Master Thesis LLM International Business Tax Law

Intellectual Property Tax Planning in the EU Common Market

The Anti-Tax Avoidance Directive and Aggressive Tax Planning Structures in the post-BEPS era

Prof.Ronald Russo-Supervisor Rebwar Taha -2nd Reader

Antonios Tzimas, anr: 776034

Academic Year: 2016-2017 Date of Submission:14/09/2017

1 Contents Section 1: Introduction

1) Abbreviations, Acronyms and Definition 4 2) Introduction of the Topic 6 3) Research Question 7 a) Motivation of the Research Question 8 4) Standard outline of the Paper 9

Section 2: Development of the Normative Framework

1. Economic Relevance of Intellectual Property in the Modern Era: 10 Innovation and Economic Growth 2. Size, magnitude and significance of Intellectual Property worldwide 10 3. Importance of Intellectual Property for Innovative Businesses 10 4. Relationship between IP and Innovation: Supporting, contradictory, or neutral 11 5. Backlash from recent uses of Intellectual Property for Tax Planning 12

Main Body

Section 3: Contemporaneous Empirical Overview: Intellectual Property Tax Planning & Aggressive Tax Planning in the IP Context

1) Section Outline 14 2) Introduction to Intellectual Property for business 14 a) Types of taxes relevant to Intellectual Property 17 3) Overview of IP Holding by MNEs 17 a) Own Development-Facilities for IP Development 18 i) R&D incentives 18 ii) IP Boxes Input 19 iii) Cost Contribution Arrangements 19 b) Acquisition from 3rd parties-Transfer Considerations of IP 20 c) Centralized and decentralized ownership 21 i) Economic, Legal and Beneficial Ownership 23 ii) Transfer of IP to a CFC 24 iii) IP Holding Companies 26 4) Global IP Exploitation 28 a) IP Boxes and R&D output 29 b) Strategic Transfer Pricing 29 i) Transfer Pricing Methods 30 ii) Transfer Pricing for IP 31 c) Advance Tax Rulings& Advance Pricing Arrangements 32 d) State Aid issues 33 5) “Aggressive Tax Planning and Indicators”: The 6 Structures 35

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Section 4: Legal Research, Literature Review and Hypothesis Development

1) Why the BEPS Actions are not enough 2) Legal Analysis of the Anti-Tax Avoidance Package 39 a) Focus on the Anti-Tax Avoidance Directive 41 b) Other contents of the Package 43

Section 5: Analysis and Evaluation

1) Analysis and evaluation of ATAD 46 a) Criticism and problematic points in the ATAD provisions 46 i) Main Problems 46 ii) Art.4 Interest Limitation Rule 46 iii) Art.3 Exit Taxation 48 iv) Art.7 General Anti-Abuse Rules 49 v) Art.8 Controlled Foreign Company Rules 50 vi) Art.9 Hybrid Mismatches 52 2) Analysis and evaluation per Tax Planning Strategy Analysis 54 a) The Double Irish with a Dutch Sandwich Structure 54 b) Luxembourg as an Intermediary Jurisdiction for Back to Back Licensing 56 c) Structuring with a Foreign Permanent Establishment 58 d) Two Tiered IP ATP Structure 59 e) ATP Structure based on IP and Cost Contribution Arrangements 62 3) General Assessment of the ATAD effects on the 6 Structures 65 a) Problems Solved 66 b) Problems not solved 67

Section 6: Summary and Conclusions

1) Major positive changes due to the ATP-Policy Perspective 69 2) Major criticism of changes due to the ATP-Policy Perspective 69 a) General Points of Criticism 69 b) Specific Points of Criticism 70 3) How can MNEs adapt to different regulatory requirements after the ATAP enactment-A Corporate Perspective 72 a) Location Options 72 b) Strategic Restructure Options 73 c) Transfer Pricing 73 d) Targeted Anti-ATAD Options 73 4) Research question answered 74 5) Conclusion 75

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Section 1: Introduction

1.1 Abbreviations, Acronyms and Definitions

ATAP: Anti Tax Avoidance Package ATAD:Anti Tax Avoidance Directive APAs: Advance Pricing Agreements ATAs: Advance Tax Agreements BEPS: Base Erosion and Profit Shifting CBCR: Country by Country Reporting CCA: Cost Contribution Agreements CCCTB: Common Consolidated Corporate Tax Base CFC: Controlled Foreign Company DTTs: Double Tax Treaties GAAR: General Anti Avoidance Rules IP Box: Intellectual Property Box IPRs: Intellectual Property Rights IGOs: Intergovernmental Organizations MNEs: Multinational Enterprises MS: Member State OECD: Organization for the Economic Cooperation and Development PE: Permanent Establishment R&D: Research and Development SMEs: Small and Medium Sized Enterprises SAAR: Specific Anti Avoidance Rules TP: Transfer Pricing

The Thesis of LLM International Business Tax Law is composed, and meant to be understood by a person of some knowledge in the field, not an expert or a tax law professor Thus, I will not define every single term encountered, but will do so only in instances where the term has a subjective/ambiguous/context-dependent meaning.

● Tax Avoidance-Tax Evasion-Tax Planning-Aggressive Tax Planning et al.

According to the EU Paper: Corporate Tax Practices and Aggressive Tax Planning in the EU: ”The term “aggressive tax planning ”has no fixed meaning and can mean different things

4 to different people”1.But researching the EU Commission terminology and other resources2, I found that:

Tax avoidance: Is generally used to describe the arrangement of a taxpayer’s affairs that is intended to reduce his tax liability. That arrangement might be legal (in line with the “letter of the law”)but also contradicts the intent of the law it purports to follow3 (against the “spirit of the law”), as the sole/predominant motive is reduction of taxes4.In the EU, the notion is limited to “wholly artificial arrangements aimed at circumventing the application of the legislation of the MS concerned5”, as defined in the standard-setting Cadbury-Schweppes6.

Tax evasion carries an element of dishonesty. In this sense, the term tax evasion is “generally used to mean illegal arrangements where the liability to tax is hidden or ignored, f.e. By hiding income or information from the tax authorities7”. That may preclude tax liability from arising at all, and instead gives rise to criminal liability, if investigated. Such was the case of Enron, were facts and circumstances were not sufficiently disclosed.

Tax planning: Arrangement of a person’s business and/or private affairs in order to minimize tax liability. Tax planning is legitimate conduct, and tax arrangements that comply with the specific wording of the law, whereas tax avoidance is more in the “grey area”8. The avoidance of double taxation, ubiquitous in International Tax Framework, as well as in tax practice, is the main justification for tax planning. One might say that it is even necessary for good governance in the international business framework.

”Tax planning may reach a point beyond what is tolerated within a legal system. That gives rise to what has been labelled “Aggressive tax planning”9.

Aggressive tax structures exploit technicalities and differences or gaps between tax systems, and usually utilize tax advantages, such as double deductions(“double dipping”).

1 European Parliament: Corporate Tax Practices and Aggressive Tax Planning in the EU [http://www.europarl.europa.eu/RegData/etudes/IDAN/2015/563446/IPOL_IDA(2015)563446_EN.pdf] 2 International Tax Structures in the BEPS Era: An analysis of the Anti-Abuse Measures & OECD Glossary of Tax Terms

3 OECD Glossary of Tax Terms [http://www.oecd.org/ctp/glossaryoftaxterms.htm]

4 As in the cases of Royal Bank of Scotland. International & European Taxation course, IBTL LLM. 5 The application of anti-abuse measures in the area of direct taxation – within the EU and in relation to third countries & Direct Taxation: Communication on the application of anti-abuse measures-within the EU and in relation to third countries-Frequently Asked Questions [http://europa.eu/rapid/press-release_MEMO-07-558_en.htm?locale=en]

6 Case C-196/04, 12 September. Restriction of freedom of establishment can be justified when relating to a wholly artificial arrangement, which aims to circumvent legislation of the MS concerned. 7 OECD Glossary of Tax Terms[http://www.oecd.org/ctp/glossaryoftaxterms.htm]

8 Fairer Shores: Tax havens, tax avoidance, and corporate social responsibility. Jasmin M. Fisher [http://www.bu.edu/bulawreview/files/2014/03/FISHER.pdf ] 9 International Tax Structures in the Beps Era: An analysis of the Anti-Abuse Measures

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“Aggressive tax planning takes advantage of the technicalities of a tax system, and can take various forms and effects including several tax advantages, such as double deductions in two jurisdictions, and might even result in “double non-taxation”, or arrangements that “push the limits “of acceptable tax planning and can be classified as tax avoidance10”. Usually, the line between tax avoidance and tax planning is very fine, and is determined by the respective tax jurisdiction, or the assessment of tax authorities11.

Finally, in the EU, the concept of Abuse is seminal, as it is a necessary prerequisite for anti- abuse rules to be justified. Hence, for their activation, a wholly artificial arrangement is necessitated, “despite formal observance of Community rules”12. Form and substance are utilized in such an analysis13”. Their detection may also lead to a justified forfeiture of fundamental freedoms for the person/entity. Jurisprudence in Cadbury Schweppes Case14 focusses on two main points15: a)Does the corporate entity/structure created reflect economic reality? And b)Does the company physically exist in terms of premises, staff and equipment?

1.2 Introduction of the Topic

Intellectual Property Tax Planning in the EU vows to investigate one of the major issues in International Corporate Taxation, that relates to the development, holding, transfer, exploitation, reporting and taxation of Intangible Assets. Although the subjects of the research are MNEs, wherever it is needed, a view from a policy standpoint will be granted.

Global Economy and Business, as it stands now, is heavily related to Intellectual Property, the latter either as stand-alone, or embedded in Products/Services/Entities. Through all levels of the economy, from research, development, to intercompany transactions, corporate processes, marketing, sales of products, or provision of services, almost everything an MNE will do, has some association with Intangible Assets, one way or another.

There are two additional global economic shifts that bolster the relevance of my Research Topic and IP Tax Planning per se:

10 EU Taxation Papers: Study on Structures of Aggressive Tax Planning [https://ec.europa.eu/taxation_customs/sites/taxation/files/resources/documents/taxation/gen_info/economic_analysis/tax_papers/taxation_paper_61.p df] 11 International Tax Structures in the Beps Era: An analysis of the Anti-Abuse Measures

12 Opinion of the European Economic and Social Committee on the Communication from the Commission to the Council-The application of anti-abuse measures in the area of direct taxation-within the EU and in relation to third countries [http://eur-lex.europa.eu/legal-content/en/ALL/?uri=CELEX%3A52007DC0785].

13 Anti-abuse measures in the area of Direct Taxation [http://eur-lex.europa.eu/legal-content/EN/TXT/?uri=LEGISSUM:l31062] 14 Judgement of the Court (Grand Chamber)of 12 September 2006.Cadbury Schweppes Overseas Ltd v Commissioners of Inland Revenue [http://curia.europa.eu/juris/showPdf.jsf;jsessionid=9ea7d0f130d5170d754862fb4b4fb8fda13bdcdd5dd9.e34KaxiLc3eQc40LaxqMbN4PaN4Me0?text= &docid=63874&pageIndex=0&doclang=en&mode=lst&dir=&occ=first&part=1&cid=414155] 15 European Commission: C-196/04-Cadbury Schweppes plc, Cadbury Schweppes Overseas Ltd v Commissioners of Inland Revenue, judgement of 12.9.2006 [http://ec.europa.eu/dgs/legal_service/arrets/04c196_en.pdf]

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● Intellectual Property is everywhere. We live in Market Economies, saturated with products, tangible or intangible moving cross border. Throughout the lifecycle of a company, trademarks, patents and other intangibles are the crown jewels of the Corporation. ● The Globalized Economy, the competitive advantages of countries, and the possibilities for international tax arbitrage, lead to huge cross border flows of products, services and money, for which International Tax Planning and Transfer Pricing are necessary tools.

These two parameters lead to:

Powerful MNEs capitalizing on intangibles to enhance company earnings & brand recognition, while outsourcing and moving offshore their major earning activitiesprofits and IP, to avoid steep tax rates and stringent compliance requirement of their Home (Developed) Countries. Simultaneously, countries or trade blocs, like the European Union, suffer from huge CIT losses, and crushing public debts, like most of the Developed Countries.

As a result:

Organizations such as the OECD and the European Union, enact “Actions” and legislation to force MNE’s to pay their “fair share “in their Home Jurisdictions. Such are the “BEPS Actions (1-15), in the EU, the “Anti-Tax Avoidance Packages”, and ultimately, the “Common (Consolidated) Corporate Tax Base”. The EU ATAD is inspired by the BEPS actions.

The OECD BEPS being soft law, and the CCCTB still in the making, in the present Thesis I will focus on the Anti-Tax Avoidance Package and the manners it will affects MNE’s IP Tax Planning Strategies.

The structure of the Thesis implicitly investigates and juxtaposes market practices of the past (before the advent of the BEPS) and projects the implementation of the Actions and the ATAD, hence post-BEPS era.

1.3 Research Question

The background and purposes of the research being illustrated by now, the Research Question is phrased as:

● Will the ATP effectively eliminate the major IP Tax Planning Strategies in the EU Common Market? How can MNE’s adapt to the changing legislative environment?

Due to the width of the subject under research, I necessitate also some sub-research questions, before I can answer the main question.

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■ How did IP Holding and IP Tax Planning for MNEs operated in the pre-Beps era, up to the last years. ■ Which are the major IP Tax Planning Strategies for MNEs utilized in the EU? ■ What does the ATAP prescribe, and how will it affect the IP Tax Planning Techniques identified? ■ How can European MNE’s adapt to the changing tax environment for IP?

1.3.a Motivation of the Research Question

It seems that European Corporate Taxation is gradually becoming more regulated and rigid due to BEPS Actions and the ATAP, and the subject matter of IPRs will face cumbersome legislation that will tighten MNE’s possibilities for Profit Shifting. Not only the ATAP, and the CCCTB(if implemented), but also other instruments such as the modified nexus approach16, reconsiderations of R&D incentives and IP boxes for control of possible illegal State Aid17, as well as other BEPS policy actions, are sure to impact the present regime. Still, there exist contradicting trends, such as tax competition, de-regulation, or new methods of tax planning for MNEs, which means it is hard to fathom whether some tax planning leeways will be widened or others tightened.

The Format of the research question, essentially exposes the main two focal points of the Thesis:

The past (pre-BEPS) and present state of IP Tax Planning in the EU and The future of the IP Tax Planning Environment, which may be complicated to predict exactly how it will be affected by the ATAP framework.

Academic Relevance Academically, there is a limited amount of studies connecting Intellectual Property and Corporate Taxation, and those that do, if we exclude the EU editions, leave untouched the subject of Tax Planning . The most useful publications have been the “EU Study in Aggressive Tax Planning and Indicators”, as well as the “International Tax Structures in the BEPS Era: An analysis of Anti- Abuse Measures”. Both were relied on in the Thesis.

Practical Relevance Again, to my knowledge, there exists no comparable study that maps the future changes to be brought for the Intellectual Property Tax Planning Environment in the EU. It is almost certain

16 Action 5: Agreement on Modified Nexus Approach for IP Regimes, endorsed by the Code of Conduct Group(Business Taxation) 17 European Parliament, DG Internal Policies: Intellectual Property Box Regimes. Tax Planning, effective Tax Burdens and Tax Policy Options

8 though that Big Companies, Big Law Firms or Consultancy Firms are preparing for the eventualities to occur due to ATAP (and the CCCTB in a second stage).

1.4 Standard outline of the Paper

My thesis comprises 5 chapters, excluding the introduction.

• Section 2:Development of the Normative Framework I introduce the subject of Intellectual Property in the context of the modern economy and stress its importance for MNEs. Questions of ethics in cross border taxation are approached, in order to set up a normative benchmark.

Main Body

• Section 3 : Past and Contemporaneous Empirical Framework of IP Tax Planning I approach IP Tax Planning by first giving an overview of the taxation of Intellectual Property, the way it has operated until recent years, until the advent of the BEPS. Then, I analyze important issues such as the nature of intangibles, IP holding structures and transfer structures for intangibles. Location incentives, transfer pricing for IP, ATRs &APAs, CCAs, ownership, and state aid issues are also treated.

• Section 4: Legal research, literature review and hypothesis development Here I approach the legal framework that will transforming the industry of IP Tax Planning. Namely, the Anti-Tax Avoidance Package will be analyzed, both in its contents, as well as to the specific relevance of their provisions towards Intellectual Property. The BEPS actions are equally important, but the fact that they are soft-law, or guidelines, subtracts from their gravity and legal value.

• Section 5: Analysis and Evaluation, The most important section of the Thesis. Evaluation and criticism is developed towards the Anti-Tax Avoidance Directive, with a focus on its problematic points. The 6 IP Tax Planning strategies are first analyzed, and then checked against the future implementation of the ATAD.

• Section 6: Summary and Conclusion Here, I summarize and conclude the effect of the ATAP framework on EU cross border tax planning for IP. Positive and negative changes from the ATAD are expounded, from a Tax Policy perspective. I then offer proposals as to how MNEs can carry out effectively IP Tax Planning after the onset of the ATAP, from a Corporate Perspective. The research question is answered, and the Thesis is concluded.

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Section 2: Development of the Normative Framework

2.1 Economic Relevance of Intellectual Property in the Modern Era: Innovation and Economic Growth

Innovation drives humanity forward, the economy upwards, stock markets to bullish pace, and makes our daily lives much easier and efficient. Historically, technological breakthroughs have been necessary for long-lasting expansions in economic output”.18 The general relation is self- evident, but quantifying the innovation contribution, is challenging19.Such innovation can be “process & organizational innovation” that increases firm’s efficiency in processing its inputs (labor, capital, resources), or “product innovation”20.

In the long term, innovation affects whole industries, as competitors need to catch-up, or disappear. The model of Western Capitalism, needs Intellectual Property to enhance individual and collective growth. Intellectual Property initiates a legal monopoly for the possessor, which allows him to extract rents from its exploitation, usually for some predetermined timespan. Intellectual Property is the key to individual (business) economic growth, but collective growth may actually be impaired due to monopolies or oligopolies. Thus, there exists a permanent conflict(or balance) between individual and collective gains21.

2.2 Size Magnitude and significance of Intellectual Property worldwide

Strictly for innovation metrics, Patent Rights is an indicative, but not conclusive proxy. The European Patent office (EPO) estimates that more than 800.000 patents are granted annually around the globe. The WIPO counts globally 2.9 million patents, 1.2 m utility models, 8.4 m trademarks, and 1.1 m industrial designs. The bulk of those originate in Asia.

Of course, the funding of R&D does not necessarily produce profits or IPRs, or it may produce profits without IPRs. R&D is work directed towards the innovation, introduction and improvement of products and processes22, and that may be directed to present processes or products. Such investment decisions are usually carried after an “R&D return to investment23” valuation, also including taxation factors.

2.3 Importance of Intellectual Property for Innovative Businesses

18 World Intellectual Property Report: Breakthrough Innovation and Economic Growth [http://www.wipo.int/edocs/pubdocs/en/wipo_pub_944_2015.pdf] 19 ibid

20 Understanding the Innovation Process: Innovation in Dynamic Service Industries [https://poseidon01.ssrn.com/delivery.php?ID=56600806509900209702710200512206611904803409504003306006500909906707910910300711909 0083021028116013087007077053105124107104088097113007008018090071115022084070125065111081008072083029015022&EXT=pdf] 21 Intellectual Property as Natural Monopoly: Toward a General Theory of Partial Property Rights. [https://law.utexas.edu/wp-content/uploads/sites/25/duffy_intellectual_property_natural_monopoly.pdf] 22 Oxford Dictionaries [https://en.oxforddictionaries.com/definition/research_and_development] 23 Measuring the returns to R&D. Hall, Mairesse, Mohnen[ http://www.nber.org/papers/w15622.pdf]

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“Generally put, an “innovation “is developing an new idea and putting into practice“ and nowadays, it is generally accepted that in the contemporary competitive technological business landscape, innovation is one of the foremost factors for firm success 24.

In 2017, many of top firms worldwide are famed for their innovative character (Amazon, Alphabet, Tesla), and vice versa, many innovative companies have stellar rise (Uber, Airbnb, Snap Inc., Tesla etc.)25.Of course, not all MNEs give the same importance to R&D (f.e. retail, oil and financial companies). Generally, throughout the business cycles, companies that break off in the expansion stage are markedly innovative(f.e. Microsoft, Nokia, Apple, Tesla)whereas innovation may subside in the late peak or plateau stages(also giving rise to “creative destruction”26).That is because IP, particularly patents, often play a crucial role in facilitating access to providers of early start capital and other financing entities which may provide a “lifeline“ for an invention to reach the marketplace27.

2.4 Relationship between IP and Innovation: Supporting, contradictory or neutral?

Disagreements persists among economists and policymakers about the exact role of intellectual property (IP) in relation to innovation. On the one hand, in theory, the IP system is considered to be absolutely necessary to “encourage creative intellectual endeavor in the public interest28”, and on the other, some observers believe that, in practice, the IP systems hinder competition to the extent that they are often seen to be playing a negative role in innovation29”. From a policy perspective, the Richest and Most Developed Countries are the most innovative ones worldwide. The OECD countries stack on the higher end of the Innovation Index30.

What matters here is that OECD countries innovate heavily, which translates in Intellectual Property, tax proceeds, and corporate tax strategies to minimize the burden and recharacterize/shift the profits in the most efficient manner. The BEPS Actions came as the OECD reaction to the Profit Shifting strategies, employed in an industrial scale by MNEs.

24 Role of Intellectual Property in Innovation and New Product Development , Christopher m. Kalanje, , SME’s Division, WIPO [http://www.wipo.int/sme/en/documents/ip_innovation_development_fulltext.html]

25 Price Waterhouse Coopers: 2016 Global Innovation 1000 study [https://www.strategyand.pwc.com/media/file/2016-Global- Innovation-1000-Fact-Pack.pdf]

26 Joseph Alois Schumpeter et al. [https://www.researchgate.net/publication/256060978_Schumpeter's_View_on_Innovation_and_Entrepreneurship] 27 Role of Intellectual Property in Innovation and New Product Development [http://www.wipo.int/sme/en/documents/ip_innovation_development_fulltext.html]

28 Ricketson, Sam., New Wine into Old Bottles: Technological Change and Intellectual Property Rights, ed. Drahos Peter “Intellectual Property”, second series, p. 389

29 Boldrin, M., and Levine, D.K., 2002, The Case Against Intellectual Property [http://levine.sscnet.ucla.edu/papers/intellectual.pdf]

30 WIPO Country/Economic Profiles [http://www.wipo.int/edocs/pubdocs/en/wipo_pub_gii_2017.pdf ]

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Unfortunately, the actors of International Corporate Taxation are not always obvious, nor their interests and actions. Companies may adhere to Corporate Social Responsibility or in contrast, simply opt for maximum profit. Countries may intend for sustainable economies or short-term tax profits. Also the revolving door means often the interests of these two are aligned, against the interests of the public. That fragmentation of actors spills over both in Tax terms and R&D environment.

2.5 Backlash from recent uses of Intellectual Property for Tax Planning

Some of the biggest Corporate Tax scandals of the last 5-10 years bear, not surprisingly, a strong connection to Intellectual Property. Tax consultants have early on identified the possibilities that IPR’s offer for profit shifting and tax avoidance. Following, are some recent examples which have caused world outrage on tax practices of MNEs:

• Starbucks Tax Avoidance in the UK

Starbucks operated in the UK since 1998, and reported losses in 14 of the15 first years of its existence, despite a 31% market share. It paid taxes of solely 8.6 million UK pounds in 15- years, on revenues of more than 3.4 billion pounds31. It’s earning stripping strategy was effectuated as such: a)Royalty payments to its Dutch Division for the licensing of Intellectual Property ( incoming royalties in the Netherlands are non-taxable) b) Overpriced payments for Coffee Beans in a Swiss, Global Procurement Starbucks entity. The transfer prices were endorsed by Dutch Tax Authorities. c) Intercompany loans to other Starbucks Units (UK Starbucks is almost entirely funded by debt32).

● The “Lux Leaks”, in the Grand Duchy of Luxembourg

Thanks to the so-called “Lux Leaks33”, 548 Private Tax Rulings between the Duchy and MNEs were uncovered. These reduced significantly the tax bill for concerned MNEs34. Additionally, IP Taxation in Luxembourg was already very lenient. “The hallmark of the Luxembourg IP Tax regime is an 80% exemption on royalties and capital gains derived from most types of IP”, leading to a 5.84% effective tax rate on “net” IP income35”. Other features included no withholding tax on incoming dividends, a participation exemption, no CFC rules etc. Luxembourg entities were often used as financing branches for Group Operations, due to

31 Through a Latte, Darkly: Starbucks’s Stateless Income Planning , Edward D.Kleinbard [http://gould.usc.edu/centers/class/class-workshops/cleo-working-papers/documents/C13_9_paper.pdf] 32 Reuters: Special Report: How Starbucks avoids UK Taxes [http://uk.reuters.com/article/uk-britain-starbucks-tax- idUKBRE89E0EW20121015] 33 Uncovered by the International Consortium of Investigative Journalism [https://www.icij.org/project/luxembourg-leaks] 34 Effects of Disclosing Tax Avoidance: Capital Market Reaction to Lux Leaks. Huesecken, Oversech, Tassius [https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2848757] 35 KPMG: Luxembourg- A hub for Intellectual Property [https://assets.kpmg.com/content/dam/kpmg/pdf/2013/06/Luxembourg-IP.pdf]

12 lenient tax treatment in the Duchy. On top of all these tax reliefs, the Luxembourg IP box and the availability of mailbox companies, allowed for almost total profit shifting from high-tax European Operations. Some of the concerned MNE’s are Amazon, CDF-Suez, and IKEA. Again, all these structures & transfer prices were endorsed by Luxembourgish Tax Authorities.

● The Apple Irish Tax Avoidance Scandal

Maybe the most contentious of the three scandals, and the most recent. Thanks to a 1991 ruling with the Irish Government, Apple managed to pay a mere 4% of a total of 200bn profits. The European Commission has ordered Apple to pay back the Irish State up to 13bn € in taxes, due to providing unfair advantage to the US MNE. Concerning the Tax Structure itself, the “Double Irish with a Dutch Sandwich36”,it is extensively analyzed in section 5.In a few words, an entity mismatch allowed the generation of “Stateless Income”, leading to the generation of hundreds or Euros, virtually tax free, while exploiting Irish and Dutch CIT& IP advantages. But the structure would not be possible without the initial transfer of IP from the US Mother company to the Bermuda entity, and the subsequent licensing to the Dutch entity. This appears to be the “root of all evil” for International IP Tax Planning. Still, transferring IP to a CFC or selling it to a non-related entity is not prohibited and is often heavily taxed.

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Main Body

Section 3: Contemporaneous Empirical Overview: Intellectual Property Tax Planning & Aggressive Tax Planning in the IP Context

3.1.Section Outline: This chapter will offer an empirical overview of cross border Intellectual Property Taxation and Tax Planning. The structure is as follows:

1) Introduction to intellectual property for business 2) Overview of IP Tax Planning by MNEs and its components 3) ATP Study: The 6 Aggressive Tax Planning structures

3.2 Introduction to Intellectual Property for business

As it was expounded in the introduction, Intellectual Property can take many forms and be utilized in a variety of circumstance, while the list remains open ended for the future. Precisely this mobility and flexibility, has allowed its wide dissemination for business purposes in our globalized era.

Purpose of Intangible Assets: In essence, Intellectual Property creates a legal monopoly to protect the works of human genius. At the same time, intangible assets are non-rivalrous and may be consumed/used by many persons at the same time at very little cost.37 The IP system fosters technological welfare and public welfare by balancing the interests and rights of both innovators and of the wider public interest38.

Intellectual property, is usually in the form of: patents, trademarks, copyrights, databases, plant variations, design rights, trade secrets, semiconductor circuits, know-how, trade secrets etc. In a Business Tax context, the most valuable and relevant IPRs are patents, copyright, trademarks, trade secrets, database rights etc. Intellectual Property Rights may be also called “intangible assets”. There exist various way to categorize intangibles:

Major Types of Intangibles39:

37 PriceWaterHouse Coopers: Valuation of Intangibles [http://www.wipo.int/edocs/mdocs/sme/en/wipo_smes_hyd_07/wipo_smes_hyd_07_www_91837.pdf]

38 WIPO: What is Intellectual Property?[ http://www.wipo.int/about-ip/en/]

39 OECD: Guidance on the Transfer Pricing of Intangibles [http://www.oecd- ilibrary.org/docserver/download/2314291e.pdf?expires=1503936525&id=id&accname=guest&checksum=FC673E5E832F265FE7AB16F5350F05C8]

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● Manufacturing Intangibles40: Patents and unpatented know-how are its main types, and as the name implies, are utilized for the manufacturing of products. ● Marketing Intangibles include, but are not limited to, trademark and trade names, corporate reputation, the existence of a developed sales force and the ability to provide services and training to customers.41 ● Hybrid Intangibles42: It is sometimes difficult to classify every intangible neatly as either a manufacturing or a marketing intangible, as some can be both. For example, corporate reputation may result from the fact that a company has historically produced high-quality products which were at the “leading edge “in its industry. • A residual, though diverse category, is the “Hard to Value Intangibles43”. They are only partly developed, or not yet commercially exploited, at the time of the transfer. Projections are highly uncertain, or intangibles for reliable comparisons may not be available. ▪ Other Intangibles and Business Attributes. These are elements that contribute to the creation of value but may not be legally protectable and may not be recognized as intangible assets for accounting and general tax purposes. Such are44 ▪ Workforce in place ▪ A commitment to undertake research and contribute to the development of future intangibles ▪ Goodwill ▪ Going concern etc. This last category is outside the scope of IP Tax Planning.

Transfer of Intangibles: Formally, intangibles can be transferred in four ways45:

● Outright sale for consideration ● Out right transfer for no remuneration (by way of gift. As a general rule, transfers without remuneration are not accepted by tax authorities). ● License in exchange for a royalty (f.e.Lump sum or periodic payment based on a percentage of sales, sum per unit)etc. ● Royalty Free License (such a transaction might also be hard to justify from a tax perspective).

40 The Transfer Pricing of Intangibles, pg.44. Michelle Markham

41 PWC: International Transfer Pricing 2014/2015 [http://www.pwc.com/gx/en/international-transfer-pricing/assets/itp-2015-2016-final.pdf]

43 International Tax Review: BEPS is Broader than Tax: Practical Business Implications [http://www.ey.com/Publication/vwLUAssets/EY-beps-is-broader-than-tax-2016/$FILE/EY-beps-is-broader-than-tax-2016.pdf]

44 Transfer Pricing International Journal: OECD, Caroline Silberztein [http://www.oecd.org/tax/transfer-pricing/46987988.pdf]

45 PWC: International Transfer Pricing 2014/2015 [http://www.pwc.com/gx/en/international-transfer-pricing/assets/itp-2015-2016-final.pdf]

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In practice though, most of Intangible transfers are much more complex, and usually constitute a form of license. Transfers of IP will be thoroughly analyzed in the following sub-sections.

Investing in Intangibles: There are mainly 4 kinds of activities through which a corporation can invest in Intangibles46:

● Development activities of the IP ● Maintenance activities of the IP ● Enhancement activities of the IP ● Purchase of IP from another party

Ownership of Intangibles: When a corporation owns an Intangible, this “possession” may not always be straightforward. There can be at varying degrees/types of ownership (including “shared ownership” between various legal owners47).For tax purposes, usually we distinguish between:

● Legal Ownership ● Economic Ownership ● Beneficial Ownership (which is a contested tax concept48)

There can be various combinations of shared ownership for the same asset, and tax authorities have to cut through them. This distinction will be addressed more precisely in the following subsections. What matters for now, is the fact that although legal ownership used to be a good proxy for the ascertainment of possession and use, with the advent of BEPS, is not anymore.

The valuation of Intangible Assets is a crucial task for every accounting and tax practitioner(and also Tax Authorities). The Global Management Accountant49 proposes for:

• The Market Approach: It employs observable market based transactions of identical or substantially similar intangible assets, recently exchanged in an arm’s length transactions. Unfortunately, those are not always easy to identify, and every Intangible Asset is for the most part unique. • Income Approach: Relates to assets that produce income or allow another asset to produce cash flows. Thus, it converts future benefits to a single, discounted amount.

46 The definition, ownership and transfer issues around intangible property under the OECD Transfer Pricing Guidelines. [http://arno.uvt.nl/show.cgi?fid=122166]

47 Shared Ownership of Intangible Assets: The case of Patent Co-Assignments.Andrea Fosfuri, Christian Helmers, Catherine Roux, March 10 2016 [https://events.barcelonagse.eu/live/files/1145-fosfuri] 48 Clarification of the Meaning of “Beneficial Owner” in the OECD Model Tax Convention-Response from IBF Research Staff[ http://www.oecd.org/tax/treaties/47643872.pdf] 49 CGMA Tools: Three Approaches to valuing Intangible Assets [https://www.cgma.org/content/dam/cgma/resources/tools/downloadabledocuments/valuing-intangible-assets.pdf]

16

• Cost Approach: Historical cost reflects the actual cost that had been incurred to develop the asset.

Importantly, for assets like: Patents, Technology, Copyrights, and Brand names, the Income Approach is the most common, followed by the Market Approach, and trailed by the Cost Approach. Valuation of Intangibles with reference to the Transfer Pricing, will be furnished on the following subsections.

3.2.aTypes of Taxes relevant to Intellectual Property

Intellectual Property, in any of the aforementioned forms or contexts, can affect most of the taxes that a company may be liable during its operations. Such are:

● Corporate Income Tax, which is the final denominator of an entity’s activities ○ Capital gains tax (f.e. on the appreciation of an intangible asset) is usually integrated in the final CIT amount. ■ Exit tax (f.e. on transferring IP assets outside the jurisdiction/EU, which gives rise to capital gains tax on the unrealized gains) ● Withholding taxes on international transactions (f.e. in royalties for license use) ● Value added tax(the assignment of Intangible property is a supply of service50) ● Dividend tax ● Gift Tax ● Wage Taxes (scientific personnel of companies might benefit from a preferential regime in many countries51) Self Evidently, MNEs deal with each of these taxes with a variety of techniques. And although the list of applicable taxes may be finite per jurisdiction/industry sector, the structures for dealing with global tax burden are not.

3.3 Overview of IP Holding by MNEs

50 European Commission: Taxable Transactions [https://ec.europa.eu/taxation_customs/business/vat/eu-vat-rules-topic/taxable- transactions_en]

51 OECD: R&D tax incentives: rationale, design evaluation [https://www.oecd.org/sti/ind/46352862.pdf]

17

3.3.a Own development-Facilities for IP Development

The archetypical Intangibles are developed/registered by a company after meticulous research and business planning. What matters for tax purposes, is that states grant a variety of tax incentives to harness the innovation and economic benefits derivable by such a process. MNEs may incur high expenses in high-tax jurisdictions to minimize tax exposure. The three major facilities a company can utilize are:

R&D incentives, IP Box (input)and Cost sharing agreements

3.3.a.i R&D incentives-Development and exploitation

R&D tax incentives are one of the most popular innovation policy tools. Essentially, they target the cost side of IP, by reducing taxes for firms that have R&D expenditure (input-related R&D tax incentives). Income based incentives on the other hand, offer preferential rates on royalties for firms that have income from commercializing IPRs (output-related R&D tax incentives).That latter category, resembles IP Boxes (see below). It is interesting to note that input-related R&D incentives are more prevalent in developed countries, whereas output-related R&D tax incentives are more important for tax havens (and only secondarily for developed countries). The major types of R&D incentives are52: • R&D Tax Credits which reduce the tax payable • Tax deferrals which allow for a delay in the payment of a certain tax

52 International Tax Structures in the BEPS Era: An analysis of Anti-Abuse Measures

18

• R&D Tax Allowances, which reduce the taxable income by certain amounts over regular business expenses(such as depreciation allowances53). • Payroll withholding tax credit for R&D wages, which grants deductions from payroll taxes and social security contributions, in the form of credits.

By 2016, such preferential regimes are well proliferated across the OECD. In the EU, out of 28 members, tax credits existed in 22 MS54, enhanced allowances in 14, accelerated depreciation in 9 and patent boxes in 9 Member States.

3.3.a.ii IP Boxes input

IP/Patent boxes offer a substantially reduced corporate income tax rate for income derived from patents and often other kinds of intangible assets.55 They may be broadly divided in two groups: The first group of regimes (including Belgium, the Netherlands, and the UK) are more targeted at incentivizing R&D investment and innovation. They focus on patents and other trade intangibles, but exclude marketing intangibles and are available for income from internal use. The second group grants preferential taxation of IP income that might have immigrated from another jurisdiction. The use of R&D incentives, coupled with IP boxes is not mutually exclusive (except in Malta56). Accordingly, a “double dipping” MNE strategy profits from R&D deductions in the country of IP development, f.e. the Netherlands, and a preferential taxation of the IP-derived income in f.e .Luxembourg. Most IP boxes are criticized for offering tax advantages for already developed IP, which creates a motive for IP migration and profit shifting, whereas R&D Credits are more geared toward stimulating overall economic benefits and societal development. For this reasons, IP Boxes are under fire from the OECDs Action 5 “Modified Nexus Approach”.

3.3.a.iii Cost Contribution Arrangements

Although not a Tax Planning Technique per se, CCAs are a good medium to reduce tax burden through planning for IP development, and as such, they are often integrated in global IP Tax Planning Strategies. Article 8.3. Of the OECD's Guidelines for Transfer Pricing defines CCAs as “a framework agreed among enterprises to share costs and risks of developing, producing or obtaining assets, services or rights”.

The CCA determines beforehand the nature of the agreement and the interest of each participant in the assets/services/rights to be developed57.

53 OECD: Tax incentives for R&D and innovation [https://www.oecd.org/sti/outlook/e- outlook/stipolicyprofiles/competencestoinnovate/taxincentivesforrdandinnovation.htm] 54 OECD Review of National R&D Tax Incentives and Estimates of R&D Tax Subsidy Rates [http://www.oecd.org/sti/RDTaxIncentives-DesignSubsidyRates.pdf] 55 DG Internal Policies: Intellectual Property Box Regimes [http://www.europarl.europa.eu/RegData/etudes/IDAN/2015/563454/IPOL_IDA(2015)563454_EN.pdf] 56 IPEG: Malta, IPR Tax Planning Opportunities. 57 The OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Authorities [http://www.oecd.org/tax/transfer- pricing/oecd-transfer-pricing-guidelines-for-multinational-enterprises-and-tax-administrations-20769717.htm]

19

There are two major types of CCAs: The most common is the one utilized in the research and development of IP, to be shared among two or more entities. The second CCA type is used to fund or obtain certain service. There also exist hybrids between these two types58.

CCAs have always been considered controversial, and as Chapter 5 proves, they are common tools of IP Tax Planning. Participants pay an amount in order to access the service or asset developed. In comparison to other transfer pricing techniques, market prices are replaced by costs and/or revenues. The assignment of costs depends on contributions and expected benefits by each entity. “The valuation of these contributions and expected benefits, however, rely on assumptions and subjective judgement, consequently they are prone to manipulation”59.

The CCA can be beneficial from a taxation viewpoint, especially when global development activities would otherwise require global cross-licensing arrangements. These last can result in a greater tax burden through withholding taxes on royalties, administrative costs, as well as additional scrutiny from tax authorities. ”CCAs can replace intra-group arm’s length payments with a more streamlined system of netted payments based on aggregated benefits and aggregated contributions”60.

CCAs came under fire, due to the OECD’s view that they facilitate BEPS, embodied in Action 8, “Revisions to Chapter 8 of the Transfer Pricing Guidelines on Cost Contribution Arrangements”. Not everybody agrees though that arm’s length prices should be ascertained, as CCAs are habitually valued on cost, which is easily auditable by tax authorities61. This polemic might be justified by the Tax planning opportunities that the CCAs offer, without causing further tax controversies. Lest not we forget that OECD’s tax authorities are more interested in tax proceeds, than fairness.

3.3.b Acquisition from third parties& Transfer considerations of Intangible Assets in general

Generally, IP assets should be recorded in the balance sheet, where all company’s assets, liabilities and shareholder’s equity are aggregated62.But internally generated IP is treated as an immediate expense, so do the R&D expenses for the creation of the IP. This means that the balance sheet does not offer a clear view on how the IP was made, or what is its real

58Cost contribution arrangements: an efficient tax planning tool?[https://brage.bibsys.no/xmlui/bitstream/handle/11250/221566/Masterthesis.pdf?sequence=1&isAllowed=y]

59 Ibid

60 BEPS Action 8:Revisions to Chapter 8 of the Transfer Pricing Guidelines on Cost Contribution Arrangements (CCAs) [https://www.oecd.org/tax/transfer-pricing/discussion-draft-beps-action-8-cost-contribution-arrangements.pdf] 61 EY, Dr. Andrew Hickmann:Proposed revisions to Chapter 8 of the Transfer Pricing Guidelines on cost contribution arrangements.[ http://www.ey.com/Publication/vwLUAssets/ey-comments-on-cost-contribution-arrangements-under-beps-action-8-29-may- 2015/$FILE/ey-comments-on-cost-contribution-arrangements-under-beps-action-8-29-may-2015.pdf] 62 When do Intangible assets appear on the balance sheet? Steven Bragg

20 value63.”Thus a company which decides to sell or license internally generated IP appears to create profits virtually out of nothing, as the IP that generated these profits does not appear on its balance sheet”. When a company obtains the IP from a third party, this transfer can be effectuated in various ways, and the transaction may be analyzed accordingly through different perspectives. Whether it is a license, sale or gift, affects managerial, tax and accounting considerations. For example, if an intangible is sold, it gives rise to capital gains or losses (depending on the asset’s value), but if it is licensed, it increases ordinary income64.

Patent transfers (or “assignments”)have more repercussions, as they constitute transfer of capital assets. For the buyer/licensee, it is more advantageous to license, as (outbound) royalty payments are generally deductible. For a sale, he needs to capitalize the payments. The seller/licensor though, will receive more favorable tax treatment if the transfer is treated as a sale rather than a license, because sale proceeds will result in capital gains/losses, whereas (inbound) royalty payments are ordinary income65.

In our context, the issue of US MNEs transferring their valuable IPRs in offshore jurisdiction, is a crucial point of Base Erosion and Profit Shifting. According to the IRS, such transfer can be part of a license agreement, a sale, a license, a capital contribution, a corporate restructuring, a provision of services, a cost-sharing arrangement or any combinations of these66.It will usually necessitate an arm’s length sale payment or an annual royalty dependent on the value of the IP at transfer.

In order to avoid form-over-substance designations, the IRS decides what type of transaction the transfer constitutes by auditing various factors, and habitually will be either a sale of an intangible to a CFC, a licensing of an intangible, or a transfer of an intangible offshore to a CFC.

3.3.c Centralized and decentralized ownership

An intangible asset held by a corporation, usually follows one of the 2 models: Centralized ownership in the parent company, or Decentralized ownership in an Intellectual Property Holding Company (IPHC). While in the past centralized MNE models were the norm, that is no more the case after the turn of the millennium67The three main reasons for this are demand side, supply side and

63 WIPO, Getting a Grip on Accounting and Intellectual Property, by Roya Ghafele [http://www.wipo.int/sme/en/documents/ip_accounting_fulltext.html] 64Tax issues for Individuals who create Intellectual Property [http://www.thetaxadviser.com/issues/2013/dec/kelley-dec2013.html]

65 Tax Considerations of Acquiring Intellectual Property [http://www.kilpatricktownsend.com/~/media/Files/articles/2014/JTAX-14-10-157-Accounting.ashx] 66 Internal Revenue Service: LB&I International Practice Service Transaction Unit. 67 Economic and Management Perspectives on Intellectual Property Management.C.Peeters et al. [https://books.google.es/books?id=aumHDAAAQBAJ&pg=PA107&lpg=PA107&dq=MNEs+IP+centralized+decentralized&source=bl&ots=oo7VmAxH5t &sig=Py9wgdlpmjc-7Lk9ASo9zGSm8Ag&hl=en&sa=X&ved=0ahUKEwj95eTS6JrWAhXDthoKHcvNCqUQ6AEIKzAA#v=onepage&q&f=false]

21 environmental/institutional factors68.Businesses can be put in a spectrum of how centralized- decentralized they are. At one hand, “cash box entities “with zero functionality, and only a legal ownership of the assets. On the other extreme, there exist “purely centralized structures”, where all functions are located such as: key decision making functions, financial strength, and all valuable (IP and non-IP) assets 69.There exist also “compromise structures “with a divisional assignment(“The Business Unit assignment model”)70.

Centralized ownership, is considered simple in principle, but due to anti-avoidance provisions, its business model is complex and potentially very costly if not planned properly71.The license fee that the central entity receives may be based on gross profit, a percentage of net or additional sales, or of operating profit72from the global exploitation of the IP.

The parent company treats offshore affiliates as routine service providers that earn limited risk- returns. Under OECD Guidance, the entities performing any outsourced activity are entitled to a portion of the profit attributable to the IP73. The extent of this profit is one of the foremost concern of effective tax planning. In the EU, MNEs are favored by a “fairly narrow application of CFC between most EU MS”74. Usually, the offshore provider of contract development activities is remunerated by a cost-plus compensation75.

Centralized ownership has various advantages in Management and Taxation. Still, many favour the decentralized ownership for intangibles, in an IPHC. Utilizing an IPHC for IP presupposes the transfer of the intangible to a favorable jurisdiction where appropriate holding vehicles usually exist. Then an “access fee “is determined by splitting the excess profit attributable to intangibles76.

In general, a centralized model is easier to administer in terms of intercompany transactions and transfer pricing, but grants extra risk to the central entity, while forfeiting the opportunity for cross border arbitrage and profit shifting. From a managerial perspective, while a centralized

68 Grandstrand et al. 69 Centralized and decentralized business models in a post-base Erosion and Profit Shifting World[https://www.kluwerlawonline.com/document.php?id=TAXI2016066]. 70 Intellectual Property (IP) management: Organizational Process and Structures, and the Role of IP donations. Carrlson, Demitriu et al [https://www.researchgate.net/publication/225630148_Intellectual_property_IP_management_Organizational_processes_and_structures_and_the_role _of_IP_donations] 71 IBFD: Centralized Intellectual Property Business Models-Tax Implications of EU Patent Box[https://www.ibfd.org/sites/ibfd.org/files/content/pdf/BIT_PPV%20Article.pdf]. 72 The transfer pricing of intangibles, Aalto Biz, Petteri Rapo [https://mycourses.aalto.fi/pluginfile.php/221307/mod_resource/content/1/Aalto%20BIZ%20-%2032E30000%20- %20Transfer%20pricing%20of%20intangibles%20-%20May%202%2C%202016%20-%2020160429_handout.pdf] 73 International Tax Review. IP: Converging tax, regulatory, and operational Forces.

74 International Tax Structures in the BEPS Era: An Analysis of Anti-Abuse Measures. 75 The transfer pricing of intangibles, Aalto Biz, Petteri Rapo [https://mycourses.aalto.fi/pluginfile.php/221307/mod_resource/content/1/Aalto%20BIZ%20-%2032E30000%20- %20Transfer%20pricing%20of%20intangibles%20-%20May%202%2C%202016%20-%2020160429_handout.pdf] 76 ibid

22 structure is more advantageous for sustaining patent expertise, and responding to cross- divisional needs, it might be slow and time consuming to address divisional needs77. For the ultimate decision as to which model to choose, not all determinants are tax related78, and the decision should account for global cash flows, allocation of the risk for intangible development, IP law requirements and more mundane transfer pricing issues. Of course, real life practicalities are relevant, f.e. where to develop an intangible and how to maintain it (Germany is better for R&D than Cayman, granting much more substance and efficiency in such a business structure, also from a tax perspective).As it becomes obvious in later chapters, decentralized models are much more efficient for IP Tax Planning, and especially on regard to US MNEs, but might be more heavily scrutinized, especially after the BEPS and the ATAD.

3.3.c.i Economic, Legal and Beneficial Ownership

“The legal owner might differ from the economic owner, although in most cases they are the same person. As the title implies, the legal owner is recognized by law as the owner of an IP. The economic owner on the other hand is the person who actually exercises control over the asset and ultimately benefits monetarily from its use79. Complex arrangements have been set in place to benefit from DTTs network (abusing treaty benefits for tax avoidance), which often separate legal ownership and economic substance/ownership. Exactly such abusive practices gave rise to the BEPS tax concept of Beneficial Ownership.

Based on updated guidelines on economic ownership, carrying the financial risks associated with the IP is not enough for an entitlement to residual profits. Employing the resources and the knowledge required to control the associated risks is important as well. BEPS shift focus from legal ownership and financial risk to “value creating functions and actual control of risks 80”. The main reason being that formal rules (ownership, benefits etc.) can be easily manipulated by MNEs, as has been done numerous times. To that end, OECD Tax Treaties have integrated both the Limitation of Benefits clause, and the Principal Purpose Test.

The Beneficial ownership concept has been introduced in the OECD Model Tax Convention, in order to deal with “treaty shopping” situations, where income is paid to an intermediary resident of a tax treaty resident, but who is not treated as the owner of that income for tax purposes (such as an agent or nominee).”Such allocation of treaty benefits to mere legal owners (“agent” or “nominee“) without any economic interest in an asset, would surpass the

77 Intellectual Property (IP) management: Organizational Process and Structures, and the Role of IP donations. Carrlson, Demitriu et al 78 Managing Intangible Property of Japanese Multinational Companies in M&A context. [https://home.kpmg.com/us/en/home/insights/2016/05/2016-issue2-article4.html] 79 Economic Ownership and Changes in Ownership Goods, Non-financial Assets, Financial Assets and Liabilities [https://www.unece.org/fileadmin/DAM/stats/documents/ece/ces/ge.20/2013/Working_Paper_2.pdf]

80 Centralized and Decentralized Business Models in a Post-Base Erosion and Profit Shifting World.[ https://www.kluwerlawonline.com/document.php?id=TAXI2016066]

23 purpose of the treaty81”.Although the concept of beneficial ownership is well propagated by now, its definition is elusive, and has acquired a large quantity of “definitional baggage”, leading to cross-border inconsistency. The term is defined in a minority only of tax legislations, where it usually stems from the law of trusts82.

In the context of double tax treaties, art. 12.4 gives a handy application of the term and its substance. “..the recipient of the dividend is not the “beneficial owner “because of a contractual or legal obligation to pass on the payment received to another person83.”On top of that, an operational definition may be inferred by identifying “the full right to use and enjoy the [income] unconstrained by a contractual or legal obligation to pass the payment received to another person”84.Thus one might say, we find the beneficial owner by exclusion. Absent any contractual obligations, or facts and circumstances to the contrary, the beneficial owner has a full right to enjoyment of the received amount/assets/dividends/royalties etc.

3.3.c.ii Transfer of IP to a CFC (IP migration)

In many cross border tax situations with a profit shifting elements, it has been shown that, in the case of development of IPRs in a high-rate jurisdiction, “the disposal of a patent to a lower-taxed subsidiary does not achieve its profit shifting objective, if the transfer price reflects the true value of the IP”(Devereux-Griffith model). In fact, the triggering of an exit tax on the full earnings value of the IP, increases the burden for the whole group. “Hence, the disposal to an offshore entity, achieves its aim only if the multinational is able to understate(within transfer pricing rules) the value of the asset when it is transferred (...) Additionaly, if the offshore entity remits royalties to its parent company in the full value of the asset, the tax planning motive is nullified”. Licensing-out a patent to a low-taxed subsidiary only results in a reduction of the group’s effective tax burden, if the royalty payment corresponds only to a fraction of the return from exploiting the patent.85” Therefore, transfer pricing documentation and valuations is necessary for tax arbitrage and profit shifting, because it is a necessary tool for understating/overstating the value of an asset in a transaction (within acceptable margins by the respective tax authorities) whether it is a sale for consideration or a license in exchange of royalties.

A caveat to the above statement stems from the accounting treatment of intangibles, where it was ascertained that expensed, self-generated intangibles may hide their true value, thus allowing for an easy understatement of their actual value86.On top of that, many academics

81 Commentary on: OECD Model tax convention: Revised proposals concerning the meaning of “Beneficial Owner “in articles 10,11,12 [https://www.oecd.org/ctp/treaties/Beneficialownership.pdf] 82 OECD Discussion Draft “Clarification of “Beneficial Owner” in the OECD Model Tax Convention”[ http://www.oecd.org/tax/treaties/48420432.pdf] 83 ibid 84 OECD Discussion Draft “Clarification of the Meaning of “Beneficial Owner “in the OECD Model Tax Convention”, response by John Avery Jones, Richard Vann and Joanna Wheeler. 85Effective Rates under IP Tax Planning [http://ftp.zew.de/pub/zew-docs/dp/dp14111.pdf]

86 WIPO, Getting a Grip on Accounting and Intellectual Property, by Roya Ghafele [http://www.wipo.int/sme/en/documents/ip_accounting_fulltext.html]

24 claim that the public indignation with the emigration of IP is hypocritical, or at least ignorant: Accusations would be valid if it was possible to simply make disappear an asset from the books and move it offshore. But most jurisdictional rules make it simply impossible to move the asset without recognizing capital gains (or losses) or without charging tax on the later inbound royalty. Therefore, both the increase in value and the income from the royalty are still subject to the taxation of the original jurisdiction87(unless “perpetual” deferral is achieved).

The counterargument to the accusations against MNEs migrating their IP, is threefold88: • IP migration essentially only causes a deferral of taxation • IP migration is often fully justified under business reality and the complex administrative needs of managing IP on a worldwide level. • Tax authorities have a huge array of tools and provisions to challenge both the deferral and to test, often unilaterally, the business reality of the emigration.

It is also important to note that global structuring of IP may not have as a sole determinant tax arbitrage, but may be dictated by other legal, economic and administrative reasons (such as protection of intangible property, capital funding, sharing in intangible development risks, tax credit issues etc.89).

IP Migration to a low-tax jurisdiction is combatted by many jurisdictions, especially by the draconian IRS rules90.In order to avoid US tax on the IP income, taxpayers usually avoid entirely having IP owned in the US, and instead, prefer to develop it offshore (especially handy when a corporation already possess an undistributed offshore “cash box” f.e. Apple). In the case of the US MNEs, their offshore affiliates must avoid the designation of “subpart F” income which is taxable back to the US. The offshore profits are not taxed, until repatriated. To avoid CFC designations, “check the box” is used to treat the offshore affiliate as a pass-through entity. Still, subpart F income designation requires more than 50% ownership, so when 2 companies partner to own an offshore affiliate (along with another entity of minimal, f.e. 0,1% ownership), then CFC imputation of income to the parent is avoided. Income of the offshore entity can be reinvested tax free in parent’s business either through traditional financing or Cost sharing agreements.

With the advent of the BEPS, such “cash box” companies are expected to fall out of use. Whereas in the pre-BEPS era, legal ownership would entitle the offshore entity to full profits, in the post-BEPS , economic substance and control, assumption of risk etc. are much more relevant in the final attribution of profit91.

87 IP Migration: What the fuss is about? Michael Hardgrove and Alex Voloshko [http://www.buildingipvalue.com/taxation/hardgrove.html] 88 Ibid 89 International Tax Review: IP migration strategies pre-and post-BEPS[http://www.internationaltaxreview.com/Article/3556018/IP- migration-strategiespre-and-post-BEPS.html]. 90 U.S. Tax Implications of offshore migration of Intellectual Property, John D. Hollinrake, Jr.[ https://thetmca.com/files/2016/04/More-U.S.-Tax-Implications-of-Offshore-Migration-of-Intellectual-Property-1.pdf] 91 International Tax Review: IP migration strategies-pre-and post BEPS. [http://www.internationaltaxreview.com/Article/3556018/IP-migration-strategiespre-and-post-BEPS.html].

25

Admittedly, the most direct contribution of the BEPS up to date is the strengthening of Transfer Pricing Guidelines by reference to the alignment of expected profits and substance(Actions 8- 10)92.Although it will be proved in chapter 5 that some structures remain resilient both to BEPS and the ATAD, some blatantly aggressive IP migrating strategies have been neutralized thanks to more stringent transfer pricing compliance rules.

Although IP migration is seen as “the root of all evils”, especially in the case of US MNEs, IP migration is but a small part of the Global IP exploitation, and CCAs can usually play the same role for lowering Group ETR93 in a Global context.

3.3.c.iii IP Holding Companies

A holding company does not produce anything, but, as the name implies, is set-up to hold legal titles, such as stocks, bonds, mutual funds, real estate, IPRs, licenses, or anything with value94. However, many companies are using shell, or letterbox companies, that do not have any employees, for the mere reason of lowering their effective tax burden95. The implementation of BEPS will most likely result in the prevention of very aggressive cases of tax planning including the use of such “cash boxes”96. The main business reasons for using holding companies is the centralization of diverse participations in one single company, in order to facilitate their management, and generate many desired effects:

• Liability limitation and separation of costs • Higher transparency of the company structure • Reduction of control costs • Use as an acquisition vehicle • As an organizational form for joint ventures

An IP Holding Company (IPHC) is usually established by exchanging a parent company’s intellectual property assets for stock in a newly-formed subsidiary corporation, which can be incorporated in certain countries having favorable tax law. There is an exchange of stock in the subsidiary as a consideration for th contribution of intellectual property. The counterparties sign

92 Ibid 93 IP Migration: What the fuss is about? Michael Hardgrove and Alex Voloshko [http://www.buildingipvalue.com/taxation/hardgrove.html] 94 The architecture of Intellectual Property Holding Company [http://www.altacit.com/publication/the-architecture-of-intellectual- property-holding-companies/] 95 International Tax Structures in the BEPS Era: An analysis of Anti-Abuse measures. 96 Centralized and Decentralized Business Models in a Post-Base Erosion and Profit Shifting [https://www.google.nl/search?q=Centralized+and+Decentralized+Business+Models+in+a+Post- Base+Erosion+and+Profit+Shifting&rlz=1C1GGRV_enNL760NL760&oq=Centralized+and+Decentralized+Business+Models+in+a+Post- Base+Erosion+and+Profit+Shifting&aqs=chrome..69i57j69i59.652j0j4&sourceid=chrome&ie=UTF-8]

26 license agreements in exchange for royalties. The subsequent payments are an expense to the parent97.

Some tax reasons for using IPHC include the exemption from tax on dividends received, the exemption on capital gains realized on the sale of the participations, a reduction of withholding taxes on dividends, interest and royalty payments, the use of tax treaties, the effective financing of participations and the pooling of profits and losses.98These advantages are granted by the laws of the state of IPHC incorporation.

Such holding companies can have various legal forms, with stock companies and limited liability companies being the most common. Partnerships usually exist when there is a margin for hybrid treatment in international law. Finally, a PE can also act as an IPHC(usually a “place of management” in the sense of Double Tax Treaties). Distinguished according to their “type/function”, they might be “management holding companies”, “finance holding companies”, “country/regional” holding companies, or “intermediate holding companies”. Here I offer some examples of the preferential treatment that HCs receive in various jurisdictions99:

Country Taxable dividends Corporate Capital Gains Withholding tax on Income Tax on shares dividends paid by Rate the Headquarter Austria Exempt 25% Exempt under 25%. Lower under tax certain conditions treaties , 0% when paid to an EU parent company Belgium 95% of dividends received are 33.99% Exempt from 25%. Lower under tax exempt from income tax (subject Income Tax treaties, 0% when paid to to conditions) an EU parent company Cyprus 100% of dividends received from 10% Exempt from No withholding tax on a foreign participation are Income tax dividends paid to non- exempt from income tax. Certain residents exemptions apply Finland Exempt 20% Generally Exempt 20%. Lower under tax treaties 0% under P-S Directive Hungary Dividends received from 10/19% Exempt from No withholding taxes on domestic or foreign sources are income tax for dividends paid if recipient exempt from income tax, except qualifying is a corporate entity in the case of CFCs pacifications Hong Dividends received from a 16.5% Exempt from profits No withholding tax on Kong company subject to profits tax in tax dividends paid to Hong Kong are not included in residents and non- the taxable income residents

97 The architecture of Intellectual Property Holding Company[http://www.altacit.com/publication/the-architecture-of-intellectual- property-holding-companies/] 98 International Tax Structures in the BEPS Era: An analysis of Anti-Abuse measures, pg.284 99 Ibid

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Ireland No participation exemption. 12.5% on business Exempt from capital 20% lower under tax Foreign tax credit in excess may income and 25% on gains tax treaties, 0% under EU P-S be credited against tax payable passive income Directive on other dividends receive within the same period

Generally, Location is important for IP Holding, because of 4 main reasons100: 1. Low corporate tax rates 2. Tax deductions for amortization of acquired IP 3. Reduced Tax rates for certain types of innovative income (an IP regime) 4. Low or no withholding tax on royalties

Of course, most such EU and offshore jurisdictions also boast an extensive tax treaty network which allows for the avoidance of Double taxation, thus servicing the purpose of International Tax Planning.

3.4. Global IP exploitation

By utilizing an IPHC, or an offshore company, many possibilities arise:

Intellectual Property will usually migrate and be held in a jurisdiction with a lower or zero worldwide income tax rates. The IPHC will usually sublicense the IP in other countries and operating entities. The IPHC will receive franchise fees and royalty payments from the franchisees or licensees and accumulate income in its favorable jurisdiction. IPHCs are usually incorporated in a country with a substantial double tax treaty network, like Cyprus, Gibraltar, Ireland, Luxembourg, Malta, the Netherlands Antilles and some others.101

MNEs might also use offshore “cash boxes” and develop IP in a country offering R&D incentives, then placing it in a jurisdiction offering an “IP box”, thus granting preferential treatment on the income and achieving a “double dipping” on IP facilities102.

It is important to note that the aforementioned model is growing out of fashion due to the advent of the BEPS(especially actions 8-10). Substance over form can cut through CFCs in favorable jurisdictions, and transfer pricing actions can impute residual profits in the higher-tax jurisdiction (or wherever value is actually created )through the alignment of taxation and substance103.

100 ‘International Tax Review: BEPS is broader than tax: Practical Business Implications of BEPS” [http://www.ey.com/Publication/vwLUAssets/EY-practical-business-implications-of-BEPS/$FILE/EY-practical-business-implications-of-BEPS.pdf]

101 The architecture of Intellectual Property Holding Company [http://www.altacit.com/publication/the-architecture-of-intellectual- property-holding-companies/]

102 Ibid

103 OECD: BEPS frequently asked questions [http://www.oecd.org/ctp/BEPS-FAQsEnglish.pdf]

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3.4.a IP Boxes and R&D output

IP Boxes differ from R&D incentives in the sense that they target the income aspect of the IP. The first type of IP boxes analyzed targets the cost-side. The design of the second group of regimes (including Cyprus, France, Hungary, Malta and the Swiss Canton of Nidwalden) is more suitable to attracting mobile IP income, in particular by allowing acquired IP to benefit from the IP Box treatment, and by not applying necessarily the regime to income made from internal use104. The most generous regimes are those that do not require the “recapture” of expensed R&D costs(before the application of the IP Box). Patent boxes have been repeatedly criticized for not boosting innovation, but instead for acting as incentives for relocation of Intangibles, thus constituting hubs for International Tax Planning. Whereas R&D incentives reward firms for the societal benefits of their research & innovations, IP Boxes introduce a preferential rate for innovations that are already protected by intellectual property rights. Most of these IP Boxes avoided the “harmful tax competition “designation by state aid rules, because they were not explicitly selective by favoring certain undertakings. But while they avoided fines from the Commission, that will not be the case with the BEPS. The introduction of the Modified Nexus Approach, since 2014, due to the Action 5 of the BEPS, requires substantial activity for a preferential regime, which is in line with the one of the main aims of the whole BEPS project, to align taxation with substance. Most of such Boxes violate the modified Nexus approach(the “second category” I mentioned). In other words, they offer advantages for IP developed elsewhere, hence contributing to harmful state competition for mobile IP, which leads to a “race to the bottom”. Member states are required to amend their IP boxes by the end of June 2021105, and make the BEPS compliant, although some have already begun.

3.4.b Strategic Transfer Pricing

My analysis, by definition treats groups of companies and their intergroup transactions. As a consequence, Transfer Pricing is a paramount consideration for MNEs, as internal transactions account for 60% of global trading transactions, which are between related entities and are transfer priced106107.Transfer Pricing is “the area of tax law and economics that is concerned with ensuring that prices charged between associated enterprises for the transfer of goods, services and intangible property are compliant with the arm’s length principle” 108. The arms’ length principle is the universal method for determining the right transfer pricing to be used between related parties from a tax perspective109, also in European jurisprudence(SGI

104 ibid 105 Council of the European Union: Code of Conduct (Business Taxation) [http://data.consilium.europa.eu/doc/document/ST-9912- 2016-INIT/en/pdf] 106 Roy Rohatgi, Basic International Taxation: Volume II (2007, 2nd ed) 239. 107 Although other valuations point to a mere 30% 108 International Tax Structures in the BEPS Era: An analysis of Anti-Abuse Measures 109 The Arm’s length Principle and the CCCTB: Solutions to transfer pricing issues for individual countries and the European Union. [http://epublications.bond.edu.au/cgi/viewcontent.cgi?article=1202&context=rlj]

29 case110). Sometimes managerial decisions should follow what tax authorities prescribe for intra- group dealings, as these can be subject of scrutiny (and fines). The OECD recognizes that the valuation of Intangibles during their development is hard, therefore ex post valuation, utilizing the three valuation models111, is crucial to ensure that value is taxed where it is created and prices are comparable with what 3rd parties would have agreed.

In the end, Transfer Pricing is not always a method to shift profit, but also a necessity, in order to avoid the challenging of intra-group prices by tax authorities. BEPS is relevant in this respect as cross border transfer prices disputed by f.e. 2 different tax authorities can be readjusted thanks to the Multilateral Instrument of Action 15.

3.4.b.1 Transfer Pricing Methods Based on the “Transfer Pricing in Post-Best World- Transfer Pricing of Intangibles”, there arise three main valuation models: ● The Market Approach ● The Cost Approach ● The Income Approach

Five transfer pricing methods can be applied to establish whether the conditions of controlled transactions are consistent with the arm’s length principle112: • Traditional Transaction Methods o Comparable uncontrolled price(“CUP”) method o Cost Plus method o Resale price method • Transactional Profit methods o Transactional Net margin method (TNMM) o Transactional Split methods

▪ CUP Method: Compares the price charged for an asset transferred or a service performed, with the price charged for property or services in a comparable uncontrolled transaction, under comparable circumstances. ▪ Cost Plus Method: The starting point is the costs incurred by the supplier for the provision of assets/services. The mark-up profit in this controlled transaction, is compared with the mark-up of an uncontrolled transaction in comparable circumstances. ▪ Resale Price Method: The price at which a product/service has been purchased from an associated enterprise, is compared with the gross margin earned in a comparable uncontrolled transaction by another entity. ▪ The Transactional Net Margin Method utilizes a net profit indicator (f.e. ratio of net profit to costs, or sales, etc) that the taxpayer earned, and is juxtaposed to the net profit

110 European Union-The SGI Case: ECJ Approves Belgian System of Selective Profit Corrections in Relation to Foreign Group Companies [https://online.ibfd.org/kbase/#topic=doc&url=/collections/et/html/et_2010_06_e2_2.html] 111 Transfer Pricing in Post-Best World- Transfer Pricing of Intangibles [http://arno.uvt.nl/show.cgi?fid=141892] 112 OECD Transfer Pricing Methods, July 2010 [http://www.oecd.org/ctp/transfer-pricing/45765701.pdf]

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arising from other controlled and uncontrolled transactions, after the deduction of operating expenses.

▪ The Transactional Profit Split Method splits combined profits of associated companies in a controlled transaction, according to an economically valid methodology. This division of profits is compared with an uncontrolled, comparable circumstance.

3.4.b.ii Transfer Pricing for IP

Intellectual Property is often thought to be unique, thus resistant to Transfer Pricing analysis and comparability. That uncertainty widens the margin for-profit shifting and harmful tax practices between related entities. “It is difficult to ascertain the true value of intangibles for transfer pricing purposes, as they are rarely traded on external markets due to their uniqueness and their central role in the generation of excess profits113.But this also means that transfer prices can be easily challenged by tax authorities, something which MNEs want to avoid”. This indicated the necessity for Transactional Split methodology.114Additionally transfer pricing for such assets is usually on a per-se basis, although it is accepted that synergies between IP use grant added value to the company115.The BEPS actions 8-10 have led to more stringent rules that MNEs can comply with, but still Transfer Pricing for IP is by default elusive.

From a corporate tax perspective, this administrative burden is heavy, when a group of companies tries to allocate tax proceeds in the most beneficial jurisdiction. Based on the amended Devereux& Griffith model on effective tax rates116, it was proved that, according to standard IP Tax planning practices, to move an Intangible in a low-tax jurisdiction, a company needs to understate the value of the asset (within the legal margins of comparability analysis), in order not to face a steep exit tax that would nullify the motive for such transfer117. In such instances, or many others, efficient documentation is paramount to implement a robust IP Tax Planning strategy. In the end Transfer Pricing should not be seen as a deviant behavior, but rather as an unavoidable administrative burden that should be complied with in all intra-Group dealings.

It is important though to note that the “OECD ALP” may diverge from the EU arm’s length principle. Although in THIN CAP GLO, the arm’s length principle was found consistent with EU law, the different applications by various tax administration “can result in uncertainty, increased costs and administrative burdens. “To that end, the EU Joint Transfer Pricing Forum tries to find pragmatic solutions to problems arising from the application of the arm’s length principle within

113 Effective IP Tax Rates under IP Tax Planning [http://ftp.zew.de/pub/zew-docs/dp/dp14111.pdf]. 114 Deloitte: BEPS Action 8: Transfer Pricing Aspects of Intangibles [https://www2.deloitte.com/content/dam/Deloitte/ie/Documents/Tax/2014-deloitte-ireland-beps-action-8-transfer-pricing-aspects-of-intangibles.pdf]. 115 Post-BEPS Application of the Arm’s Length Principle to Intangible Structures, Marta Pankiv [https://www.ibfd.org/sites/ibfd.org/files/content/pdf/itpj_PPV_free_article_march_newsl_2017_internatonal_post_beps.pdf 116 The Impact of Tax Planning on forward-looking effective tax rates [https://ec.europa.eu/taxation_customs/sites/taxation/files/taxation_paper_64.pdf]. 117 European Parliament. DG Internal Policies: Intellectual Property Box Regimes [http://www.europarl.europa.eu/RegData/etudes/IDAN/2015/563454/IPOL_IDA(2015)563454_EN.pdf]

31 the EU 118”. Also, it is important to stress the importance of the Multilateral Arbitration Convention, designed to allow the easy cross border adjustment of Transfer Pricing claims.

3.4.c Advance Tax Rulings & Advance Pricing Arrangements

An advance tax ruling (“ATR”) (or private tax rulings) can be defined as a “letter ruling, a written statement, issued to a taxpayer by tax authorities that interprets and applies the tax law to a specific set of facts”. It concerns specified future transactions, and prescribes a model that both counterparties can rely on119. Nearly all OECD countries offer such a possibility to eligible taxpayers120.

An advance pricing arrangement (“APA”) is an arrangement which determines in advance of controlled transactions, an appropriate set of criteria (e.g. method, comparable, and the appropriate adjustments thereto) for the determination of the transfer pricing for the scope of transactions, over a predetermined period of time121. An APA is formally initiated by a taxpayer, one or more associated enterprises, and one or more tax administrations. There exist unilateral, bilateral or multilateral rulings, that can both provide certainty, avoid future controversies by tax authorities, and also alleviate the danger of double taxation122.

MNEs count on both ATAs and APAs to gain certainty on future conduct. But if unilaterally agreed, they may create conflicts, when two different jurisdictions and tax authorities are affected. Hopefully, Action 15 of the BEPS can mutually resolve such cross border disputes. Both types of agreements also require significant time and material investment to be drawn. In many cases, such as in Luxembourg (the Lux Leaks), they were associated with complex tax structures, often with an IP element (Amazon, Ikea), that led to an almost zero effective tax rate. “They were of particular interest for aggressive tax avoidance of MNEs because more sophisticated international tax structures like transfer pricing of Intellectual Property, hybrid finance or disregarded entities are typically associated with high risk of tax litigations123”. Such practices are under attack in the EU, (also in the Ireland-Apple and the Netherlands-Starbucks case124, or in the FIAT-Luxembourg case), often under the doctrine of illegal state aid.

118 European Commission, Memo: Guidelines on Transfer Pricing-Frequently asked questions [https://ec.europa.eu/taxation_customs/business/company-tax/transfer-pricing-eu-context/joint-transfer-pricing-forum_en] 119 Countering Tax Avoidance at the EU after “Lux Leaks”. A history of tax rulings, transparency and BEPS: Base erosion profit shifting or Bending European Prospective Solutions. [https://poseidon01.ssrn.com/delivery.php?ID=62011600709511407810506906507612506703507409001603703407702612410012000607800708206 809811001600411605503900701712303110601107809802502908403910901908202200301912409105601600100700012309402810006808510900 5123100026091091123001101099119083094074085122031&EXT=pdf] 120 IMF: Introducing an Advance Tax Ruling Regime [https://www.imf.org/external/pubs/ft/tltn/2016/tltn1602.pdf] 121 EY:Guide to Advance Pricing Agreements [http://www.ey.com/gl/en/services/tax/international-tax/guide-to-advance-pricing- agreements--apa----apas--the-basic-elements] 122 OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations [http://www.keepeek.com/Digital-Asset-Management/oecd/taxation/oecd-transfer-pricing-guidelines-for-multinational-enterprises-and-tax- administrations-2017_tpg-2017-en#.WaRHNz6g-Uk] 123 Tax Avoidance through advance tax rulings: Evidence from the Lux Leak Firms[25810511110110411212611300702810508803800203505400202709600201510200012100212608307104310304901110300111008609901 702812510809305801700801507208100210107612203109802206004908409110811910406912312500310606601109202111211003010009912009 4012071120091086065]. 124 The Apple and FFT cases: possible incompatible state aid through tax rulings [https://www.debrauw.com/newsletter/apple- fft-cases-possible-incompatible-state-aid-tax-rulings/]

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In general, ATR & APAs have both advantages and disadvantages. Importantly, they provide certainty, necessary for effective business planning, and foster cooperation between taxpayers and tax authorities. On the other hand, they may actually increase the risk of BEPS, when their application is one-sided(see next sub-chapter of illegal state aid), and or/when beneficial rulings are granted in order to attract companies & assets from other, less favorable jurisdictions125. The EU has accurately delineated exchange of information as a remedy for such harmful tax practices by some States: Council Directive 2011/16/EU on administrative cooperation in the field of taxation, will include in its scope the obligatory disclosure of Advance Tax Rulings. In this manner, preferential rulings as f.e. of Luxembourg (see below) will attract scrutiny by the Commission for control of State Aid, thus ensuring a fairer use of such agreements in the EU.

3.4.d State Aid Issues

State aid constitutes an infringement of EU Competition Law (mostly arts.101-109 TFEU). Although tax competition between states is generally accepted, state grants must be consistent with TFEU objectives. The so-called three step test is used to ascertain selectivity126.

In our context, two types of selective advantages are relevant:

▪ State aid through preferential regimes (IP Boxes) ▪ State aid through APAs and ATRs

State Aid through MS’s IP Boxes have been recently examined under both the (soft law) rules of the Code of Conduct on Business Taxation, as well as the (hard law) State Aid provisions127. Under state aid rules, both the Cypriot IP Box and the UK IP Box have caused disagreements, but in the vein of the Spanish IP Box, they were deemed “not explicitly selective by favoring certain undertakings based on objective factors such as region, sector, size or legal form”128.But building on the Code of Conduct for Business Taxation, and the endorsement of the “modified nexus approach”(BEPS Action 5), which prescribes for the “substantial activity”(preferential taxation will be granted only to self-developed IP129), all of the MS IP Boxes were deemed to violate the nexus approach, and thus need to be amended. Interestingly, due to primary European law requirements, countries are not free to restrict the IP Box benefit to IP which has been created domestically in order to incentivize domestic R&D

125 IMF: Introducing an Advance Tax Ruling Regime [https://www.imf.org/external/pubs/ft/tltn/2016/tltn1602.pdf] 126 1st the reference tax system must be identified.2nd it must be established whether some firms receive a selective advantage in comparison to firms in similar legal and factual situation. 3rd it must be ascertained whether that measure is justified by the “general scheme “of the system. 127 Compatibility of IP Box Regimes with the EU State Aid Rules and Code of Conduct, Joris Luts [https://www.kluwerlawonline.com/document.php?id=ECTA2014025] 128 European Parliament, DG Internal Policies: Intellectual Property Box Regimes [http://www.europarl.europa.eu/RegData/etudes/IDAN/2015/563454/IPOL_IDA(2015)563454_EN.pdf] 129 BEPS and the EU: Michael Devereux, Anzhela Yevgenyeva and John Vella[http://www.etpf.org/papers/IFS2015/ETPF2015_BEPSEU.pdf].

33 activity130. This has allowed for asset &profit shifting, by f.e. moving the IP to Luxembourg, where it enjoys a myriad of preferential provisions, allowing for several of the 5 Tax Structures of our tax analysis, section 5. It will be interesting to see whether the prohibition of discrimination on ground of nationality contradicts the modified nexus approach, where that latter prescribes IP box advantages only to self-developed (and non-acquired) IP.

State Aid through ATRs & APAs: Generally, it is considered that, for the context of research, Advance Tax Rulings and Advance Pricing Agreements have a big influence in the ETR of entities involved. That is obvious in the number of MNE’s in recent scandals (Apple, Starbucks, Lux Leaks), having concluded such agreements. “The commission does not call into question the granting of tax ruling by the tax administrations of the Member States, in order to provide certainty to taxpayers 131(...). But according to the DG report, some of the rulings were solely structured around the intragroup transfer of Intellectual Property, by setting the remuneration for financing entities of the group”. The only function of such financing companies was the transfer of funds or intellectual property from one group entity to another. An even more harmful type of rulings, allowed for deduction on payments between the group entities, for payments that never happened132.

In 2014, the Commission opened four formal investigations where it raised concerns on tax rulings. These concerned rulings for Apple in Ireland, Starbucks in the Netherlands, Fiat Finance & Trade in Luxembourg, and Amazon in Luxembourg133.

▪ Luxembourg-Fiat: The tax rulings issued, allowed for an artificial and extremely complex intra-group transfer pricing methodology that the Commission disapproved(…) leading to a 5% ETR lowed than ordinary rules stipulated.

▪ The Netherlands-Starbucks Manufacturing EMEA BV: A tax ruling issued by the Dutch Authorities in 2008 greatly minimized Starbucks manufacturing’s tax base as compared to its accounting profit. (…) The Commission argued that the endorsement of non- justifiable royalties allowed for profit shifting to the Swiss HQs, thereby conferring a selective advantage to the company, and greatly reducing its taxable profit.

▪ Luxembourg-Amazon: Pending a final decision, the Commission set out a preliminary view of the rulings constituting state aid134. The APAs concluded underestimated taxable

130 ibid 131 DG Competition Working Paper on State Aid and Tax Rulings [http://ec.europa.eu/competition/state_aid/legislation/working_paper_tax_rulings.pdf] 132 ibid

133 Commission Staff Working Document, accompanying the document: Report from the commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the Regions, Report on Competition Policy 2015 [http://s3platform.jrc.ec.europa.eu/-/commission-staff-working-document-accompanying-the-report-from-the- commission-to-the-european-parliament-the-council-the-european-economic-and-social-?inheritRedirect=true] 134 KPMG Euro Tax Flash: EU Commission published a decision on its state aid investigation into Luxembourg tax rulings issues to Amazon [https://home.kpmg.com/content/dam/kpmg/pdf/2014/11/etf-244.pdf]

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profits and deviated from the arm’s length principle, hence conferring a selective advantage.

▪ Ireland-Apple: In a high profile case, it was ascertained that the selective treatment towards Apple, permitted the MNE to pay in 2014 an ETR of only 0.005% of its European profits. Since 1991, these rulings created “stateless income”, by routing payments in paper “head offices”. The European Commission concluded that Ireland granted tax benefits worth 13€ bn, which should be returned to the state. In a twist, Ireland vows to fight the EU order, although Irish Tax Authorities decided to discontinue the structure and close the loophole for the so called “double Irish”135.

It is both interesting and unnerving, to notice that of the biggest MNE Tax scandals of the last years, ALL involve state aid or at least state complicity in one way or another.

3.5 “Aggressive Tax Planning and Indicators”: The 6 Structures

The present chapter introduces the most seminal issue of the Thesis: The 5 IP Tax Planning Strategies that I will eventually subject to the ATAD.

Two academic publications have been mainly utilized. The one is the “International Tax Structures in the BEPS Era: An analysis of Anti-Abuse Measures” by the IBFD, and the other is the “Study on Structures of Aggressive Tax Planning and Indicators”, Final Report, by the European Commission on its Taxation Papers. The latter comprises a part of the Anti-Tax Avoidance Package.

I will begin with the IBFD Book, that serves as a more generic and approachable introduction on various IP Tax Structures. 2 IP structures have been identified, based on actual practices, and the first even illustrates the infamous “Double Irish with a Dutch Sandwich”. Then, 3 structures from the “Aggressive Tax Planning and Indicators“ have been chosen, out of a number of 7, with the 5 excluded being more generic. Those 5 structures, will then be judged under the light of the Anti-Tax Avoidance Directive of the EU, in section 5 “Analysis and Evaluation”. Some of their components are already under fire by the BEPS, but as BEPS is not yet fully implemented in a harmonized manner in the EU, it seems that the ATAD, despite its shortfalls, is the legislative instrument capable of discontinuing such structures.

• The “Double Irish with a Dutch sandwich “structure.

135 The Guardian: Ireland to close the Double Irish loophole [https://www.theguardian.com/business/2014/oct/13/ireland-close-double- irish-tax-loophole]

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It was first implemented in 1980s by companies such as Apple, Facebook, Google, IBM, Microsoft, Starbucks and Yahoo. It leads to the generation of “stateless income”, by employing a mismatch on the place of management.

• Luxembourg as an Intermediary jurisdiction for back-to-back licensing arrangements.

“ Back to back licensing” is often employed in order to avoid withholding taxes on royalty payments. The structure ensures that, by routing the income derived from IP through an intermediary company resident in a favorable jurisdiction, withholding tax on the related royalty payment is avoided.

• Structuring with a foreign permanent establishment.

Another structure used for exploiting IP rights in a tax efficient manner, entails routing the income derived from royalties through a foreign branch, as detailed below,

Jurisdictions commonly used for this purpose are Hong Kong, Ireland and Switzerland.

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• Two-tiered IP ATP structure.

The ATP structure is established in connection with a multinational group’s global operations utilizing its IP assets. The structure assumes that MNE Group, a multinational company headquartered in MS A, owns IP rights and plans to develop new IP rights.

The ATP structure takes advantage of mismatches in the rules on tax residence of a company incorporated in an MS. Such mismatches enable the ATP structure to benefit from the deduction for royalty payments under license/sub-license arrangements without any inclusion of the received income in any of the group’s entity.

• ATP structure based on IP and cost-contribution agreements.

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The ATP structure is established in connection with a multinational group’s intra-group transfer of manufacturing and sales operations and supporting intangibles. This ATP structure takes advantage of the allocation of all (or most) of the royalty payments to a tax-free company, and at the same time benefits from R&D tax credit and the deduction of royalties paid in a high-tax MS.

The overall minimization of the group’s global income is achieved mainly by means of royalty payments to a tax-free company.

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Section 4: Legal Research, Literature Review and hypothesis development

For the strictly legal section of the Thesis, I will focus on the Anti-Tax Avoidance Package and precisely on the ATA Directive which is law under implementation (“Member States should apply these measures as from 1 January 2019”136). The CCCTB is also important for the IP Tax Planning environment, but as it remains a proposal, I will not include its content and effects in the following chapters. Importantly though, the three packages are connected in the following fashion:

● The BEPS Actions are the policy inspiration behind the Anti-Tax Avoidance Package, although with some variations137.But the 15 Actions are soft law, and many hurdles must be overcome for their application (f.e. domestic implementation, international cooperation etc). For the moment, only Actions 8-10 on Transfer Pricing are directly applicable(through the OECD Transfer Pricing Guidelines).Those that amend DTTs will require first the adoption of the MLI, Action 15. ● ATAP is under implementation, but that “does not mean that the European Commission has given up on the adoption of the Common Consolidate Corporate Tax Base (CCCTB) which was a central part in its Action Plan on Corporate Taxation”.138 ● Because the CCCTB is sometimes deemed to be too ambitious, the ATAP is seen as a package of measures that is less overhauling, but will still affect EU Corporate Taxation in a positive and overreaching manner. The CCCTB is the 1st pillar of the June 2015 Action Plan for Fair and Efficient Corporate Taxation in the EU. The CCCTB is considered the best solution to combat profit shifting, and institute transparency and effective corporate taxation in the EU139.Probably it will implemented first in the form of an harmonized Corporate Base, before making it to the (full) CCCTB.

4.1 Why the BEPS are not enough:

The BEPS is the policy inspiration behind the ATAP, and constitutes a soft-law agreement between the OECD countries, the G20 Countries, and some low-capacity developing countries. They have been agreed in October 2015 after a two year negotiation140. Most EU MSs are

136 European Commission: The Anti-Tax Avoidance Directive [https://ec.europa.eu/taxation_customs/business/company-tax/anti-tax- avoidance-package/anti-tax-avoidance-directive_en] 137 “The Package builds on 2015 OECD recommendations to address tax base erosion and profit shifting (BEPS), European Council 138 Tax Journal: The European Commission’s Anti-Tax Avoidance Package [http://www.kwm.com/~/media/SjBerwin/Files/PDF/2016/03/kwm-tax-journal-european-comissions_anti-tax-avoidance-package.ashx?la=en]

139 European Commission Proposes anti-tax avoidance Package [https://www.pwc.com/us/en/tax- services/publications/insights/assets/pwc-european-commission-proposes-anti-tax-avoidance-package.pdf] 140 Tax Notes International:Are the final BEPS reports on Actions 8-10 Effective Now? Jason Osborn, Brian Kittle and Kenneth Klein [https://www.mayerbrown.com/files/News/25680069-b1af-47dc-9815-42c958625b0e/Presentation/NewsAttachment/3b2a839b- c884-4f6c-974a-4488e2b64694/Osborn_Klein_Kittle-08-22-2016.pdf]

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OECD countries, except: Bulgaria, Latvia, Lithuania, Malta, Croatia, Romania, Cyprus. Despite that, the OECD has designed an inclusive framework that allows non-OECD members to participate “on equal footing141”.Up to now, more than 100 countries have agreed on the implementation of the BEPS. The key-word in the BEPS is coordination, or else the approximately 250 billion Corporate Tax Gap142 sustained by the OECD countries will not be effectively adressed. The BEPS Actions will also update two very important OECD frameworks: Transfer Pricing Guidelines, will be amended based on Actions 8-10, and OECD’s model tax treaties will be updated via the Multilateral Instrument, Action 15.

The BEPS are a well-structured answer to a variety of harmful tax practices. But there is a hurdle: For the most part, the final BEPS reports are not self-executing, but depend on domestic legal application of the individual state. Exceptions to this, are BEPS actions 8-10, which act as revision on the OECD Transfer Pricing Guidelines, and the Action 15 MLI which aims to automatically amend a huge number of DTTs143. In total, the BEPS Actions implementation according to its own report144, stipulates: • Revisions to Transfer Pricing Guidelines are directly applicable • Other require changes through tax treaties or the MLI • Others need domestic application, namely CFCs, Hybrids, Interest deductibility, CFC rules, and preferential IP regimes that reinforce harmful tax practices.

A monitoring mechanism has been put in place to ensure the application by the OECD countries, but again, discrepancies in implementation and the inherent difficulty of harmonizing an extreme volume of provisions across different jurisdictions and competing interests, means that the BEPS might not be implemented in practice as envisaged. For this reason, there exists substantive guidance on the Application of the Actions145, and although in the right direction, full implementation is far from achieved.

Fortunately, in the EU, the ATAP will play exactly this role. Even thought the ATAP might stumble also on issued of implementation, being a Directive, means that margins of application will be much tighter for states legislatures. Additionally, the BEPS implement some actions not existent in the ATAD ambit, such as the modified nexus approach. Already, the following jurisdictions are implementing more strict criteria in the provision of IP Box advantages: Cyprus, Belgium, Netherlands and Ireland are modifying their regimes to “BEPS compliant boxes”146.

4.2. Legal Analysis of the Anti-Tax Avoidance Package

141 EY: The latest on BEPS-2016-Year End Review: A review of OECD and Country actions [http://www.ey.com/Publication/vwLUAssets/EY-US-the-latest-on-beps-2016-in-review/$FILE/EY-US-the-latest-on-beps-2016-in-review.pdf] 142 OECD: Myth and facts of BEPS [https://www.oecd.org/ctp/myths-and-facts-about-beps.pdf] 143 OECD Published Multilateral Instrument for Implementing BEPS in double tax treaties [https://www.pwc.com/gx/en/tax/newsletters/tax-policy-bulletin/assets/pwc-oecd-publishes-multilateral-instrument-for-implementing-beps.pdf]. 144 OECD BEPS project: Explanatory Statement [http://www.oecd.org/ctp/beps-explanatory-statement-2015.pdf] 145 EY: The latest on BEPS-2016-Year End Review: A review of OECD and Country actions [http://www.ey.com/Publication/vwLUAssets/EY-US-the-latest-on-beps-2016-in-review/$FILE/EY-US-the-latest-on-beps-2016-in-review.pdf], 146 Ibid

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The Anti-Tax Avoidance Package, contains the following legal instruments:

● The Chapeau Communication (and the Staff Working Document147) ● The Anti-Tax Avoidance Directive Proposal148. ● Recommendation on Tax Treaties149 ● Revision of the Administrative Cooperation Directive150 ● Communication on External Strategy for Effective Taxation151

4.2.a. Focus on Anti-Tax Avoidance Directive

Presented initially on 28 January 2016, the Anti-Tax Avoidance Directive is the cornerstone and most important legislative instrument of the whole Anti-Tax Avoidance Package, as well as of the present Thesis. It was adopted by the European Council on June 20 of 2016152: On 21 February 2017, a new agreement was reached (ATAD 2153) that subtracted the “switchover rule “and extended the scope of art.9 on “hybrid mismatches with 3rd countries”. The following 5, legally-binding anti-abuse measures should be applied by all Member States as of 1st January 2019. They will effectively combat aggressive tax planning structures. The most important clauses are154:

● The Controlled Foreign Company (CFC) rules ● The Exit taxation provisions ● The Interest Limitation ● The General Anti Abuse Measures ● Hybrid mismatches

1)CFC Rules(art.7 ATAD)

147 Communication from the Commission to the European Parliament and the Council: Building a fair, competitive and stable Corporate Tax System for the EU [http://eur-lex.europa.eu/legal-content/EN/TXT/?uri=COM%3A2016%3A682%3AFIN].

148 Directive (EU) 2016/1164 laying down rules against tax avoidance practices that directly affect the functioning of the internal market[ http://eur-lex.europa.eu/legal-content/en/TXT/?uri=CELEX:32016L1164] 149 Commission Recommendation (EU) 2016/136 of 28 January 2016 on the implementation of measures against tax treaty abuse[ http://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX%3A32016H0136]

150 Proposal for a council directive 2011/16/EU as regards mandatory automatic exchange of information in the field of taxation[http://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:52017PC0335] 151 Communication from the commission to the European Parliament and the council on an External Strategy for Effective Taxation [http://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX%3A52016DC0024]

152 European Commission, The Anti-Tax Avoidance Directive [https://ec.europa.eu/taxation_customs/business/company-tax/anti-tax- avoidance-package/anti-tax-avoidance-directive_en]

153 Proposal for a Council Directive amending Directive (EU) 2016/1164 as regards hybrid mismatches with third countries [http://eur-lex.europa.eu/legal-content/EN/TXT/?uri=celex%3A52016PC0687] 154 European Commission, The Anti-Tax Avoidance Package: Fact Sheet [http://europa.eu/rapid/attachment/IP-16- 159/en/Anti%20Tax%20Avoidance%20Package%20Factsheet.pdf.]

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The Controlled Foreign Company155 rule will allow the Member State where the parent company is located to tax any profits that the company parks in a low or no-tax country. The CFC rule is triggered if the effective tax rate in that third jurisdiction is less than 40% of that of the Member State in question. The company will receive a tax credit for any taxes that paid abroad. This will ensure that profits are effectively taxed in the Member State where they were actually generated156.

2)Exit Taxation(art.5 ATAD)

Assets such as intellectual property, usually valued at their projected future income, are often not taxed when they are moved from an EU Member State to a third country(unless stipulated by domestic law). This allows companies to shift their valuable assets from Member States to low- or no-tax countries, and receive licensing profits in the low-tax jurisdictions, despite the asset having been developed in the MS jurisdiction(and costs being deducted in the MS). The Directive will oblige Member States to apply an exit tax on assets moved from their territory. The exit tax should be based on the value of the assets at the point of migration. Since companies are obliged to inform tax authorities of their balance sheets describing their taxable assets, Member States can see when an asset such as intellectual property has "disappeared". This will ensure that profits from high value assets cannot be shifted out of the EU untaxed.157From an IP perspective, this is probably the most relevant and critical part of the legislation.

3) Interest Limitation(art.4 ATAD)

Interest payments are generally tax deductible in the EU. This give ample opportunities for tax planning and group financing arrangements in the EU market: High-debt burdens entities in high-tax jurisdictions, allowing for interest payment deductions. Meanwhile, the group financing entity, placed in a favorable jurisdiction(f.e. Luxembourg or Switzerland) receives the interest, which is taxed on a minimal rate. The Group’s overall burden is thus greatly reduced, and high tax jurisdictions receive no tax proceeds due to interest stripping. The Directive puts a limit to the amount of net interest that a company can deduct from its taxable income, based on a fixed ratio of its earnings. Thus debt shifting is greatly hampered158.

4) General Anti-Abuse rules (GAAR)(art.6 ATAD)

155 art .7 Anti-Tax Avoidance Directive

156ibid

157 ibid

158 ibid

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The essence of Aggressive tax planning rests in seeking ways to minimize tax burden, by utilizing domestic or international rules& loopholes. Aggressive tax planners circumvent existing anti-avoidance provisions or devise novel tax avoidance techniques, that are not yet covered by existing rules. For this reason, a General Anti-Abuse Rule can tackle artificial tax arrangements, despite the absence of a specific anti-avoidance rule that covers the situation. It functions as a “safety net” for anti-abuse, and more importantly, allows the circumvention of “wholly artificial tax arrangements” and instead, targets the underlying economic substance159(or non substance).

5) Rule on Hybrid Mismatches (art.9 ATAD)

International aggressive tax planning utilizes mismatches and technicalities between two or more jurisdictions, in order to achieve a minimal ETR. Specifically, an entity or an item of income may be characterized differently in two jurisdictions. This allows f.e. a deduction in both countries, or the creation of stateless income (Apple case) etc. The ATAD combats such mismatches, by forcing the country of destination to treat the income/entity in the same manner as the country of origin does. This rule thus combats effectively hybrid instruments and entities160.

4.2.b. Other Contents of the Package

● Revision of the Administrative Cooperation Directive161

Overhauling the previous Directive (Directive 2011/16/EU as regards mandatory automatic exchange of information in the field of Taxation162), the revised edition “proposes country-by- country reporting(CbCR) between Members State’s Tax Authorities on key tax-related information on multinationals operating in the EU”. Hence, once a country receives information concerning Parent’s company’s subsidiaries, the data will be automatically communicated to the other MS’s. The Directive implements BEPS Action 13163.

● Recommendation on Tax Treaties164

159 ibid

160 ibid

161 Council Directive amending Directive 2011/16/EU as regards mandatory automatic exchange of information in the field of taxation [http://eur-lex.europa.eu/resource.html?uri=cellar:89937d6d-c5a8-11e5-a4b5-01aa75ed71a1.0014.02/DOC_1&format=PDF]

162 Council Directive 204/107/EU of 9 December 214 amending Directive 2011/16/EU as regards mandatory automatic exchange of information in the field of taxation

163 European Commission, Anti-Tax Avoidance Package: Fact Sheet [http://europa.eu/rapid/attachment/IP-16- 159/en/Anti%20Tax%20Avoidance%20Package%20Factsheet.pdf.

164 Commission Recommendation of 28.1.2016 on the implementation of measures against tax treaty abuse [https://ec.europa.eu/transparency/regdoc/rep/3/2016/EN/3-2016-271-EN-F1-1.PDF]

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The existence and necessity of Tax Treaties for the apportionment of Taxing Rights between jurisdictions on Bilateral Pairs of Countries is a well-documented, as well a “sine-non-qua” element of the International Tax System. Problems arise when these are exploited for the purpose of tax avoidance or tax-evasion, through minimal or no-taxation, treaty shopping, profit shifting or other abusive strategies that deprive state budgets of millions. This recommendation, draws inspiration and momentum from the Final Report’s Action 6.Its main contents are: 1)General Anti-Avoidance rule based on a “principal purpose test” (PPT) 2) (Revision of the) Definition of Permanent Establishment

● Communication on an External Strategy for Effective Taxation

The purpose of this part of the Anti-Tax Avoidance Package, is to coordinate the actions of EU members, in order to identify potential perils for the effective taxation in the EU common market. According to the Commission, the Rationale of the external strategy to be unfolded, can be summarized as “more effective response to external base erosion threats”, “more unified stance on global tax issues, more cooperation and a stronger link between EU Tax Policy and other policy priorities, as well as more clarity for third countries”.165

● And the Study on Aggressive Tax Planning166

The study on aggressive tax planning is the foremost instrument of the ATAP that I utilized in the systematic analysis of present thesis. The study was launched in the beginning of 2015 and published in January 2016. With a view to reviewing its contents, the objectives of the study were: 167 ● The identification of “model” ATP structures. ● The Identification of critical factors that facilitate or allow for ATP, the so called Indicators (Active, Passive and Combined sets). ● And the review of individual MS tax rules & Practices which can expose a Member State to Aggressive Tax Planning.

A sneak-peak of its conclusions, illustrate large legislative discrepancies between MSs and a lack of harmonization, while pinpointing the most relevant indicators: A lack of CFC Rules, base erosion through the financing of Intra-Group Entities, an absence of detailed rules to counter mismatches between MS jurisdictions, dividend flow-through provisions, and

165 Communication from the commission to the European Parliament and the Council on an External Strategy for Effective Taxation[http://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX%3A52016DC0024]

166 European Commission Taxation Papers: Study on Aggressive Tax Planning and Indicators [https://ec.europa.eu/taxation_customs/sites/taxation/files/docs/body/taxation_paper_61.pdf]

167 Study on Structures of Aggressive Tax Planning and Indicators: Platform for Tax Good Governance[https://ec.europa.eu/taxation_customs/sites/taxation/files/docs/body/pres_atp_study.pdf]

44 finally, the preferential patent boxes which were deemed to be the most crucial elements facilitating Aggressive Tax Planning Structures. Third jurisdictions have also responsibility in Aggressive Tax Planning Structures, either through their zero or low taxation, or through limited Anti-Abuse rules, facilitating abusive structures originating in the EU.

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Section 5: Analysis and Evaluation

1) Analysis and evaluation of the ATAD:

There exist two levels of analysis on this question:

The first, is legalistic and theoretical. What does the law prescribe in the Anti-Tax Avoidance Directive? That is an easy question to answer. What is impossible to assess, is the actual implementation of the envisaged tax framework .In the following sub chapter I will illuminate some dark points on the implementation of the Anti-Tax Avoidance Directive in Member States.

Secondly, I will assess the theoretical application of the Anti-Tax Avoidance Directive on the 6 IP Tax Planning Structures.

a) Criticism and problematic points in the ATAD provisions.

As one may guess, the application of the Anti-Tax Avoidance Directive in the context of complex cross border transactions, is affected by a multitude of domestic provisions, potentially hampering its effectiveness. Here I contrast its main provisions, with public and personal criticism of problematic points and potential inefficacies.

5.1.a.i Main problems:

• Discrepancies in the Implementation168: The ATAD prescribes a “de minimis approach” which means that some MSs may stipulate much more restrictive measures than others(although I deem that highly unlikely). Also, it is very probable, that some of the Member States with policy interests in attracting highly mobile capital and assets, specifically Intangibles, f.e. Luxembourg, or Netherlands, may offer less restrictive measures, either through the implementation of the provisions per se, or by enacting other legislative measures & benefits to compensate for the more stringent ATAD- inspired policies. • Eligibility: The Anti-tax Avoidance directive’s scope applies to all entities subject to Corporate Income Tax. Possible discrepancies between Members States may offer leeway for special purpose vehicles, or other legal forms f.e. Partnerships that do not fall within the scope of the CIT. • Finally, the content of the ATAD may be re-amended until its implementation. Indeed, the overreaching “switchover rule” has been dropped of the final Anti-Avoidance law169. Additionally, the ATAD has already been amended (now it is called ATAD 2), by

168 Uncertainties following the final EU anti-tax avoidance Directive [http://kluwertaxblog.com/2016/10/17/uncertainties-following- final-eu-anti-tax-avoidance-directive/] 169 EU drops controversial “switchover rule” from final anti-tax avoidance law [https://www.out-law.com/en/articles/2016/june/eu- drops-controversial-switchover-rule-from-final-anti-tax-avoidance-law/]

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implementing BEPS 2 in Art.9, through a more inclusice scope for hybrid mismatches170 (with MS and non-MS countries).

Of course, there are so many details in the implementation that may not be practically illustrated. The devil is in the details, especially in Corporate Taxation. Here I analyze some individual problematic points of the specific articles, based on the ATAD and its amending document (ATAD 2171).

5.1.a.ii Art. 4 -Interest Limitation Rule

Article 4 is the one with the least relevance for IP Tax Planning, as it is mostly connected with financing-earning stripping. That may still have a place in complex IP structures. For the sake of completeness, I will analyze it also here:

1. Exceeding borrowing costs shall be deductible in the tax year in which they are incurred only up to 30 % of the taxpayer's earnings before interest, tax, depreciation and amortization (EBITDA) 3.By derogation from paragraph 2, the taxpayer may be given the right: a) to deduct exceeding borrowing costs up to EUR 3 000 000 (or 30%, whichever is higher) b) to fully deduct exceeding borrowing costs if the taxpayer is a standalone entity (the amount of 3.000.000 shall be considered for the entire group) 6. The MS of the taxpayer may provide for rules(3)(…) to carry forward nondeductible borrowing costs.

This article largely follows the BEPS recommendation in Action 3, to reduce earning stripping through excessive debt finance. Member States are not obliged to apply the interest deduction limitation rule to financial undertakings such as banks insurance companies, pension funds and certain investment funds172.Also, the Directive does not provide any further guidance on when existing measure is “equivalent effective”173. ATAD provides for two alternative worldwide group ratio escape rules, namely (1) an equity escape rule or (2) an earnings-based worldwide group ratio rule.174

The major identified problems in the implementation of this article, are: • Domestic implementation: The EBITDA-provision may face some constitutional issues in certain EU MS, as f.e.in 2016, the German Federal Court of Finance claimed that the German Interest limitation rule (Zinsschrabnke) is in breach of the German Constitution

170 Proposal for a Council Directive amending Directive (EU) 2016/1164 as regards hybrid mismatches with third countries & CFE ATAD 2:Agreement reached at ECOFIN 21 February 2017 [http://eur-lex.europa.eu/legal- content/EN/TXT/?uri=celex%3A52016PC0687] 171Proposal for a Council Directive amending Directive (EU) 2016/1164 as regards hybrid mismatches with third countries [http://eur-lex.europa.eu/legal-content/EN/TXT/?uri=celex%3A52016PC0687] 172 Tax Flash: Political agreement EU to implement anti-tax avoidance measures (Anti-Tax Avoidance Directive) [https://www.loyensloeff.com/nl-nl/news-events/news/tax-flash-political-agreement-eu-to-implement-anti-tax-avoidance-measures-anti-tax-avoidance- directive] 173 PWC: ATAD: What does it actually mean for financing [https://news.pwc.be/atad-actually-mean-financing/] 174 Loyens & Loeff: Tax Flash: Political agreement EU to implement anti tax avoidance measures (Anti Tax Avoidance Directive)[ https://www.loyensloeff.com/nl-nl/news-events/news/tax-flash-political-agreement-eu-to-implement-anti-tax-avoidance-measures-anti-tax- avoidance-directive]

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because it violates the principle of equality175. That may be the case also in other jurisdictions, as all the ATAD provisions need to pass similar MS’s tests in numerous, possibly fragmented, national legislative bodies. • There exists the possibility that groups of companies sitting on top or below the “regulated financial institutions, such as banks, insurance companies, pension funds and certain investment funds” may circumvent or cheat the provision, also because of their easy access to assets and finance. Concerning investment funds, an important question will be whether fund vehicles are seen as the “top entity “of a consolidated group. If the answer is yes, then the group ratio escape will not normally help (the consolidated group will often have a high equity). If the fund is not included in the consolidation (which may be the case in many countries) there may be more possibilities to increase the “interest deduction ceiling”176.

5.1.a.iii.Art. 5 –Exit Taxation

Exit taxation is especially relevant with regards to IP being transferred in more favorable jurisdictions. Art. 5 stipulates:

1. “A taxpayer shall be subject to tax at an amount equal to the market value of the transferred assets, at the time of exit, less their value for tax purposes, in any of the following circumstances”:

(a)a taxpayer transfers assets from its head office to its permanent establishment in another Member State or in a third country (b)a taxpayer transfers assets from its permanent establishment in a Member State to its head office or another permanent establishment in another Member State or in a third country (c) a taxpayer transfers its tax residence to another Member State or to a third country (d) a taxpayer transfers the business carried in an PE out of a Member State

(all of the above provisions are activated when the “original “MS had otherwise no right to tax the transferable asset)

2.A taxpayer may defer the payment of an exit tax referred to in paragraph 1, by paying it in instalments over at least 5 years(…)

The rationale of this provision is to curb the transfer of high-value assets towards favorable jurisdictions, where they can be exploited at much higher margins. It’s ambit directly includes IP migration, which is considered “the root of all evil” in IP Tax Planning. The inspiration for the exit tax lies on the CCCTB and not the BEPS. The “receiving” state has to accept the difference of tax-book value ascertained by the “origin” state. The provision seems

175 Norton Rose Fullbright: German Federal Court of Finance questions constitutionality of German interest limitation rule [http://www.nortonrosefulbright.com/wissen/publications/137127/german-federal-court-of-finance-questions-constitutionality-of-german-interest- limitation-rule] 176 Uncertainties following the final EU Anti-Tax Avoidance Directive [http://kluwertaxblog.com/2016/10/17/uncertainties-following- final-eu-anti-tax-avoidance-directive/]

48 equitable and targets one major method of profit shifting. Still, many problems may arise in its application: • Differences in calculating book-tax value between states, which can lead to gross deviations, or even to purposeful under-valuations or heavy exit taxes that cannot be disputed by the taxpayer. If the “receiving state” is an extra-EU one, or non OECD compliant, how can the ATAD force it to accept the valuation of the “origin “state? • Intricate Transfer Pricing methodologies and disputes, in the cases where an intangible is concerned. Being notoriously hard to value, due to the absence of comparable, there exist possibilities for understatements of the value of the asset (but also of “overstatement” by tax authorities). Also, as the Devereux& Griffith model on effective tax rates177 proved, the company must understate as legally possible the value of the asset, to avoid a nullification of the profit shifting motive (although the avoidance of an exit tax is not the only determinant in a successful IP strategy). • Companies may minimize or simply circumvent such exit taxes, or at least alleviate their effects, by developing partially an intangible in the high-tax jurisdiction, and improving it in the favorable-tax jurisdiction, through own or outsourced development. In essence, the exit tax provision is a good answer, but one that may be avoided, through an adjustment of business and tax models. • Exit tax does not apply to Parent-Subsidiary relations178. Hence, an IP may migrate to a low-tax jurisdiction, and as long as dividends remain undistributed from SP, then most of the value of the IP will not be “caught” from a tax perspective. As a caveat, a suspension of Treaty Freedoms for an extra-EU transfer (based on f.e. the protection of the Tax Base) could oblige the Parent to pay an exit tax.

5.1.a.iv Article 7 -General anti-abuse rule

General anti abuse rules are perfect for countering artificial IP arrangements with the aim of tax minimization/profit shifting. Article 7 prescribes that for the calculation of CIT:

1) a MS shall ignore an arrangement or a series of arrangements which, having been put into place for the main purpose or one of the main purposes of obtaining a tax advantage that defeats the object or purpose of the applicable tax law, and are not genuine having regard to all relevant facts and circumstance. 2) An arrangement or a series thereof shall be regarded as non-genuine to the extent that they are not put into place for valid commercial reasons which reflect economic reality. 3) Where arrangements or a series thereof are ignored in accordance with paragraph 1, the tax liability shall be calculated in accordance with national law.

The General Anti Abuse Rule is meant to be interposed when Specific Anti Avoidance Measures are not enough, or “for tackling abusive tax practices that have not yet been dealt with through specifically targeted provisions”. The concept of an arrangement or scheme,

177 The Impact of Tax Planning on forward-looking effective tax rates[https://ec.europa.eu/taxation_customs/sites/taxation/files/taxation_paper_64.pdf]. 178 “It is also helpful to clarify that transfer of assets, including cash, between a parent company and its subsidiaris fall outside the scope of the envisaged rule on exit taxation”.

49 according to most GAAR provisions encompass a variety of agreements, undertakings, and promises, regardless if they are implicit/ explicit and enforceable or not179. It is the most controversial of the 5 provisions, as it is vague, both in doctrine and jurisprudence. Its application is expected to be ten times more problematic:

General Issues: • How to apply “in a uniform manner”? The GAAR is a vague and open ended instrument meant to address situations that SAARs cannot. It is almost certain that GAAR cannot be applied in a uniform manner between MS and towards 3rd countries, or even within MS, which creates much more problems than it solves in cross border circumstances. “Minimum harmonization, which is the approach (art.3) of the Directive proposal, bears the risk of creating up to 28 different GAARs: o A “non uniform manner “will give rise to discriminations across the EU. o A “non uniform manner” application, without the presence of safeguards, may give rise to double taxation. The Directive does not approach this problematic issue180. o A “non uniform manner” might actually boost tax competition between states. o Even if the GAAR is applied in a uniform manner, there is not safeguard that domestic judicial control will not quash some of its applications unilaterally, or that the actual application will not diverge.

• How to interpret the provision: o How do you determine when an arrangement is put in place for the main purpose or with one of the main purposes to obtain a tax advantage? o What is the “purpose and objective” of the tax rules? o Which reasons are valid ? o How do you determine economic reality? o Additionally, it has been concluded already, that the artificiality test, based on Cadbury swipes is insufficient. This article will transpose this inherent vagueness in a super-principle that will grow even more complex, fragmented and vague due to its future non-formal implementation. • The vague terms, inadequate definitions, and the inherent abstractness and prospectiveness of the GAAR might lead to tax authorities utilizing this “super principle” for purposes outside the scope of “hard abuse “and artificiality, for example with the single purpose of taxing bigger proportions of MNE’s profits.

5.1.a.v Article 8- Controlled Foreign Company Rules

179 International Tax Structures in the BEPS Era: An analysis of Anti-Abuse Measures [https://www.ibfd.org/IBFD- Products/International-Tax-Structures-BEPS-Era-Analysis-Anti-Abuse-Measures] 180 Conferederation Fiscale Europeene: Opinion Statement FC 3/2016 on the European Commission’s proposal for an Anti-Tax Avoidance Directive [http://www.cfe-eutax.org/sites/default/files/CFE%20Opinion%20Statement%20FC%203- 2016%20on%20the%20Anti%20Tax%20Avoidance%20Directive.pdf]

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CFC rules are a good catch-all measure to remedy profit shifting in low tax jurisdictions by MNEs:

1.”The Member State of a taxpayer shall treat an entity, or a permanent establishment of which the profits are not subject to tax or are exempt from tax in that Member State, as a controlled foreign company where the following conditions are met: a)In the case of an entity, the taxpayer (…) holds a direct or indirect participation of more than 50 % of voting right, or owns directly or indirectly more than 50% of capital or is entitled to receive more than 50% of the profits of that entity b)the actual corporate tax paid on its profits by the entity or permanent establishment is lower than the difference between the corporate tax that would have been charged on the entity or permanent establishment under the applicable corporate tax system in the Member state of the taxpayer and the actual corporate tax paid on its profits by the entity or permanent establishment181.

The eligible categories of income are:

i)interest or any other income generated by financial assets; (ii)royalties or any other income generated from intellectual property or tradable permits (iii)dividends and income from the disposal of shares (iv)income from financial leasing (v)income from immovable property, unless the Member State of the taxpayer would not have been entitled to tax the income under an agreement concluded with a third country (vi)income from insurance, banking and other financial activities (vii)income from services rendered to the taxpayer or its associated enterprises”

CFC rules, along with the exit taxation article, are the most crucial provisions affecting IP Tax Planning in the ambit of my research.” CFC rules have the effect of re-attributing the income of a low-taxed controlled subsidiary to its parent company”.

Also, according to the preamble, “the scope for a legitimate application of CFC rules within the Union should be limited to artificial situations without economic substance”. As a result, the heavily regulated insurance and finance industries will most likely escape the scope of the rules, giving the possibility of avoiding CFC imputation182, should complex arrangements be set up.

Several problems arise from the stipulations of article 8:

• Avoiding the participation threshold:

181 This translates to 50% ETR differential, or of 40% for other Tax Practitioners. Reference Tax Policy Bulletin: Ecofin Agrees EU-Wide Rules in Anti-Tax Avoidance Directive[https://www.pwc.com/gx/en/tax/newsletters/tax-policy- bulletin/assets/pwc-ecofin-agrees-eu-wide-rules-in-anti-tax-avoidance-directive.pdf]. 182 EU Anti Tax Avoidance Directive has implications for the Insurance, Finance and Asset Management Sectors [http://www.ey.com/gl/en/services/tax/international-tax/alert--eu-anti-tax-avoidance-directive-has-implications-for-banking--insurance-and-asset- management-sectors]

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• The threshold of 50% participation may be circumvented in a variety of ways, by providing for specific ownership structures of the controlled foreign company or other more imaginative ways, conduit companies etc. • Through contractual agreements, one can retain practical control but avoid the formal definition of control. The CFE states that such restrictions will just give rise to new forms of tax planning183.The concept of beneficial ownership will be probably utilized to ascertain the substance of control over the CFC. • Avoid the 40% ETR differential threshold for CFCs. • The 40% percent (compared to the parent’s ETR) of threshold for passive income may be circumvented in the cases where an offshore company provides also (active) services to global customers (in the case of IP Tax Planning, f.e. know how to customers) or for maintenance/ improvement of the IP. Modern technologies can facilitate such business restructurings. • The 40% rate difference may be not effective in cases where the parent company is f.e. Bulgarian (10% CIT) Cypriot(12.5%), from Gibraltar (10%) etc and the controlled foreign company’s ETR slightly more than 40%. This means that all jurisdictions with a 5% ETR, conventionally considered “offshore “and low tax rate”, will escape the scope of the rule, and again, purely for passive income.

Other problems arising from the stipulation of the CFC rule: • Danger of double taxation of the same income • The article infringes the OECD & DTT principle of taxing the income where it arises. • As is the case with the GAAR, it is hard to impossible to ascertain the “substantive economic activity”, and the “artificial arrangement” criteria. Additionally, the margin between these two may be obscure, and prone to judicial annulment or MSs jurisdictional discrepancies. • The CFE points another issue, insofar as the categories of activities also concern genuine active operational activities (including active group financing activities) and holding activities (everything that does not concern passive or mobile income).

It appears that there exist certain leeways to circumvent the CFC rules. This is especially relevant as low-taxed CFCs are frequently utilized by MNEs for Aggressive Tax Planning structures.

5.1.a.vi Article 9-Hybrid mismatches

183 Confederation Fiscale Europeene: Opinion Statement FC 3.2016 on the European Commission’s proposal for an Anti-Tax Avoidance Directive of 28 January 2016. [http://www.cfe- eutax.org/sites/default/files/CFE%20Opinion%20Statement%20FC%203-2016%20on%20the%20Anti%20Tax%20Avoidance%20Directive.pdf]

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As I expounded, the apex of Aggressive Tax Planning is the double deduction, and/or no- taxation. Harmful tax practices are greatly facilitated by Hybrid Mismatches, either regarding entities (Hybrid entities) or payments/ transactions (hybrid instruments). “The effect of such mismatches is often a double deduction (i.e. deduction in both states) or a deduction of the income in one state without inclusion in the tax base of the other. “184 Such is also the case in the Double Irish structure. Article 9 of the ATAD stipulates:

1)To the extent that a hybrid mismatch results in a double deduction, the deduction shall be given only in the Member State where such payments has its source 2)To the extent that such a hybrid mismatch results in a deduction without inclusion, the Member State of the payer shall deny the deduction of such a payment.

Although this article is mainly targeted against “structured arrangements” it may be difficult to ascertain the criteria for such a designation. The rule applies on “associated enterprises” , with the term “associated” applying for direct and indirect interests of 25%+, and for certain types of mismatches, at 50%+ of ownership interest.

On top of article 9, an amendment185 of the Anti-Tax Avoidance Directive (“the ATAD 2”) greatly widened the scope of the hybrid mismatch rule, and thus effectively implemented the BEPS Action 2 “Neutralizing the Effects of Hybrid Mismatch Arrangements”. Hence the article now encompasses: • Hybrid entity mismatch leading to a double deduction • Hybrid financial instrument mismatches • Hybrid transfers • Hybrid permanent establishment mismatches • Imported Mismatches • Dual resident mismatches

The scope of the rule encompasses both MSs and 3rd countries.

The EU went much further than the “linking rules” proposed by the OECD, and instead provided for “complete mutual recognition of the fiscal qualification of an entity, permanent establishment or financial instrument” that follows the designation of the source state as a guiding principle186. Interestingly, the rule grossly contradicts the sovereign tax prerogative to designate which entities are independent taxpayers for the levying of corporate tax.

184 Proposal for a Council Directive laying down rules against tax avoidance practices that directly affect the functioning of the Internal Market[http://eur-lex.europa.eu/legal-content/en/TXT/?uri=CELEX:32016L1164]. 185 Proposal for a Council Directive amending Directive (EU) 2016/1164 as regards hybrid mismatches with third countries [http://eur-lex.europa.eu/legal-content/EN/TXT/?uri=celex%3A52016PC0687] 186 Confederation Fiscale Europeene: Opinion Statement FC 3.2016 on the European Commission’s proposal for an Anti-Tax Avoidance Directive of 28 January 2016[http://www.cfe- eutax.org/sites/default/files/CFE%20Opinion%20Statement%2C%20OECD%20Art5%20PE.pdf].

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In general, this provision deems to address hybrid mismatches (also with 3rd countries, as of the date of the amendment), which can be found in numerous IP Tax Planning Structures. Thus, as of its design and intention, it is seem to be effective, but two legal issues persist:

• The linking rules may go too far • Some OECD principles are tramped (taxation where income occurs, linking rule versus mutual recognition rules) • Domestic tax independence is hampered, and it is even more stressed when applying to third, non EU countries. • What if a hybrid instrument/entity is not part of a “structured arrangement”? o How can one ascertain the “structuring intention” of an arrangement? • It might be the case that some extra-EU jurisdictions utilized in such arrangements (f.e. Bermuda on the Double Irish) will be reluctant to enforce such detrimental measures.

5.2 Analysis and evaluation per Tax Planning Strategy

Finally, in this subsection I will subject the 6 identified IP Tax Planning Strategies to the projected effects of the Anti-Tax Avoidance Directive. The tax planning mechanism is illustrated in the left column, and my post-ATAP assessment on the right one. In the blue brackets, there will be a reference to the previous chapters of the Thesis, where each subcomponent is analyzed.

5.2.a The Double Irish with a Dutch Sandwich structure (or creating “stateless income”)-Structure 1 The structure at hand is the apex of US MNEs migrating their IP rights in low-taxed offshore CFCs[3.3.c.ii.], that offer preferential tax treatment due to the existence of an IP/Patent-box regime[3.3.a.ii].

Mechanism After the ATAP

(Step 1)The US parent Company establishes an Irish Subsidiary Irish Co1, effectively managed in a tax heaven f.e. Bermuda.[3.4.d] (Step 1)The hybrid mismatch of the Irish Co1 is to be discontinued, due to the art.9 of the ATAD[4.2.a], and the amended provisions of ATAD 2[5.1.a.vi] on hybrid entities.

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Under US rules, Also, in 2014 the Irish place of residence government announced that is based on companies would no longer incorporation be able to incorporate in (hence Ireland), Ireland without also being while under Irish tax residents there187. Tax Law, the place of management is (Step 2-3)The DutchCo and deciding the IP Company Ireland may (Bermuda). not pass the artificiality test of GAAR, art.6 The US parent owns the IP, and licenses to the Irish Co1 the rights to develop it ATAD[4.2.a].There is no and exploit it[3.3.b]. substantive reason for their (Step 2)Irish Co1 further licenses the IP to Dutch Co, a company resident in the existence, apart from the tax Netherlands, which subsequently sublicenses the right to the group IP Company, advantage achieved therein. an Irish Company, managed and controlled in Ireland.

The IP Company enters into licensing agreements with other operating companies within the Group[3.4]. CFC rules will probably also discern an artificial (Step 3)Ireland treats the payments by IP Company to Dutch Co as royalty[3.3.c.ii.] arrangement and might payments for the use of IP. The taxable profits of IP Company are thus reduced by impute income of the the amount of deductible royalties that it pays further to Dutch Co. The remaining operating profits derived by the IP Company are subject to 12.5 % Corporation Tax in Ireland, companies(downstream of the tax rate applicable to active business income. Moreover, the royalty payments IP Company Ireland) to the made by IP Company to Dutch Co are not subject to withholding taxes under the MS companies Interest and Royalties Directive, which disallows the levy of withholding taxes on instead[4.2.a], thus inflating interest and royalty payments between affiliated companies resident in the their tax liability, as long as European Union, provided that certain conditions are met. CFC designations are DutchCo is subject to 20/25% corporate income tax in the Netherlands. However, satisfied. due to the fact that the Tax Base of Dutch Co is reduced by the amount of (Step 3) Actions 8-10 on deductible royalties further paid to Irish Co2, only an arm's length spread remains Transfer Pricing will lead to taxable in the Netherlands[3.4.b]. Outbound payments made by Dutch Co to Irish a very limited attribution of Co1 are not subject to withholding tax, as the Netherlands does not impose such income to the Dutch entity, tax under its domestic law. as it performs almost no function at all[4.1].Still, most (Step 4)In order to avoid US Tax obligations that might be triggered in the case, the profit would accumulate to US parent company uses the check-the-box election in the United States[3.3.c.ii] the Bermuda-Irish Entity. for IP Company and Dutch Co, so that these companies are disregarded as separate entities for US Tax Purposes. Accordingly, the transactions carried out between IP Company, Dutch Co and Irish Co1 are invisible for US Tax (Steps 3-4) Also, any purposes(where worldwide taxation operates). This ensures that the companies preferential treatment of IP avoid generating “Subpart F” income for US Tax Purposes(Subpart F is reserved for income both in Holland and US CFCs). Ireland will have to be “BEPS compliant”[3.3.a.ii]

187 Irish budget abolishes corporate tax avoidance scheme [https://www.theguardian.com/world/2014/oct/14/ireland-abolish-double- irish-tax-scheme-apple]

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Similar structures have been implemented using a company resident in Switzerland i.e. benefits only for IP or Luxembourg instead of Netherlands(all of these boast preferential IP fulfilling the substantial Boxes)[3.3.a.ii]. activity criterion.

The result of this structure, is the tax free, so-called “stateless income”, which is then invested in US R&D operations[3.3.a.1]. The structure has been utilized by major MNEs like Google and Apple[2.5].

Assessment: Most of the harmful components herein would be addressed through the ATAP (hybrid entity, artificiality of the structure, and IP Box use in the Netherlands/Ireland for imported IP).Some harmful components would remain: Check-the-Box, CCAs to fund a mother entity tax- free, and other beneficial provisions in EU MSs. But overall, the structure would be definitely discontinued after the BEPS/ATAP.

5.2.b Luxembourg as an Intermediary jurisdiction for back to back licensing arrangements-Structure 2

Back to back licensing is often employed in order to avoid withholding taxes on royalty payments. The following is an example of such a structure: Mechanism After the ATAP (Step 1) A US-based MNE enters into a cost-sharing agreement with another group entity [3.3.a.ii](International Co) resident in a favorable tax jurisdiction, such (Step 1)International Co, as Isle of Man. The two companies pull resources together in order to finance the resident in the Isle of Man may performance of R&D activities to enhance existing IP, ensuring that the resources not pass the GAAR artificiality contributed by each party are in line with the expected benefits[3.4.b]. test[4.2.a.], also due to it funding For this purpose, the two companies enter into a buy-in license agreement[3.3.a.ii], millions of R&D in the under which the US- US[3.3.a.i.], while having Based company minimal activity and substance. grants certain IP rights The CCA agreement has to be to International Co. scrutinized under the updated TP guidelines. If no economic (Step 2)Irish Co, a functions are attributed, the group company agreement might be rendered resident in Ireland that invalid[4.1]. is engaged in manufacturing and (Step 2)The existence& function distribution, acquires or of the LuxCo, as well as its tax incorporates a shelf relations with Irish Co and company in International Co would be Luxembourg (LuxCo). challenged on artificiality& tax International Co enters into a royalty-bearing license agreement with LuxCo for structuring grounds by the certain IP rights[3.3.b]. LuxCo subsequently sublicenses such IP rights to Irish Co, GAAR[4.2.a.]. its parent company resident in Ireland. (Step 3) The tax ruling could be challenged in Luxembourg for control of state-aid[3.4.d].

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(Step 3)Irish Co obtains a deduction for the royalty payments made to LuxCo. Especially in the case here, that Moreover Ireland does not levy any withholding tax on such payments due to the LuxCo performs almost no applicability of IR Directive. The interposed LuxCo is remunerated with an arm’s function apart from conferring length margin (i.e. the difference between the royalties received and the royalties domestic /EU tax advantages. paid). Lux Co may seek to obtain a tax ruling before entering into transaction in The IP Box exploitation by Lux order to ensure that the profits to be obtained by LuxCo will not be challenged by Co, would not pass the modified the Luxembourg Tax Authorities[3.4.c] and that the company may benefit from tax nexus test (the IP was not incentives in Luxembourg. Due to the fact that Luxembourg provides for an developed there in order to exemption of 80% of the net IP income received[3.3.a.ii], such income is subjected qualify for preferential treatment to a low level of taxation in Luxembourg of income)[3.4.d].

This arrangement also ensures that the royalty payments made by LuxCo to the If LuxCo ETR is that low (80% Group’s company in Isle of Man are not exemption due to IP Box) this subject to any withholding tax in could potentially activate CFC Luxembourg, country which abolished Rules in the Irish Parent-LuxCo levying of such taxes after the subsidiary(passive income is implementation of the IR Directive for all eligible for CFC imputation to the companies, whether or not resident in an parent)[4.2.a].Also LuxCo EU member State. Also no tax is levied on misses “substantive economic the royalty income of International Co in the Isle of Man, due to the applicable o% avitivity”art.7,2 ATAD[5.1.a.iv]. CIT rate. The whole structure results in a The dividends distributed by LuxCo to its parent company in Ireland are not subject tax-free “cash box” in the Island to tax at source under the Luxembourg Participation exemption regime. Moreover, of Man that can fund tax free under the provisions of the Parent-Subsidiary Directive, Ireland grants a credit in CCA research into the respect of the underlying foreign taxes levied on the profits out of which the US[3.3.c.ii]. Being an dividends were distributed by LuxCo. embodiment of an ATP structure, the possibility that the whole The structure achieves minimal taxability, preferential IP rates, and generous structure would be scrutinized tax-free funding of US R&D through the Man’s International Co “cash under ATAD’s GAAR provisions box”[3.3.c.]. seems very likely. If not, for BEPS or the ATAP, American Tax Authorities, would probably not accept the whole structure[3.3.c.ii] and impute tax proceeds back to the parents.

Assessment: The present structure would be definitely discontinued: The whole structure is fully artificial, with the pinnacle of the Isle of Man entity, subject to 0% Tax, acting as a cash box. CFC imputation would also annul the Tax Planning, and the IP Box benefits granted to the Luxembourg entity would probably not make it through the modified nexus approach. Some harmful components would remain: Check the box in the US (although most likely the IRS would anyway not accept the structure)the use of a global “cash box” for CCAs, and the existence of a European “Tax Haven” (Isle of Man with 0% CIT and wide access to European Directives

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&DTTs. Regardless, the structure would certainly not make it pass the ATAP and the BEPS Actions.

5.2.c Structuring with a foreign Permanent Establishment-Structure 3

Another structure used for exploiting IP rights in a tax efficient manner is routing the income derived from royalties through a foreign branch with an IP Box, as detailed below Mechanism After the ATAP

(Step 1)In this scenario, the IP is owned by the group’s IP Company resident (Step 1)One issue here is in a favorable tax jurisdiction f.e. Luxembourg. IP Company allocates the IP having a Luxembourg entity rights to a foreign branch DutchCo, which then sub-licenses the rights to possessing IP rights granted exploit it to the final users within the group, the Operating Company in return from a parent for a royalty payment[3.4]. company[3.3.c.ii], but as proved in the Thesis, there (Step 2)The tax implications of this structure are as follows: At the level of the are legitimate manners to foreign branch Dutch Co, the royalty income is subject to no taxation or a low achieve such IP acquisition level of tax, due to the existence of a favorable tax regime, applicable to without detrimental tax income derived from IP in the jurisdiction where the branch is located(IP consequences[ibid]. Box)[3.3.a.ii]. The utilization of IPRs from (Step Luxembourg to the Dutch 3)Luxembourg, Co does not trigger exit the country of tax[4.2.a], due to the latter residence of IP being a foreign branch, thus Company does not a distinct legal entity. not tax the profits derived through (Step 2)The modified the foreign nexus approach (although branch. This is not in the ATAD) may limit due to the fact the favorable taxation of that the structure IP income from DutchCo, is used in as well as the eligibility of jurisdictions providing for an exemption of the foreign branch profits, or that the IP Box benefits in otherwise do not tax profits derived by foreign branches, as long as Luxembourg[3.3.a.ii], as Luxembourg has signed a double tax treaty with a country that uses the the substantial activity exemption method as double tax relief mechanism. Some jurisdictions (e.g. criterion is missing ( the IP Cyprus, Malta) provide for an exemption of profits derived through a foreign was granted from the Parent branch under domestic law. Thus although the country of residence of IP Company). Company might be a high-tax jurisdiction, any income derived from licensing the IP would not be subject to taxation there. Another issue would be the updated Transfer Guidelines Another important factor is the existence of a favorable treaty between the cutting through the structure, country of residence of IP Company and the country of residence of the due to accumulation of tax-

58 subsidiaries making royalty payments. Such treaty may reduce or even fully free profits in Luxembourg, eliminate any withholding taxes on royalty payments. Luxembourg for instance, whereas no value was has an extensive network of tax treaties, on top of the Interest and Royalties created or functions were Directive for payments made from subsidiaries resident in the EU Member performed there[3.4.b.ii]. States. (Step 3) is based on (Step 4)Moreover, the income derived by the IP Company, might be subject to domestic provisions, hence tax under existing CFC rules at the level of its parent company[4.2.a]. will not be affected However, as discussed in the first example, above (regarding “Double Irish with a Dutch sandwich structure”) making use of the existing check the box election In the present structure, no might eliminate the risk for US based MNEs[3.3.c.ii]. Of course, having the major steps or headquarters in a favorable jurisdiction, would absolve the possibility of CFC arrangements were ETR discrepancy. identified that would justify the activation of the This structure results in the accumulation of virtually tax-free profits in provisions of the ATAD. the favorable jurisdiction of Luxembourg, while employing domestic legislation& tax treaty provisions, for a strategy that may be resilient The structure is heavily against the Anti-Tax Avoidance Directive. based in the existence of DTTs and EU directives. Considering that Luxembourg is a hub for group’s financing entities[2.5], Perhaps only a CFC means that potentially profits might not be required to be repatriated in the designation[4.2.a.] between Parent’s company jurisdiction. Parent Company-Lux IP Company, based on artificiality, could nullify the structure. The preferential IP Box treatment granted by the Dutch Co would be discontinued, due to Action 5 of the BEPS.

Assessment: The present structure will probably remain resilient to the ATAD, although BEPS Action 5 will limit the possibilities for a preferential IP-Box treatment. The structure could still utilize, instead of the Netherlands, another jurisdictions with DTT network and low CIT, thus rendering the structure resistant to the ATAD, but possibly annullable through the BEPS.

5.2.d Two tiered IP ATP structure-Structure 4

Again, this structure pertains to an MNE and its global use of Intellectual Property Rights. The parent company is established in MS A, owns certain IP rights and plans to develop more IP rights.

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This ATP structure entails the utilization of a tax residency mismatch[4.2.a], incorporated in an MS. This allows both a deduction for the royalty payments in the licensing/sublicense agreements, while avoiding the inclusion of the received income, giving rise to a mismatch allowing for “stateless income”, as in the case of the “Double Irish”[2.5].

MECHANISM After the ATAP

The ATP structure is established by means of the following (Step 1)The transfer of present IP rights transactions and activities: from the MNE Group to Company B1 is either (Step 1) MNE Group establishes Company B1 as a wholly- owned subsidiary which is registered in MS B, but is managed a) Sale or a and controlled in State E(non MS) and is therefore b)Cost Contribution Arrangement. Tax-resident there. State E is a non-MS, and does not levy any If corporate income tax(f.e. Bermuda). This mismatch leads to 1a)a lump sum payment at fair market “stateless income”[4.2.a]. value is established for the use of present IP[3.3.c.ii]. The transfer of MNE Group transfers ownership of all its existing and future IP present IPRs by MNE Group to rights to Company B1. The transfer of the existing IP rights Company B1 could be subject to high takes place either directly as a sale[3.3.c.ii] or pursuant to a cost- exit taxation, especially if the IP is sharing or cost-contribution agreement[3.3.a.iii]. The transfer of mature and valuable[5.1.a.iii]. Art.5 on future IP rights takes place pursuant to a CCA. exit taxation of the ATAD would not be applicable, both for not activating its (Step 2) Company B1 establishes Company D, a subsidiary scope, arts.5.1a-1d, but also because in resident in MS D, and Company B2, a subsidiary tax resident in the preamble (10), “it is also helpful to

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MS B. Company B1 licenses all of its IP rights to Company D in clarify that transfers of assets including exchange for a royalty[3.3.b]. Company D performs no functions cash, between a parent company and and holds no assets besides the sub-licensed IP rights. Moreover, its subsidiaries fall outside the scope of Company D bears little or no risk with regard to the royalty the envisaged rule on exit taxation”. flows[3.3.c]. Thus ATAD art.5 exit taxation would Royalty payments from Company D to Company B1 are not be activated, unless that was deductible to Company D. MS D does not levy withholding tax on justified by a suspension of Treaty royalty payments under its domestic law Freedoms, for the protection of domestic tax base, or due to another justification.

if 1b) Company B1 will make a buy-in payment for the present IP Rights to the MNE group. The transfer of future IPRs is based on a CCA that can strip profits according to individual MNE strategy, while developing IP for both entities to exploit[3.3.a.iii].

Also, under its domestic laws, MS B does no subject Company (Step 1) The case of Company B1, B1 to taxation, since Company B1 has no taxable presence in incorporated in MS B but tax resident in MS B, and is centrally managed and controlled in State E, and its State E (f.e. a low or no CIT state like income arises outside MS B. State E does not levy CIT (f.e. Bermuda) is a typical example of a Bermuda). Thus, the transaction is tax free. hybrid entity. Such mismatches will be discontinued based on amended art. This creates a situation where there is deduction of royalty in MS 9 of the ATAD (&”ATAD2”) D and no inclusion of the royalty as taxable income anywhere, classifying it as hybrid instrument[4.2.a.]. (Steps 2&3): The existence and structured arrangements of Company D and Company B2 are very likely to fall within the ambit of the art.6 General Anti Abuse Rule, because they have minimal functions, risks and operations, and instead are entities set up for the effectuation of an Artificial Arrangement[5.1.a.iv]. Also, updated TP guidelines would recognize no economic substance/risk undertaken in the intra-group dealing of these entities, apart from a tax motive.

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(Step 3) Company D sub-licenses the IP rights to Company B2 in (Step 5): The dividend distribution by exchange for a royalty. Company B1 to the MNE Group is Both companies receive and pay royalty, but their taxable profits problematic. Company B may be are minimal, as according to Transfer Pricing Rules, they are considered a CFC for the MNE Group, entitled to small profits (“a small spread”) due to their minimal and a much larger share of its profits functions and risks. may be imputed to the Parent[5.1.a.v]. Both the ownership threshold (“wholly (Step 4) Company B2 sub-licenses the IP rights to OpCo, an owned subsidiary”) and the rate operating group member company resident in MS C, in exchange differential (Company B produces for a royalty. Company B2 performs no functions and holds no “stateless income”, hence minimal ETR) assets besides the sub-licensed IP rights. Moreover, Company are satisfied. That could be alleviated if B2 bears little or no risk with regard to the royalty flows[3.3.c.ii]. the MNE Group was an American Corporation with the possibility to Contrarily, OpCo is subject to CIT in MS C, but OpCo may strip “check the box” and disregard the such profits through the outbound royalty towards Company B2, entities[3.3.c.ii]. If not, the B1 could as long as that spread goes uncontested by tax authorities[3.3.c]. utilize almost all its profits through the The royalty payment is free of withholding tax in MS C. This can CCA to fund the overall MNE group for stem from future R&D operations[3.3.a.i]. a)the EU Interest-/Royalty directive, b)from a tax treaty between MS C and MS B, or The present structure will probably c)from the domestic laws of MS C. not survive the BEPS & ATAP, mainly due to its hybrid entity B1, fully (Step 5) All the profits of Company B1 are distributed as structured arrangements with no dividends to MNE Group. economic relevance, consistent profit Such dividends are subject to participation exemption, i.e. no stripping, problematic TP withholding taxes are levied either by MS B or State E, and no CIT documentation for Companies B1, D, is imposed in MS A. B2 having no functions/economic rationale/ risk associated[5.1.a.iv].The MNE’s multistate operations are virtually tax free due to tax implementation of Country by Country treaties-EU legislation, and the resulting profits are deemed Reporting would surely inform state “stateless income”. Tax free proceeds are also heavily authorities on the artificial scheme invested in MNEs operations through the CCA, thus no need herein[4.1]. to repatriate[3.3.c.ii].

Assessment: The present complex structure would not survive the advent of the ATAD and BEPS. Exit taxation for the non-MS State E, as well as for the hybrid entity are certain to be scrutinized. Same goes for the GAAR cutting through the whole artificial arrangement, Parent- CFC imputation and TP documentation not proving any economic substance for the transactions of entities D & B2.Many assumptions for the acceptance of TP documentation would be too farfetched for the post-BEPS era. To conclude, the existence of CBCR (BEPS Action 13) would surely inform MSs tax authorities of the scheme.

5.2.e ATP Structure based on IP and cost-contribution arrangements-Structure 5

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The ATP structure is established in connection with a multinational group’s intra-group transfer of manufacturing and sales operations and supporting intangibles.

The overall objective of the structure is to minimize taxation of the group’s global income. This is achieved mainly by means of royalty payments to a tax-free company.

MECHANISM After the ATAP

(1) MNE Group establishes Company B1 as a wholly-owned subsidiary based in State B (Step 1)The (a non-MS, e.g. a tax haven)[3.3.b] and assigns the responsibility for the manufacture transfer of the and sale of products outside MS A, together with the supporting intangibles, to Company existing and B. MNE Group continues to carry out research and development activities for the group. ongoing non-MS The transfer of the existing and ongoing non-MS A IPRs takes place pursuant to a cost- A IPRs takes sharing or cost-contribution agreement[]. Company B is obliged to make a buy-in place pursuant payment for pre-existing IPRs to MNE Group on arm’s-length terms. The buy in payment to a cost-sharing may be a lump sum or a running royalty[3.3.b]. The outbound remuneration is or cost- deductible/depreciable for Company B. contribution agreement[3.3. a.iii]therefore, only an updated TP assessment would be relevant. The fact that Company B1 is a non-EU resident could

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be important in that respect.

Yet again, the CFC legislation of art. 7 would preclude such an IP Tax Structure, by imputing the considerable profits of Company B in and it is based its non-MS, low on anticipated benefits[]. Finally, the MNE group will be entitled to an R&D tax credit in taxed MS A for the full amount of its R&D expenditures. jurisdiction, to the parent company[5.1.a. (2) Company C and Company D are established in MS C and MS D respectively as v]. Both the wholly-owned subsidiaries of Company B1. Company C contractually assumes ownership responsibility for producing all the MNE Group’s products and selling the MNE Group’s threshold and products outside MS A and contractually assumes the risks associated with the business. the rate Thus, Company C serves as the principal company responsible for the manufacture and differential would sale of the group’s products, and thus its taxable income is comprised of global (non-MS most likely be A) sales revenue. Thus, the CITR is calculated as= (gross sale revenues)-(fees to satisfied, as well Company D) –(royalties to Company B)[3.3b]. as the artificiality of the structure(use a (3) As the owner of non-MS A IPRs of the group, Company B licenses those IP rights to non-MS entity Company C. Accordingly, Company C pays royalties to Company B for the licenses of for MS the non-MS A IP rights of the group. These royalties are deductible for Company business). C[3.3.b]. Also, MS C does not impose withholding tax on royalty payments(IR Directive). If State B is a tax haven, State B does not impose corporate income tax upon receipt of royalties, or (Step 3,4,5) The it may subject them to low rate due to an IP Box regime[3.3.a.ii]. GAAR provisions would most likely not be activated, as the entities in the structure have well defined substantive and economic criteria(2-5).

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Transfer Pricing regulation would probably not challenge Company’s D fee-basis reward. Only the interposition of an extra-EU company to administer EU trade could be challenged. (4) Company C engages Company D to serve as a contract manufacturer. Under the manufacturer agreement, Company D manufactures the group’s products, whereas (Step 6)The Company C bears the principal risks associated with the production of the products. The accumulation of actual production of the products may take place in Country D or in a branch of Company Tax Free profits D in a low-cost manufacturing country. Thus Company D serves as the contract in the non-MS manufacturing entity responsible for the production of the group’s products. It is State B means remunerated on a fee-basis, which is assumed to be equal to the direct and indirect costs that they may be of production plus a mark-up[3.4.b.i]. These fees constitute its only taxable income. distributed as dividends to the (5) The manufactured products are the property of Company C, which sells the products Group, or be to – or by means of related sales and marketing entities located in – higher-tax invested jurisdictions around the world. The contractual arrangements between Company C and alternatively the marketing companies specify that Company C assumes the principal risks relating through CCAs, to the marketing of the products[3.4.b.ii]. Accordingly, the remuneration for the or through marketing& sales entity reflect their limited risk status and is based on comparable traditional limited-risk marketing and distribution companies. Such agreement may be sealed with financing[3.3.c.ii] an APA. .

(6) All excess profits of Company B are distributed as dividends to MNE Group. Dividends are subject to participation exemption, thus no withholding taxes are levied in State B and no corporate income tax is imposed in MS A. Assessment: Despite its complex strategy, this structure may prove to be quite resilient, because it is not particularly exposed to the provisions of the ATAD. Only a CFC designation of Company B could impute the profits of the company to the MNE group. Also tax authorities could challenge the interposition of a non-EU entity in an structure populated by EU entities. Apart from these caveats, the structure would potentially survive due to the business rationale in its structuring, but a CFC imputation could lower that tax benefits derived herein.

5.3 General assessment of the effects of the ATAP on the 6 structures

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From the targeted analysis of the 5 IP Tax Structures identified, I extracted several conclusions as to how the Anti-Tax Avoidance Directive will curb such proliferated but harmful practices. The result of this analysis proves that structures employing heavily hybrid characterizations, low tax arrangements, IP Boxes, and artificial arrangements, may be under fire, mostly due to the ATAD but also the BEPS.

Others that utilized principally domestic provisions, EU Directives and DTTs might prove more resilient(structure 3 and perhaps structure 5).The strongest elements allowing for future IP ATP structures are most likely CCAs(to be scrutinized by the updated TP Guidelines), EU “tax haven characteristics”(including overly beneficial Intellectual Property Holding Companies, or domestic provisions), and potentially a “double dipping” of R&D/IP Box(“BEPS compliant”). Of course, the avoidance of double taxation through legal provisions should not be disallowed. The issue of strictness of GAAR is a wild card in the application of the 5 structures. It can potentially combat at least 4 of the 5 structures (1,2,4,5).

As many of these structures employ the use of IP boxes for IP developed elsewhere (1,2,3,4) the modified nexus approach, and not the ATAD might be the most crucial regulation to alleviate their harmful practices. The “Study on Aggressive Tax Planning and Indicators” has already pointed IP Boxes as the single biggest element allowing for Aggressive IP Tax Planning Structures. Still, I consider it doubtful whether the soft law modified nexus approach can completely overcome domestic legislation allowing for IP boxes, or whether these jurisdictions will not counter-legislate beneficial facilities to retain their competitive advantages.

One of the most important features of BEPS is the updated TP Guidelines, which, being directly applicable, can immediately alleviate gross profit shifting. Importantly, they may be used to scrutinize CCAs with limited substance. CBCR will also allow tax authorities to cut through obscure MNE structures and act accordingly to tackle Base Erosion.

5.3.a Problems were solved concerning

• Hybrid entity mismatches. Especially mismatches related to the infamous “Double Irish” and similar structures that create “stateless income “(Structures 1,4,5).

• Artificial arrangements and entities. Several of the above components may fall under the ambit of the General Anti Avoidance Rule, or of the Artificiality Test of the CFC rules(Structure 1,2,4, probably 5). This assessment though cannot be conclusive, as I have proved that the GAAR brings numerous issues concerning its implementation and judicial treatment, also due to the lack of an effective test on artificiality. Still, the introduction of the GAAR seems promising for flow-through entities and companies solely designed with a tax motive (usually placed offshore, and holding valuable IP). • The Exit tax provisions have a good motive, and can stop an MNE for transferring directly its most valuable IPRs in low-tax jurisdictions without paying a hefty price. But

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they may be circumvented first by not being applicable to Parent-Subsidiary relations188, and secondly, through Cost Contribution Arrangements and Cost Sharing. Also, a parent company may still prefer to emigrate its IP assets, and pay the exit tax bill, if the long term benefits outweigh the short-term expenses. In the end, exit taxes preexisted in many domestic legislations, so their ATAD introduction might not be so groundbreaking as it seems. • CFC rules that preexisted in some domestic legislations, may effectively curb the use of off-shore or low-tax entities utilized for profit shifting, or at least reattribute partially the CFC tax proceeds, provided an adequate ETR-differential exists between Parent- Subsidiary(and the ownership threshold is met). As in structure 4, the ETR differential may counter many harmful arrangements(5.1.a.v.). In the case of powerful US MNEs, the existence of a “check the box” regime on the top of the structure can nullify the effectiveness of CFC Rules in the long term. This US regime allows certain business entities to make an election as to whether the entity will be fiscally transparent or opaque for US tax purposes. Also, as was proved in ch.4, certain jurisdictional pairs of Parents- CFC might avoid the ETR differential necessary to activate the rules herein. • IP Boxes: Although not pertaining to the ATAP but on the Action 5: Modified Nexus Approach, the IP Boxes have an important role in Aggressive IP Tax Planning Structures. Realigning the benefits granted with the locus of the IP development would certainly reduce the damage of IP Tax Structures, like in structures 1,2,3 and beuond. The research of the “Aggressive Tax Planning and Indicators” of the ATAD resulted in the same conclusion. But a question remains whether jurisdictions are willing to give up such facilities. And even if jurisdictions like Netherlands, Luxembourg discontinued such structures, other jurisdictions would compete to fill the gap.

5.3.b Problems were Not solved concerning:

• MNE group companies that sit in the top of structure, especially when they are based in the US and can utilize the “check the box” possibilities(structures 1,2,3), or avoid artificially the 50% threshold. • Earning stripping, and generally tax planning utilizing strategically CCAs.CCAs are completely legal, but in an artificial structure, they can be challenged from a GAAR & TP perspective. • Utilization of jurisdictions like the Isle of Man (0% CIT, which enjoy all the array of EU legislation for the limitation of double taxation)are in effect “European tax heavens” (structure 2). • Until the full implementation of the modified nexus approach, IP Boxes (structures 1,2,3) can always minimize the tax burden for income from IP routed in such jurisdictions and play role in most structures. Combatting such preferential regimes would most likely lead to the institution of more such measures in competing jurisdictions. Also, preferential

188 ATAD, recital 10:”It is also helpful to clarify that transfers of assets, including cash, between a parent company and its subsidiaries fall outside the scope of the envisaged rule on exit taxation”. [http://eur-lex.europa.eu/legal- content/EN/TXT/?uri=uriserv:OJ.L_.2016.193.01.0001.01.ENG&toc=OJ:L:2016:193:TOC]

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treatment of IP income may be achieved through other legislative provisions (see f.e. Luxembourg IPHCs). • Branch arrangements may create problem, as they allow both for no-exit taxation (the branch is not a distinct legal entity) and some jurisdictions, f.e. Cyprus exempt from taxation income from branches (structure 3) • If indeed the ambit of the exit taxation does not include Parent-Subsidiary relations that may leave untouched many possibilities for the shifting-out of valuable assets. But moving assets outside of the EU could lead to a suspension of fundamental freedoms (structure 4) for the entity, through justification of protection of the tax base. This would oblige the parent company to pay an exit tax for the extra-EU transfer. • IP assets may emigrate and the exit tax may be paid. Afterwards, the parent company might choose to improve the asset through a cost-contribution arrangement. In this way, the initial exit caught only part of the (later) value of the IP, while avoiding scrutiny in the EU and exit process. • The accounting treatment of intangibles will always allow a degree of tax planning. Self- developed intangibles can be used to inflated expenses, while their later value might not be accurately evident in the balance sheet [3.3.c.ii] • Without resorting to complex& aggressive arrangements, profits may be strategically stripped/transferred through strategic transfer pricing providing for minimal functions and risks in select jurisdictions. As long as the result goes uncontested by a tax authority, no problem arises in strategical profit shifting. Still, as actions 8-10 are directly applicable, coupled with the CBCR, coordinating jurisdictions might show less tolerance for entities lacking economic substance. • There is a lot of reliance on the overreaching applications of the GAAR, but there are many doubts if they will be implemented and enforced satisfactorily to dispel most of the structures like above. Tax competition, and the number of jurisdictions vying for corporate profits would mean that there will always be leeway in the EU for artificial arrangements.

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Section 6: Summary and Conclusion

6.1 Major positive changes due to the ATP-Policy Perspective

• The abolition of hybrid mismatches. Hybrid entities are prevalent in many abusive arrangements such as the Double Irish Arrangement, utilized also in the Apple tax scandal, where they provided for "stateless income”. Also, the amended ATAD 2 gave even more attention in hybrid entities and instruments, PEs& reverse hybrid mismatches. • The countering of artificial entities and arrangements through the overreaching General Anti Avoidance Rule and the CFC imputation provisions, meant to deal with situations where Specific Anti Avoidance Rules are not helpful, or where there is limited jurisdiction of domestic tax authorities. Also, the Commission can step up to police their implementation, when it is suspected that inefficient application resembles state aid. • The Exit Tax provisions for highly valuable assets, although such provisions may be circumvented, or in some cases where already in place in some MSs. This provision is the one with the most relevance by reference to IP Tax Planning. • The CFC rules, despite the controversies they create, have the possibility of capturing a wide array of conduit companies, offshore or EU low-taxed entities, and impute huge profits to the home jurisdiction.

6.2 Major criticism of changes due to the ATP-Policy Perspective

6.2.a General Points of Criticism

• Domestic implementation of the ATAD by MSs o ATAD prescribes for a “de-minimis” approach189.This means that member states are free to implement more restrictive measures. Such differences would resume the tax-motivated relocations and arbitrage of today. o Due to the scope of the Directive and the diverse domestic regimes, it is very possible that there will exist great discrepancies in the implementation, judicial control and judicial enforcement. A non-formal implementation will create many issues, and offer fragmented solutions in the EU context. The overall objective of EU CIT harmonization will fail again. o Potentially, some MS that have significant interests in Aggressive Tax Planning & IP Tax Planning (f.e. Luxembourg),and limited sources of national wealth, may either implement inefficiently the measures, or legislate countermeasures- loopholes, in order to continue to attract mobile capital and valuable intangible

189 ATAD, art. 3 minimum level of protection [http://eur-lex.europa.eu/legal-content/EN/ALL/?uri=celex:32016L1164]

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assets. Same goes for non-EU jurisdictions which are free to not follow the BEPS and of course the ATAD.

• Scope: “The Directive applies to all taxpayers that are subject to corporate tax in one or more Member States, including permanent establishments in one or more Member States of entities resident for tax purposes in a third country.190“ Does this mean that transparent entities or special purpose vehicles are exempt? This would shift many tax planning strategies& ”competences” in such transparent entities.

• The ATAD may not address all IP Tax Planning Strategies: Some of the IP Tax Planning Strategies would prove resilient against the scope of the provisions, and entities would be free to continue on propagating and refining their aggressive tax positions(structure 3, and to a lesser degree 5, as they rely mostly on DTTs, domestic and EU provisions). Of course, new ATP strategies may be devised, before legislation can catch up. Simpler or modified variations of the 5 structures could also make the cut.

• “MNE Flight”: the new strict measures may lead MNEs to simply relocate their intangibles or presence in 3rd country jurisdictions. This trend was already seen in the United States during 2014, when several MNEs undertook inversions and thereby relocated offshore191”.This would further erode the corporate base in the EU. As long as the CFC does not distribute its dividends, it remains non-taxable, and there exist other ways to reutilize such profits for the benefit of the Group.

6.2.b Specific Points of Criticism

• Interest limitation(art.4) o Domestic implementation maybe problematic f.e in Germany the similar interest limitation rule “Zinsschranke” was voted unconstitutional, and also the Directive does not provide any further guidance on when existing measure is “equivalent effective192”. o Possibility to circumvent, especially utilizing “regulated financial institutions“ (MSs are not obliged to include them), sitting on top or below the company/companies. • Exit Taxation(art.5) o Possible discrepancies in calculation of tax-book value between states. o Issues with the valuation of intangibles, due to the absence of comparable, thus wide margin for manipulation. o Exit tax does not apply to P-S relations, and as long as Subsidiary profits are undistributed and/or reinvested through CCAs, the exit tax motive is nullified. o Companies may simply outsource R&D in 3rd jurisdictions and be licensed the IP, while deducting royalties from the high-tax-jurisdiction entity. Also, CCAs

190 ATAD, General Provisions, art. 1 [https://ec.europa.eu/taxation_customs/business/company-tax/anti-tax-avoidance-package/anti-tax- avoidance-directive_en] 191 International Tax Structures in the BEPS Era: An analysis of Anti-Abuse Measures 192 PWC: ATAD: What does it actually mean for financing [https://news.pwc.be/atad-actually-mean-financing/]

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allow for ample manipulation no matter the location, although the updated Transfer Pricing Guidelines may combat this. o MNEs may simply add value to the IP asset after the IP migration in a beneficial jurisdiction. • GAAR(art. 6) o The most problematic measure: how to apply GAAR in “uniform manner”? If not, many problems will surface, such as discrimination, loopholes, and maybe double taxation. ▪ Non-uniform implementation may result in “jurisdiction shopping”. o How to interpret the provision? ▪ concepts such as “purpose and objective”, “economic reality” and the artificiality test193 are very abstract, and such may be their implementation. o Danger of abuse of GAAR by tax authorities to boost tax profits (not only confined to “hard abuse”). A caveat to this statement is that the EU Commission might police the enforcement of the GAAR through its state-aid rules. • CFC(art.7) ○ It’s scope is limited to artificial arrangements. Again that may be hard to test& prove, and may even be abused by tax authorities. • It may be circumvented both in the equity threshold (specific structures)and the ownership threshold. • It may be circumvented based on income type(f.e. provision of know- how in order to characterize the income as active), and the rate differential for a low taxed EU MS. o The 40% rate difference may be not effective in cases where the parent company is f.e. Bulgarian (10% CIT) or Cypriot(12.5%) etc. and the CFC’s rate slightly more than 40%. This means that all jurisdictions with a 5%, conventionally considered “offshore “and low tax rate”, will not fall within the scope. • Double taxation may occur(although a credit is granted in the parent jurisdiction), and also income may be taxed not where it arose. • Its application may compromise normal business processes that have no motive of tax avoidance. • In regard to powerful US MNEs, It may be circumvented by the check- the-box rules, or by invoking an exception such as for group financing activities in the UK194.

• Hybrid Mismatches(art. 9)+ATAD 2195

193 Based on ECJ’s Judgement in Cadbury Schweppes. 194 International Tax Structures in the BEPS Era: An analysis of Anti-abuse Measure 195 European Commission: Proposal for a Council Directive amending Directive (EU) 2016/1164 as regards hybrid mismatches with third countries [http://eur-lex.europa.eu/legal-content/EN/TXT/?uri=celex%3A52016PC0687]

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o Violate the OECD “linking rules”, by applying mutual recognition on the fiscal qualifications. “It is unclear why such a far-reaching intervention in the national corporation tax systems has been chosen196.” o The validity of the home state’s designation of the nature of the entity/instrument may be contested, and also oversteps domestic qualification prerogatives. On EU, some “tax havens” may be unwilling to cooperate. The interplay between the linking rules and Double Tax Treaties is currently the subject of the Working Party no1 on Tax Conventions and Related Question”197. o Overall, the recommended rules are likely to apply only in specific circumstances, subject to various conditions around the definitions of financial instrument, hybrid mismatches, timing differences, related person, structured arrangements and so on198.

6.3 How can MNEs adapt to different regulatory requirements after the ATAP enactment- A Corporate Perspective

6.3.a.Location options • MNEs may continue to rely on favorable locations for a multitude of benefits o Countries like Luxembourg, Cyprus or the Isle of Man etc. enjoy the full range of EU legislative benefits (Parent-Subsidiary Directive, Interest and Royalties Direct and Participation exemption),beneficial domestic provisions, favorable IPHCs, low CIT rates, as well as an extended network of DTTs and IP Boxes. o Countries like the aforementioned ones are often eager to provide Advance Tax Rulings and Advance Pricing Agreements, in order to attract investment to their small size economies. • Although exchange of Information and more stringent state aid rules could impact the advantages of such Rulings. It will become more important to receive a ruling that cannot be easily contested, than achieving a minimal ETR. o Also, a combination of CCAs, R&D incentives and an (BEPS compliant) IP Box can minimally reduce tax burdens in the interior of EU, and provide huge benefits to sophisticated tax structures. The existence of a sophisticated workforce is another important factor for location in an MS. o Use holding companies in select jurisdictions (f.e. Austria, Belgium, Cyprus, Finland, Hungary, Ireland)[3.3.c.iii] o Identify jurisdictions that are reluctant to the adoption/ formal implementation of the ATAD, or that enact countermeasures or loopholes to circumvent the

196 CFE: Opinion statement on the European’s Commission for an Anti-Tax Avoidance Directive of 28/1/2016 [http://www.cfe-eutax.org/sites/default/files/CFE%20Opinion%20Statement%20FC%203- 2016%20on%20the%20Anti%20Tax%20Avoidance%20Directive.pdf] 197 OECD: Working Party no1 on Tax Conventions and Related Issues [http://www.oecd.org/officialdocuments/publicdisplaydocumentpdf/?cote=CTPA/CFA/WP1(2015)1&docLanguage=En] 198 International Tax Structures in the BEPS Era: An analysis of Anti-Abuse measures.

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Directive, or that have more relaxed approaches to GAAR and CFC enforcement etc. o MNEs that are US residents and may “check the box”, can drastically lower their global tax burdens. o In the end, good infrastructure and other business reasons might lead a company to operate exclusively in a high tax jurisdiction199, despite a higher ETR. In the bigger picture, taxation is a very important determinant for an MNE, but certainly not the only one.

6.3.b.Strategic restructure options

• Grant value to intangibles through staged-development-maintenance-enhancement of IP in various jurisdictions, while utilizing R&D expenses, IP Boxes and offshore holding companies for tax optimization. Especially in the EU, there will be a gradual turn towards R&D incentives, that are deemed more neutral to taxation and better at stimulating innovation200.BEPS compliant IP boxes may attract considerable attention in the future. • Utilize CCAs and non-MS countries to develop, fund, and exploit intangibles. They can create IPHCs, while further marketing& sales are effectuated by commissionaire201 arrangements (common strategy to avoid PE designation)/ independent distributors/ subsidiaries taxable on a small arm’s length spread. IP development placement in a low tax jurisdiction can play equal role with intra-group debt stripping but without the BEPS ratio limitation202. • Low-substance foreign offshores might find it hard to distribute tax-free dividends to their parent companies. Traditional financing (through bonds, stock market etc) can easily solve that problem.

6.3.c.Transfer Pricing • Utilize Transfer Pricing valuations to understate the value of an asset while moving it in a favorable 3rd jurisdiction or in the EU. Generally, it is wiser to use TP to ensure compliance, than to obtain disputable profit margins. • Traditional Transfer Pricing may always help in tax optimization. It’s important to note that the avoidance of controversy is sometimes more important than the most efficient allocation of tax proceeds per intra-group entity. APAs can certainly help in securing such tax and business certainty.

6.3.d.Targeted Anti-ATAD options • Place more emphasis on entities that are not subject to CIT and thus fall outside the scope of the ATAD. Examples are partnerships, special purpose vehicles etc.

199 Germany f.e. has so many qualified engineers, that it does not require tax facilities to attract companies. 200 ibid 201 “A commissionaire is a legally and economically independent agent that sells in the source country on behalf of the foreign company resident in another state (residence country) 202 International Tax Structures in the BEPS Era: An analysis of anti-abuse measures

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• Avoid CFC’s passive income designation, by providing also services to customers through an offshore entity. The advent of the information economy facilitates such a tax motivated restructure. • Circumvent CFC rules by structuring for less than 50% ownership, or provide for the location of a controlling corporation in a low-tax EU MS(f.e. Cyprus, Bulgaria), thus facilitating the avoidance of the threshold, even for a CFC taxed at 4,1% effective CIT rate. • MNEs should keep in mind though, that inefficient CFC and GAAR application by MSs will be controllable by EC State Aid regulation.

6.3.4 Research Question Answered

After the long preceding chapters, I am in position to answer the research question. That has been rendered by first approaching and solving the 4 sub research questions:

■ How does IP Holding and IP Tax Planning for MNEs work? ■ Which are the major IP Tax Planning Strategies for MNEs currently in the EU? ■ What does the ATAP prescribe, and how will it affect the IP Tax Planning Techniques identified? ■ How can European MNE’s adapt to the changing tax environment for IP?

Which led me to the main research question being answered:

● Will the ATP effectively eliminate the major IP Tax Planning Strategies in the EU Common Market? How can MNE’s adapt to the changing legislative environment?

The ATP will indeed eliminate many of the major IP Tax Planning strategies in the EU, or at least, many of their sub-components. Out of the 5 designated strategies, the majority will be definitely discontinued, or at least modified to survive(1, 2, 4, most probably 5). The ATAP is balanced, overreaching, and targets some of the most important problems in the IP context, such as exit taxation, hybrid arrangements, abusive structures (with the GAAR) and artificial CFCs. In my opinion, the effectiveness of the ATAD relies heavily on the implementation of these two last measures that have the possibility to catch a wide array of aggressive tax planning situations, when specific provisions are not enough, and detailed legislation might take time to address. It is probable though, that due to inefficient or fragmented implementation, as well as MS countermeasures, the effectiveness of the ATP might be compromised. The degree of intervention by the Commission (through State-Aid test for inefficient application) will be a crucial parameter in the end-result. Importantly, 2 DTT concepts will assist ATAD implementation: the Principal Purpose Test and the Limitation of Benefits clause in tax treaties.

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On top of the ATAP implementation, the later (C)CCTB, although in theory very ambitious, will be a very effective measure from a policy perspective and will greatly affect major EU MNEs and their IP Tax Planning workings. In combination with the ATAP it can provide an airtight consolidated tax system, but I deem that such an optimal scenario is overoptimistic and probably the full consolidation will not be delivered, or will do in a manner that leaves certain vulnerable points, f.e. business dealings with residents of 3rd countries. For the CCCTB, a new era and level EU cooperation would be necessitated, which I deem equally unlikely at the moment. For the next decades, we will have to rely almost exclusively to the ATAP, the BEPS and some other soft law instruments203.The fact that the European Commission can challenge a purposefully abusive/inefficient application, certainly adds to the effectiveness of the ATAD.

6.3.5 Conclusion

The present Thesis has covered a wide variety of Corporate Tax issues, in order to illustrate in the most exhaustive possible manner the interplay of EU Business taxation and IP Global exploitation. This not only granted a wide and in depth understanding of the subject by my part, but also managed to offer substantiated answers to the complex questions I faced.

The conclusion proves that some things will evolve: market practices, legislation, International & EU policy cooperation etc., but some others, such as the inventiveness and resolve of MNEs to minimize legally or abusively their tax burdens, will persist. On the counterargument, that may be a quasi-legal defense to International Cooperation overregulating and taxing a huge scope of activities, with abstract and brute force instruments (Hybrids, Cfc, GAAR, etc). This struggle does not seem to be losing steam, and it seems that even if in 15 years from now, the ATAP and perhaps the CCCTB are fully implemented, we will be confronting new abusive IP Tax Planning practices, and will be designing frameworks to dismantle novel, overly aggressive and abusive structure. The momentum granted by the BEPS project has indeed changed the rules of the game for States and MNEs, but its innate weaknesses (namely, the fact that most of its Actions remain “soft law”) meant that more concrete legal obligations were necessary.

Wide cooperation would be needed between all stakeholders to instate a healthy International Tax System: IGOs with their International Tax Legislation, MNEs with Corporate Social Responsibility, States with a view to sustainable cooperation instead of tax competition and overtaxation, civil society with its buying and voting power, and finally the academia with its legal and contemporary analysis, should all combat Base Erosion and Profit Shifting, as well as Aggressive Tax Planning, especially for the over- lucrative and elusive industry of Intellectual Property. The opposite, could lead to a collapse of public funding, whilst MNEs enrich themselves with aggressive tax structures in EU and offshore favorable jurisdictions.

203 F.e. The Code of Conduct in Business Taxation

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I conclude with a rhetorical question: Do all these aforementioned actors want to actually cooperate productively, instead of competing for CIT income? My answer is no. I believe that each and every actor in the end, takes decisions based on the bottom line. Is it possible to align all the competing interests in the IP Tax Planning Environment? Of course not. The reason is twofold: Global Market Economy and Human Nature.

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