HM Treasury’s David Gauke on October 3 said the UK does not support the adoption of the nexus approach described the OECD’s interim report on harmful tax practices to determine if intellectual property regimes reward “substantial activities.”
The UK prefers a transfer pricing approach, said Gauke, who spoke before the Securities Industry Conference.
The harmful tax practices report, released September 16 as a part of the first set of deliverables under the OECD base erosion and profit shifting (‘BEPS’) project, reflects a general agreement among countries that the presence of “substantial activities” is an important factor in determining whether a preferential regime is harmful, but states that no agreement has been reached among nations on how to measure substantial activities. Once countries agree on the substantial activity requirement, all countries with intellectual property regimes will be judged using that standard, including the UK’s patent box regime.
The OECD guidance sets forth a detailed description of the nexus approach, which is the most popular approach currently under consideration. The approach requires a nexus between the income benefited under the regime and the expenditures incurred that contributed to the income.
Gauke said that the UK has concerns with the nexus approach’s compatibility with EU law. Restrictions on eligible expenditures could influence the location of business activities within the EU, potentially infringing the freedom of establishment, he said.
Further, by dictating the qualifying commercial structure, the nexus approach is overly restrictive, presenting significant difficulties for businesses which are not engaged in profit shifting, he said
Moreover, Gauke said the proposal is inconsistent as it does not allow acquisitions from third parties, but does permit third party outsourcing. It also “requires incredibly detailed tracing of expenditure and income,” he said.
Using transfer pricing principles to define the substantial activity threshold would be much more practical, he said.
Gauke said he rejected any suggestion that the UK’s patent box provisions facilitate profit shifting. “Let me be clear here: categorically, it does not create an opportunity for businesses to reduce their taxes without increasing their value to the UK economy,” he said.
A company must either have developed the IP itself, or actively manage the commercial exploitation of the IP, Gauke noted.
“If all a business wanted to achieve was to shift their profits in order to receive a lower tax rate, then this simply would not be worth the hassle,” he said.
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