R&d Tax Incentives: Creating an Unlevel Playing Field?

• Publication year: 2017

R&D Tax Incentives: Creating an Unlevel Playing Field?

Stefanie Kavanagh

R&D TAX INCENTIVES: CREATING AN UNLEVEL PLAYING FIELD?

Stefanie Kavanagh^*

Introduction

In many countries, including the United States, governments have implemented regulations that aim to encourage expenditure on research and development ("R&D"). Often, the regulations used to encourage R&D can have the effect of stifling innovation. This is because the tax incentives available for R&D disproportionately benefit large multinational enterprises ("MNEs") and do little to benefit startups and small businesses. As a result of the disparate benefits received from R&D-related regulations, startups and small businesses, which often have very innovative and cutting-edge ideas, are unable to compete with large MNEs. Because of this inability to compete, innovative ideas are left unrealized.

A. Tax Incentives Can Create an Unlevel Playing Field

A report issued in 2013 by the Organisation for Economic Co-operation and Development ("OECD") looked at the effect of tax incentives, which make up more than a third of all public support for R&D in the industrialized world.¹ The OECD report concluded that MNEs benefit the most from tax incentives, because they can use tax planning strategies to maximize support for innovation.² The OECD found that this creates an unlevel playing field that handicaps domestic companies and startups.³

MNEs are able to maximize the benefits of tax incentives for R&D through the use of cross-border tax planning strategies. For example, a MNE could perform R&D through a company located in a country that provides a R&D tax

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credit (such as the United States), but then move the intellectual property ("IP") that is produced by the R&D to a holding company located in a country with a more favorable tax system (such as the Netherlands). The Dutch holding company could then license the IP to the U.S. company and pay little to no tax on the income from licensing the IP due to favorable tax rates on royalty income in the Netherlands. Through this cross-border tax planning, the MNE is able to benefit from the U.S. R&D tax credit while also benefitting from the more favorable tax rates in the Netherlands when it uses the IP. The United States gets the short end of the stick as a result, since it is not able to tax the income produced by the IP that it subsidized through the R&D tax credit. Unlike a MNE, a startup or small business is unable to use cross-border tax planning to maximize the benefits it receives from R&D tax incentives. For example, a startup or small business that only does business in the U.S. that receives a R&D tax credit relating to its production of IP has no option but to use the IP in the U.S., and thus will pay tax to the U.S. Government on income produced by the IP.

In addition to the competitive disadvantage created by tax planning opportunities, until recently U.S. startups and small businesses were also disadvantaged because they were sometimes not able to...