the OECD guidance on income attribution to permanent establishments, the guidance is very clear in its focus on functions performed by people as the key driver of entitlement to intangible related returns, rather than the more traditional concepts of legal or economic ownership.

The practical challenge presented by this guidance is to identify which specific actions are covered by the definitions presented above. In some cases, this will be clear, particularly if all of the potentially relevant functions are performed in a single entity. Where it becomes less evident is when teams of people in a number of entities perform functions that potentially meet the definition. While it is possible to consider a model in which there are several contributors to the key functions (in which case the intangible returns might be allocated on the basis of a contribution analysis) it is more likely to be the case that companies choose to select the most relevant functions as the basis for allocating the intangible related returns.

What does this involve in the real TMT world?

As noted above, the importance of intangibles is consistent throughout this sector and, in particular, intellectual property is at the heart of the majority of product and process innovation. As an example, a company may view the process of developing intellectual property as consisting of the following six steps:

• concept vision – developing the entrepreneurial idea;
• initial feasibility testing – technology needs assessment;
• development planning;
• full development, possibly including outsourced research and development, programming etc;
• market positioning and launch strategy; and
• ongoing product development and lifecycle management.

For each of these six steps, there will be significant functions and risk bearing that align with the OECD guidance described above. In the first step, there will be a person or a team who develop an initial idea for a new product, technology or media evolution that might be promising. The initial concept development itself clearly falls within the scope of the key functions, as does the decision to move the concept into feasibility testing and to incur the associated costs and bear the risk of not receiving a return on the investment. As the process continues, further elements of the intellectual property are developed, as the concept moves through the development journey towards becoming a commercial product.

Each step requires key decisions about how the idea is to develop – each of these decisions also involve a degree of risk – such as the decision to invest time and resources in the development process. A sound functional analysis will take stock of these key inputs, and will also identify the key development risks, noting who is responsible for the decision to bear the risks.

At the conclusion of the functional analysis, it will become evident which entity, or entities, should receive the intangible related returns. The next challenge is to determine how much the return should be. The revised OECD chapter offers some clear guidance on this point (see sections D.2–D.4 of the draft revised Guidelines), differing somewhat from the previous guidance and thereby inviting transfer pricing practitioners to ensure they refresh their familiarity with the updated guidance.

Conclusion

The TMT sector faces numerous transfer pricing issues. However, of the multitude of potential issues, the treatment of intangibles is likely to be one of the most contentious in coming years, given the high levels of interest by politicians and tax authorities. The fact that the OECD is in the process of fundamentally updating the guidance relevant to intangibles makes this a very current issue, as multinationals are advised to update their transfer pricing arrangements in 2013 in anticipation of the finalisation of the guidance in 2014.

The most fundamental change in the guidance relates to determining which entity should receive the economic reward for providing valuable intangibles to related companies. The guidance is not ‘business as usual’ with respect to this point – there are fundamental changes which require attention, the most important of which is the need to give priority to the important people functions discussed above. If intangible related profits do not follow the relevant people functions, multinationals should expect serious questions from tax authorities who have witnessed the wrath of both politicians and the public at large to aggressively challenge companies that do not pay the appropriate amount of tax.

CFC reform and intangibles

Jonathan Hornby
Managing director, Alvarez & Marsal Taxand UK LLP
Email: jhornby@alvarezandmarsal.com
Tel: 020 7715 5255

The reformed CFC rules are proving effective as some high profile emigrants in the industry are set to return to the UK.

Dissatisfaction with the controlled foreign company (CFC) regime is one of the key reasons for around 20 UK-headquartered multinationals relocating overseas in the last five years. The ‘old rules’, which evolved in a haphazard fashion after their introduction in the mid-1980s, failed to satisfactorily accommodate modern international business practices. Their application became increasingly unclear, particularly from a European law perspective. Those groups that said goodbye to the UK, temporarily at least, include some high profile names in the TMT sector. This is unsurprising given that much of their enterprise value is underpinned by intangible assets and the old rules were draconian in respect of income from intangibles in situations where the assets in question had little or no nexus with the UK.

However, happily the reformed CRC rules are proving effective as some high profile emigrants in the industry are set to return to the UK. This is welcome timing given the trend towards centralisation to drive cost savings and increased pooling of technology and innovation.

Commencement and overview

These legislative changes apply for accounting periods of a CFC beginning on or after 1 January 2013. The overriding themes are those of a shift towards a more territorial basis of taxation and a removal of the automatic assumption that there has been an artificial diversion of profits from the UK. It is worth noting that, even where the new rules bite, they should only result in an apportionment of those profits that have been adjudged to have been diverted from the UK rather than the entire profits of the entity in question.

Given what is essentially a more relaxed playing field, now is a good time for UK groups in the TMT sector to review the ownership structure of their portfolio of intangible assets, in addition to their structures for the development and acquisition of new brands and technologies to determine the opportunities that may be presented by the new regime. Exemptions and safe-harbours may now be available which were hitherto out of reach.

Application of entity level exemptions

If the new legislation is worked through in the order apparently intended, one can get bogged down quickly in complex ‘gateway’ tests, before getting to the ‘safe-harbours’ and eventually arriving at a series of ‘entity level exemptions’ which, where applicable, take the entire profits of a CFC out of the charge anyway. In practice, the path of least resistance is to start with the entity level exemptions before embarking on the less straightforward analyses required to determine the outcome of the gateway tests.

A full review of the conditions required to meet each of the entity level exemptions is outside of the scope of this article but the ‘excluded territories exemption’ (ETE) is worthy of further consideration in the context of an offshore company that is being used to hold and exploit centralised intangible assets.

The conditions to qualify for the ETE which are set out in detail in TIOPA 2010 Chapter 11 are broadly as follows:

• The CFC must be resident in one of the territories specified in the excluded territories regulations. It is interesting to note that jurisdictions that would present a relatively straightforward option for the tax efficient ownership of intangibles, such as Ireland, are not included in the list of excluded territories which can be found in the Controlled Foreign Companies (Excluded Territories) Regulations, SI 2012/3024.
• The total amount of the CFC’s ‘restricted income’ must not exceed £50,000 or, if greater, 10% of its accounting profit for the period. There are a number of categories of restricted income but the most relevant ones in this context are likely to be:
• income in respect of which the CFC is exempt from tax in the CFC’s territory of residence;
• income which is subject to a reduced rate of tax by virtue of a local law – the main purpose of which is to encourage (directly or indirectly) investment in the CFC’s territory;
• income where, although tax has been paid on it locally, the shareholders or some other related party of the CFC are entitled to a refund of the taxes paid by the CFC;
• non-local income that is effectively offset by a notional interest deduction; and
• income that has been reduced as a result of a ‘one-sided’ transfer pricing adjustment.

The categories of restricted income are particularly relevant in examining whether classic offshore structures for IP ownership employed by non-UK parented organisations in the sector could now be brought into play by UK participants. It seems clear that those IP structures that rely on the Maltese tax refund scheme; the Belgian notional interest deduction; or, Dutch informal capital contributions will all be incapable of satisfying the conditions for ETE.

Less clear is the restriction on income that relates to investment incentives. HMRC’s draft guidance on this area refers to ‘tax holidays’ – potentially a relatively narrow concept. Whereas, the drafting of the statute suggests something altogether much wider and would seem to capture those regimes that offer preferential regimes for the taxation of income derived from IP. Presumably the idea of such regimes is to generate inbound investment for the jurisdictions concerned and would therefore give rise to restricted income.

n   The IP condition must be met – this should be the case provided that none of the CFC’s IP was transferred to the CFC by, or derived from IP held by, a UK related person during the current accounting period or the previous six years. To the extent that part of the CFC’s IP was obtained from the UK, then the UK element cannot be ‘significant’ or alternatively, the value of the IP held by related persons cannot have been significantly reduced by the transfer or derivation.

In summary, the ETE is likely to be of most relevance to groups looking to centralise IP offshore, where the IP in question has no recent connection to the UK. Even where this is the case, if an overall low effective rate of taxation is to be obtained in respect of the exploitation of intangibles, it will be necessary to identify a means of minimising the foreign tax liabilities which does not cause the income generated to fall into one of the categories of restricted income. Depending on how HMRC choose to interpret the ‘tax holiday’ restricted income class, there may be opportunities here. In any case, the availability of the ETE should at least make the compliance process much more straightforward for groups that own intangibles in jurisdictions on the list through vanilla structures.

Application of gateway test: business profits

The new CFC legislation has been designed to ensure that only those business profits that have been artificially diverted from the UK pass through the gateway and therefore suffer a CFC charge. This is approached by employing certain OECD concepts to determine the connection that profits of the CFC have with the UK. A full review of these concepts is outside of the remit of this article but suffice to say that the cost of performing such an analysis is likely to be complex and expensive. Even where profits may filter their way through the gateway, amounts can be excluded should they meet certain other criteria for exclusion. The trading profits exclusion or ‘safe-harbour’ is of particular relevance to an IP holding company that is actively involved in the development, exploitation and protection of that IP. Again, from a practical perspective it makes sense to cut out the middle man and go straight to the safe-harbour as to the extent the conditions are met, all of the CFC’s profits should be excluded from charge in any case.

The conditions for exclusion which are set out in detail in TIOPA 2010 ss 371DF–371DL can be summarised as follows:

• business premises condition: the CFC has business premises in the territory in which it is resident which are occupied and used with a reasonable degree of permanence;
• income condition: no more than 20% of the CFC’s trading income can be derived from UK resident persons;
• management expenditure condition: no more than 20% of the expenditure of the CFC on managing or controlling relevant assets or risks (management expenditure) relates to a member of staff or other individual that carries out these functions in the UK;
• IP condition: this condition is similar to the corresponding condition in the ETE described above; and
• export condition: this relates to CFCs earning income from the export of goods from the UK and is unlikely not to be met in respect of an IP company.

Additionally, the trading profits safe-harbour contains a TAAR that denies the safe-harbour if the conditions would not have been satisfied but for an organisation or reorganisation of a significant part of the business of the CFC’s group, a main purpose of which was to satisfy such conditions.

Where an offshore operation has sufficient commercial substance, and it is not substantially employed in eroding the UK tax base, it should be capable of satisfying the conditions for exclusion. This may afford an opportunity for UK based multinationals to establish regional centres of excellence for IP ownership and development, whilst preserving any tax benefits that may arise from locating such activities in jurisdictions which either benefit from a low tax regime or which have particular incentives over and above those available in the UK for companies that own and develop intangibles.

Even where a particular entity cannot satisfy the detailed criteria of either the ETE or the trading profits safe-harbour, a CFC charge could still be avoided on detailed application of the gateway tests. As those tests are formulated on OECD principles concerning the attribution of profits to an enterprise based on functions and risks, then tax planning based around a solid commercial fact pattern and real economic substance should be effective even if takes a bit more work to get to the desired end result.

The impact of the patent box regime

Shiv Mahalingham
Managing director, Alvarez & Marsal Taxand UK LLP
Email: smahalingham@alvarezandmarsal.com
Tel: 020 7715 5234

Fabrizio Lolliri
Senior director, Alvarez & Marsal Taxand UK LLP
Email: flolliri@alvarezandmarsal.com
Tel: 020 7715 5200

All groups in the TMT space should examine their intellectual property policy to take full advantage of the UK patent box.

The patent box regime was introduced by FA 2012 (introducing CTA 2010 new Part 8A) to encourage investment in the UK by:

• providing an additional incentive for companies in the UK to retain and commercialise existing patents and to develop new innovative patented products here;
• encouraging companies to locate the high-value jobs associated with the development, manufacture and exploitation of patents in the UK; and
• maintaining the UK’s position as a world leader in patented technologies.

The effective date of the legislation is April 2013; the reduced 10% rate of tax will be phased in as follows:

Multinationals in the TMT sector incur significant costs in this constantly changing environment as they develop valuable intellectual property in the form of patents, copyrights, trademarks, designs, know-how and trade secrets. It is therefore important to ensure that this investment and the projected returns are structured in a tax efficient manner, with the UK patent box representing a critical planning tool. 

Revenues in the global TMT sector exceeded $5trn in 2011/12 with growth of 8.1% (source: Bloomberg) – but competitive pressures and changes in the service model brought about by advancing technology have resulted in an on-going need to find cost advantages and we have been approached by a number of industry participants to review global intellectual property policy and structure. It is helpful that HMRC and HM Treasury are supporting businesses aiming to establish what elements will or will not qualify for the reduced rate. At present, income from patents will qualify and the regime does not extend to income from other types of intellectual property. However, all income from the sale of products with a patented element should qualify.

Some industries with the ability to register patents have traditionally relied on other forms of protection. For instance, secrecy where patenting a process might give a foreign competitor important information; or copyright where software is a key part of the product or service delivery. Even where patents are registered in a business, in-house intellectual property lawyers may be selective as to which patents should be applied for and, in which jurisdictions.

It may take some years to explore the practices in a business, and encourage an internal change of policy to start registering patents, but the tax savings on offer for business that do this are vast. In the longer term, it is expected that once a business understands the advantages of involving the UK in its patent processes then the government’s aims should be realised. However, it is difficult to imagine these benefits having an impact if businesses do not take advantage of the value on offer.

Not all patents are within the scope of the patent box rules (for HMRC’s guidance, see its Corporate Intangibles Research & Development Manual at CIRD200000). We recommend the following steps for businesses in the TMT sector (after identifying intellectual property types) to help them determine the application and extent of the patent box regime:

Step 1: Does the business hold a qualifying patent? Qualifying patents include patents granted by:

• the UK Intellectual Property Office;
• the European Patent Office; and
• other EU member states which have comparable patentability criteria, and search and examination practices to the UK.

There is a requirement for legal ownership or an exclusive licence (joint ownership is permitted).

Patents can be developed or acquired; however, the business needs to be actively involved in the patent development cycle.

Step 2: Does the business receive qualifying income in relation to the qualifying patent? Qualifying income will include:

• worldwide income:
• royalties/licence fees; and
• income embedded in patented products;
• compensation and damages;
• income from the sale of patents; and
• patents for the provision of services are not included at present – however as noted, the consultation period is still open.

Step 3: Calculate total profits in relation to the qualifying income. Income from patents should be isolated and finance costs should be excluded. Worldwide profits from all ‘qualifying patents’ may include both new and existing patents, as well as acquired patents (providing they have been further developed).

Step 4: Remove ‘routine’ profit. The regulations suggest a 10% mark-up on tax-deductible expenses as a means of isolating ‘routine profit’. The concept of routine functions is central in transfer pricing regulations and is often defined as functions that are not economically significant and/or are capable of being outsourced. A cost-plus mark-up is considered an appropriate arm’s length return for these services – however, there would need to be consistency with transfer pricing requirements in the relevant jurisdictions.

Step 5: Attribute ‘non-routine’ residual profit to patent and non-patent IP. Non-patent IP will ordinarily include trademarks and trade names and non-patentable intellectual property.

In summary

It is clear that many aspects of TMT intellectual property income will qualify for the UK patent box regime (e.g. newly developed content, valuable software, cloud technology, next generation products). The UK regime was introduced to encourage investment in the UK (and to dissuade groups from moving operations outside of the UK); it is starting to have the desired effect in conjunction with other favourable taxation initiatives in the UK and we recommend that all groups in the TMT space examine intellectual property policy so that they can take advantage of this opportunity.

European comparison for holding intellectual property

Kevin Hindley
Managing director, Alvarez & Marsal Taxand UK LLP
Email: khindley@alvarezandmarsal.com
Tel: 020 7715 5235

Despite the introduction of the UK patent box, the TMT sector will continue to look to the IP holding regimes available in other European jurisdictions.

The UK patent box regime has been criticised for having too narrow a base in that, in general only, patentable technology can qualify for the reduced rate of tax of 10%. This is a particular issue for the TMT industry sector as not all generated intellectual property (IP) will be patentable – for example software development. Indeed, sometimes companies may choose not to patent new technology for commercial reasons, choosing other methods of IP protection instead. So how do some alternative European jurisdictions for holding IP measure up against the UK?

Luxembourg

The Luxembourg IP holding regime works to give an 80% exemption of income from qualifying IP. With a tax rate of 29.22% applicable to Luxembourg City, this gives an effective rate of 5.844% on qualifying income. It is important to understand that the exemption is applied to the net income of the company so deductions for expenses (for example interest payable on debt financing to acquire the IP) are also effectively taken. The base of the regime is relatively broad and includes qualifying IPs such as patents, trademarks, domain names, design or models and copyrights on software. For this reason the Luxembourg IP regime has been popular with consumer brand companies but it can also be a good regime for companies in the TMT sector.

For software development to qualify for the regime it is important that the company is the legal owner of the software as a matter of Luxembourg law and that the IP is not acquired from a related party after 31 December 2007. This means that the company must own all of the source code for the project. For example, if a company develops a piece of software completely on its own, then this should qualify for the regime. However, a company developing software using Java would not qualify as the company would not own the IP relating to the use of Java itself.

As for other incentives, the holding of qualifying IP is exempt from the net wealth tax in Luxembourg.

An incentive is also available for individuals that are relocated to Luxembourg to be part of a research and development (R&D) team. Although not specifically linked to the ownership of IP, incentives for the purchasing of equipment to be used in the R&D process can also be valuable.

Netherlands

The Netherlands hopes to attract TMT companies with the innovation box regime. Similarly to the Luxembourg regime the innovation box works by exempting 80% of the income attributable to the box. As the rate of tax in the Netherlands is currently 25%, this means that an effective rate of 5% can be achieved on qualifying income relating to Netherlands owned IP. Unlike the Luxembourg regime, IP cannot be brought into the Innovation Box and must be self generated.

The base of the innovation box is wider than that of the UK patent box and can be of use to companies in the TMT sector. Patents automatically qualify for the regime but it is also possible to have other forms of IP within the box provided the Dutch government issue a certificate in respect of the R&D activity that is generating the IP. The criterion for the issuance of a certificate is generally that there needs to be some element of innovation. There is some subjectivity around this and it is certainly less well defined than the guidance around what would qualify for R&D incentives in the UK for example.

A common issue in the operation of the innovation box is how to establish the level of profits that qualify. For example, if a company in the TMT sector provides a hardware product to customers that incorporates technology that has an R&D certificate, the issue is how best to calculate how much of the profit relates to the hardware and how much relates to innovation, thereby qualifying for the box. In practice both the taxpayers and the Dutch tax authorities have settled on a residual profit split methodology to deal with cases such as these.

The Netherlands also offers deductions from wage taxes and R&D allowances on costs other than salaries where an R&D certificate is obtained. The R&D allowances take the form of a super deduction of up to 140% of qualifying costs.

The Basque Country

Spain has a patent box regime that exempts 50% of gross income relating to self generated IP, but the Basque Country (technically the regions of Biscay, Alava and Guipuzcoa) have a patent box regime that goes much further.

The Basque Country exempts 60% of gross income in relation to qualifying IP that is self generated or 30% of IP that is acquired from third parties. The regime applies to Spanish resident companies that are based in the Basque Country and foreign entities with permanent establishments there as well. There is a requirement that 25% of the transactions of the company need to be carried out in the Basque Country in order for it to qualify.

The base of the regime is deliberately very broad and includes income, including that from related parties, from patents, models, industrial designs, semiconductor product topography, domain names, plant variety rights, secret formulae and know-how. For this reason the credit can be very important to companies in the TMT sector, particularly those that have no desire or ability to obtain patents for their IP.

The Basque patent box regime is compatible with the R&D tax credit regime and a company can claim both. R&D tax credits in the Basque Country can be worth 30% of R&D costs and sometimes higher depending upon the particular company’s circumstances.

Ireland

Ireland provides an incentive for IP holding through a low rate of corporation tax, the availability of capital allowances on intangible assets and R&D tax credits. If the holding of IP in Ireland entails active exploitation of the IP then the Irish company can enjoy trading status and be taxed at 12.5% on its profits rather than at the usual rate of 25%. In order to obtain trading status it is important that there is sufficient substance in Ireland. This would include a sufficient number of suitably trained personnel, active exploitation of the IP and the incurring of marketing and legal costs in relation to the IP and its defence. Rulings are available from the Irish Revenue in case there is some uncertainty on this.

Capital allowances are available for capital expenditure incurred in the creation and acquisition of intangible assets, including the acquisition of IP. Qualifying capital expenditure can be written off against up to 80% of a company’s income from managing, developing or exploiting the IP. The cost of the intangible asset can be written down in line with the accounting treatment (i.e. depreciation) or over a period of 15 years.

Ireland also has a system of R&D tax credits which can give a super deduction of 37.5%. This is achieved by way of a 25% R&D credit and a trading deduction of 12.5% for R&D expenditure. It is not possible to claim both capital allowances for expenditure on specified intangible assets and to claim R&D credits on the same expenditure. Some employee incentives are also available for those relocating to Ireland to participate in the R&D function.

Conclusion

The UK has some way to go to compete on the international stage for ownership of IP. The base of the patent box is too narrow and the effective rate achievable is not low enough for a compelling case to be made to centralise IP in the UK in the absence of other commercial drivers. For this reason companies in the TMT sector will continue to look to the IP holding regimes available in other European jurisdictions.

An in-house view on the tax and commercial pressures

Businesses in the TMT sector have fewer physical and more intangible assets than those in many other sectors and the products provided to customers are often intangible. Much of the law and practice in tax has developed to deal with the manufacture, distribution and sale of physical goods and international tax law is still struggling to catch up. Answers to questions such as exactly where profits are earned, how costs should be allocated and whether withholding taxes should be applied are often far from clear. The work in progress at OECD on the taxation of intangibles is therefore very welcome although companies in this field need to be responsive to the changing environment. The most noteworthy trend, reflected both in the UK and at OECD, is the focus on significant people functions as the prime generator of value. For TMT companies this has implications for the location of key executives but it is very important that policy-makers and tax administrators, as well as in-house tax professionals and advisers, do not lose sight of the importance of the location of existing assets and of risk taking. As with any other sector business risk should be appropriately rewarded where it has been assumed. Even more importantly it is easy to allow our excitement about new platforms, delivery systems, exciting gadgets and novel functions to distract from the key value driver which, at the end of the day, is content. The most scintillating delivery system in the world will fail commercially without good quality content behind it. The owners of content should therefore be appropriately rewarded for their contribution to the business.

The patent box has been widely welcomed and does provide incentives for research and development activity. For many businesses in the TMT sector, however, much of the intellectual property will not be patentable but, rather, will consist of copyrightable content, software or data. With attractive regimes available in other countries the UK will need to keep on the agenda the potential broadening of the patent box to include these categories of intangible assets if it is to remain truly competitive.

The OECD, European Commission, G8 and authorities in the UK are focussing on the problems of base erosion and profit shifting (BEPS) and following recent media coverage the use by multinationals of tax planning strategies which result in base erosion or profit shifting has come under a very sharp focus. Businesses in the TMT sector are under as much competitive pressure as those in any other sector and will need to respond by becoming more efficient, lower cost, nimbler and better at harnessing the very latest technology developments. In order to do this they will have to centralise their operations, research and development and customer fulfilment and this means moving functions to central locations. Tax will usually be a secondary consideration, after business essentials have been fully addressed, and the challenge for tax authorities and other stakeholders will be to differentiate between those cases where the TMT business has undertaken a real and necessary reorganisation and those where a tax planning strategy has been effected. Tax authorities will need to understand their customers very well indeed to accurately characterise complex business model changes.

The TMT sector is very global and it is quite possible for a supplier in any country to provide customers in any other country, and any other time zone, with services. Competition is intense and it is particularly important to avoid obstacles to domestic businesses which make it more attractive for a customer to purchase from a non-UK supplier. One example of a problem in this context is the rate of VAT on electronically supplied materials. E-books are subject to 20% VAT in the UK but lower rates of VAT in some other countries. For example, an e-book sold to a consumer from Luxembourg is currently subject to 3% VAT so a supplier selling an e-book from a sales office in Luxembourg has a substantial advantage over a UK business. This particular issue will be resolved in 2015 when new rules will mean that the rate of VAT applicable in the country in which the customer is based will apply to sales to consumers although it may be resolved sooner as the European Commission is taking proceedings against Luxembourg on the grounds that the rate is excessively low. There remains the difficult issue of paper books being zero rated while e-books are subject to 20% VAT, a poor incentive to migrate from paper publication to the more efficient digital world. 

See Reports for recent in-depth reports examining the tax issues affecting other business sectors:

• The pharmaceutical industry (by KPMG)
• Property (Taylor Wessing)
• Banks (Freshfields Bruckhaus Deringer)
• Not-for-profit (PKF)
• Insurance (Norton Rose)
• Infrastructure (Pinsent Masons)
• Oil and gas (Herbert Smith)