If intangible assets are a significant part of your business, it is important to manage them in a way that meets the business and legal objectives. Moving the intellectual property offshore may contribute not only to its protection and flexibility of exploitation, but also reduce the tax burden on the related income.
Offshore IP Holding Company
Intellectual property, like computer software, technical knowledge, patents, trademarks or copyrights, can be held in a jurisdiction with a lower or zero worldwide income tax rates. You can incorporate an offshore company, then transfer it the title to intellectual property with the right to sub-license and further exploit it in other countries. This offshore intellectual property (IP) holding company will receive franchise fees and royalty payments from the franchisees or licensees, including from the associated companies, and accumulate income in a low-tax area.
Royalty payments are often subject to withholding tax in the country of origin. And most probably will be taxed again in the country of domicile. To mitigate double taxation it is recommended to incorporate an IP holding company in a country with a substantial double tax treaty network, like Cyprus, Gibraltar, Ireland, Luxembourg, Malta, The Netherlands Antilles and some others.
By including more offshore entities in the scheme, to merely separate IP holding and royalty collection processes, it is possible to bring the effective tax rate nearly to zero.
Just like that, many advisors propose more or less sophisticated offshore schemes attractive on the face of it, however, missing the key point of how to implement it all in practice. To develop and employ a reliable business structure the IP planning is to be more insightful.
Tax authorities in high-tax countries always pay much attention to IP transactions involving offshore jurisdictions, especially with the associated companies. It’s quite obvious that the main intention of such offshore business is to save on taxes. To make it all legally is vital indeed.
Transfer of Intellectual Property Offshore
While being in the process of creation of a new piece of intellectual property, it might be more prudent to involve an offshore company as a foreign partner or financial sponsor at this stage. Participation in development would entitle it to register as the owner or co-owner of the property.
If you involve an offshore company later, you have to sell or assign the title to the property to the offshore company, and this kind of transactions triggers the transfer-pricing regulations. The latter require a fair market price deal as if no associated parties were involved. Consequently, in most cases you will have to pay capital gains tax.
Management of Intellectual Property Held Offshore
If you put your intellectual property offshore, you cannot continue using it as if nothing changed. The IP holding company is supposed to become a virtually independent business entity making a balance of its economic interests, internationally accepted business customs and requirements of the law.
The associated companies are to pay royalties on the arm’s length principle. Charging excess royalties in favor of a low-taxed company is a sign of uncovered expatriation of profits earned in a country with high taxes. Charging under-market or zero royalties from low-taxed foreign affiliates might be easily qualified as illegal reducing the local tax base in a high-tax country.
To develop and implement a really working intellectual property strategy covering tax efficient ownership, management and exploitation, you have to plan it carefully, in advance and with assistance of professionals.