Patent Boxes and The Erosion of Trust in Trade and in Governance

270 Int. J. Public Law and Policy, Vol. 6, No.
3, 2019
Patent boxes and the erosion of trust in trade and in

governance
Esperanza Buitrago Diaz

Maastricht Centre for Taxation,
Faculty of Law,
Maastricht University,
Bouillonstraat 3, 6211LH Maastricht, The Netherlands
Email: e.buitragodiaz@maastrichtuniversity.nl
Abstract: Patent boxes spawned trust concerns in trade but also in governance
given the migration of enterprises and of intellectual property assets only for
tax reasons. The G-20 and the OECD reacted with soft law measures
introducing the nexus to R&D (the proportional expenses related to it) as a
standard to restore trust in governance (as requirement for governments issuing
post-BEPS patent boxes and IP regimes) and substantial activities as a standard
to restore trust in enterprises engaged in the IP trade. The new standards apply
the rationale of input incentives to the back end of the innovation chain. The
crucial question is whether the solutions found are appropriate and suitable to
restore trust without hindering innovation and entrepreneurship. While dealing
with such question, the work shows a number of shortcomings in regard IP
regimes after BEPS Action 5 and how a narrow tax approach may lead to
inefficiencies and frustration.
Keywords: patent boxes; output incentives; input incentives; IP regimes; nexus

approach; modified nexus approach; research and development; intellectual
capital.
Reference to this paper should be made as follows: Buitrago Diaz, E. (2019)

‘Patent boxes and the erosion of trust in trade and in governance’, Int. J. Public
Law and Policy, Vol. 6, No. 3, pp.270–304.
Biographical notes: Esperanza Buitrago Diaz is a researcher of the Maastricht

Centre for Taxation (MCT) of Maastricht University (UM). She is the Head of
the postgraduate tax courses for Ibero-American countries at UM Campus
Brussels. She is the author of a number of tax law publications and winner of a
number of prices for her research on intangibles. She holds a PhD degree on
taxation granted by Salamanca University and LLM degrees on Financial Law
and Intellectual Property from the Universities of Rosario and Los Andes,
respectively. She is an alumni of the Max Planck Institute for Tax Law and
Public Finance (Germany).
“The hardest thing in the world to understand is income taxes”. This is what
Albert Einstein told Mr. Leo Mattersdorf, his tax adviser in the USA almost 80
years ago. Having moved around different European countries and the USA,
Einstein may have realised that while gravity is universal, unavoidable and
follows the rule of nature, taxes and tax laws are as many as stars in the sky,
each one with its own gravitational attraction expressed in different legal rules
and interest of sovereign states, without a force bringing together unified rules
for global citizens and cross border transactions. The uneven societal and
Copyright © 2019 Inderscience Enterprises Ltd.

Patent boxes and the erosion of trust in trade and in governance 271
economical world conditions, competition and a tax global scenario, plenty of

differences, of tax incentives and tax avoidance make it difficult to believe that
trust in tax laws can emerge as one of the fundamental forces in trade and
governance. “The hardest thing in the world to understand is income taxes”.
This is what Albert Einstein told Mr. Leo Mattersdorf, his tax adviser in the
USA almost 80 years ago. Having moved around different European countries
and the USA, Einstein may have realised that while gravity is universal,
unavoidable and follows the rule of nature, taxes and tax laws are as many as
stars in the sky, each one with its own gravitational attraction expressed in
different legal rules and interest of sovereign states, without a force bringing
together unified rules for global citizens and cross border transactions. The
uneven societal and economical world conditions, competition and a tax global
scenario, plenty of differences, of tax incentives and tax avoidance make it
difficult to believe that trust in tax laws can emerge as one of the fundamental
forces in trade and governance.
1 Introduction
It is already 5 years after Mr. Wolfgang Schäuble, called for a ban on the so-called
innovation boxes, patent boxes or the like (IPB) in a meeting of European Union (EU)
finance ministers. While claiming that such tax break offered by a number of EU member
states resulted in unfair competition for foreign investment, the minister pointed out that
IPB were also at odds with EU rules and the European spirit (Breidthardt, 2013). R&D
leading countries did not feel comfortable with the incentive due to two main reasons:
The first regards the migration of enterprises only for tax reasons. Countries claimed that
their tax bases were eroded and that harmful tax competition arouse, mainly because the
connection between the IP assets and the R&D originating the intangible was not
required to benefit from IPB.
The second regards the engagement of enterprises in profit shifting manoeuvres
lacking sound commercial reasons in their IP strategies, in particular through IPB. Part of
the fear was that by spreading their intellectual property (IP) assets around the globe,
enterprises either benefit from tax advantages in multiple jurisdictions and also engage in
tax gimmicks such as the creation of shell companies, (also referred as conduit), or
deviate from market conditions with transfer pricing of IP assets (in breach of the arm’s
length principle), amongst other strategies oriented to artificially shift profits to low or
non-tax jurisdictions.
The European Union and the Organization for Economic Cooperation and
Development (OECD) reacted with measures to restore trust. The EU Commission seeks
to tackle the issue by means of positive EU law, with the Anti-avoidance Directives but
also within the proposal for a Directive on an EU Common and Consolidate Corporate
Tax Base, known as CCCTB. The Commission choice is for input incentives,
recommending EU member states to avoid IPB as a policy instrument (Directorate-
General for Research and Innovation, 2017). Other measures used at the EU level include
the state aid regulation and the code of conduct, hard and soft law, respectively. The G-20
and the OECD made use of soft law by releasing Action 5 of the Base Erosion and Profit
Shifting Package (BEPS), dealing with harmful tax practices and IPB not related to R&D.
As a result of Action 5 countries are monitored and invited to adjust their IPB to the new
standards.
272 E. Buitrago Diaz
This paper deals with the breach of trust in IPB pre BEPS. I submit that trust in
governance and in trade got compromised and explain how the IPB standards approved
by the OECD attempt to address the distrust. I look into its causes, the societal actors
involved, the solutions adopted, their legitimacy and ability to overcome the situation.
While doing so, I call for a re-examination of the criticism towards incentives related to
the back end of the innovation chain, known as output incentives. IPB are the most
representative ones.
Given its nature, IPB are tax regimes intended to incentivise the location of IP assets
in a given jurisdiction. IPB are also considered effective mechanisms to influence the
location of enterprises, (Schwab and Todtenhaupt, 2016). Scholars relate this to the IPB
capacity to change corporate behaviour (Fichtner and Michel, 2015). The box normally
entails a reduced fee of corporate tax on qualified income, i.e., income derived from
R&D and of general or specific forms of IP, as well as a generous treatment of R&D
expenses made in the IPB country, depending on the features of the IPB regime offered.
Since the focus of this paper is on issues related to trust, a comparison of the regimes is
not offered; instead I focus on the scientific questions emerging from the standards
approved by the OECD. An updated comparison of IPB regimes was released recently by
PWC (2017).
IPB normally do not operate in isolation. Instead, IPB relate to other tax strategies to
maximise profits and are normally used in combination with other tax incentives, e.g.
deductions, tax credits on R&D, as well as other planning tools, for instance cost
contribution arrangements, transfer pricing, as well as strategies related to the
decentralisation of ownership, for instance, in one or more IP holding companies and in
combination with other tax planning instruments. This paper does not analyse all possible
IP planning strategies; instead the focus is on the nexus and the modified nexus approach
as the standards agreed for IPB and in view of its impact in the law and on innovation.
In order to reach the objectives set, the work is divided in three sections. The first one
analyses the connection between IPB and trust, mapping the distrust and framing it as an
issue for trade and governance. The second section looks into the tools used to tackle
harmful tax competition by the OECD and the EU, mainly soft and hard law. It makes an
insight into the formal quality of the rules and their ability to serve their intended purpose
and to appropriately balance conflicting interests of stakeholders, in particular in relation
to countries with different degrees of development. The third section focuses on the
encouragement of research, development and innovation (R&D&I) as main grounds for
the new standards set to restore trust. For this purpose I present a review of arguments
from a public and private perspective, the interest of enterprises and societies on
innovation and the issues related to it: on the one hand the freedom of enterprises to
organise its own business, with an insight on strategies of decentralisation of IP assets
and, on the other, the challenging dilemma of tax incentives and the expected spillovers
to society.
The dilemmas posed by IPB are similar to the ones faced by other tax incentives, in
particular concerning the difficulties to measure their real benefit. In this paper I add to
the debate by looking into the microeconomic analysis justifying the change and the
adoption of the new standards, making evident the limitations of a pure disciplinary tax
approach. Although my work highlights a number of aspects that have not been
considered or even misunderstood, further multidisciplinary, interdisciplinary and
empirical research is needed to undertake the challenge of restoring trust without
hindering innovation.
2 Mapping trust, distrust and the new standards for IPB
2.1 The link to trust

By offering a lower taxation of some proceeds from IP, IPB ease the tax burden of
enterprises, influencing its location and the one of intangible assets. While such feature
was linked to innovation policy it was also related to artificial strategies ending up in the
breach of trust. The latter connection is quite recent and came hand in hand with the
evolution of coordinated measures to tackle avoidance, abuse of tax laws and other
strategies eroding the countries tax bases. At a global level the works are leaded by the
OECD and at the regional one by the European Union. As to Saint-Amans, the Director
of the OECD Centre for Tax Policy and Administration: “Tax is all about trust” [OECD,
(2014), p.68], arguing that trust in taxation is in the heart of tax and public policy and of
the international measures adopted in the Action Plan on BEPS.
Although it is not clear what is the OECD approach to trust, or whether its scope is
only related to harmful practices, BEPS focuses on the latter and attempts a multilateral
solution, acknowledging that unilateral efforts were not enough to restore trust or to
rebuild an international tax system based on consensus. As to Saint Amans, the BEPS
package and in particular the Multilateral Convention to Implement Tax Treaty Related
Measures to Prevent Base Erosion and Profit Shifting (MLI) were the only way to
modernise the world tax system that could prevent double taxation, tax avoidance and
abuse (OECD, 2014). The MLI already covers over 75 jurisdictions and entered in force
last 1 July 2018. Before this statements neither tax laws, nor tax principles or legal
scholars used to refer to trust.
BEPS Action 5 introduced new standards for IPB whilst arguing that rather than
promoting innovation, IPB propitiate profit shifting by enterprises and, state’s
competition for foreign investment and state revenues. This shows that the merits of the
dispute lay down on the lack of trustworthy rules for the issuance of IPB by countries,
giving place to harmful tax competition. Such situation made the shortages related to trust
and global tax governance evident. For instance, countries requiring no link to R&D in
their territories raised suspicion and distrust by not encouraging R&D in their own
territories but benefiting from the income derived from the goods, rights or property
(GRP) resulting thereof. The feeling was as if those countries were stealing the income
that other was entitled to, increasing the concerns on the route of capital to tax havens
and from IP assets to IP havens, (denounced by NGOs for a long time, e.g., van Dijk
et al., 2006).
Given that IPB are successful in influencing the location of enterprises, the scenario
created by IPB regimes has forced non-IPB countries to consider whether they should
follow suit (Dharmapala, 2017). The political debates show the dilemma for
governments: to be or not to be… an IPB country. Some even argue that the 16% rate on
IPB vs. the 35% Corporate Income Tax (CIT) only helps to retain certain French-based
companies in France rather than to attract foreign companies (as to Pichot, in Kirwin,
2016). In the USA for instance, this was highly debated before the 2017 tax bill (Fichtner
and Michel, 2015; Gravelle, 2016), and at the present is disputed in Germany. As a
reaction to IPB, in 2018 Germany restricted the deduction of royalties paid to IP boxes
which do not carry out substantial activities if the royalties are not taxed at a minimum
rate of 25%. If this is not the case, the deduction is limited proportionally. The deduction
is partially or fully denied if the royalty income benefits from low taxation due to a
‘harmful’ IP regime in the sense of BEPS Action 5 (Becker and Englisch, 2019). In my
view, such measure is consistent to the current German proposal of a minimum tax
approach seeking to ensure that the overall tax burden on business profits does not fall
below certain level. For IPB that level is what is acceptable under German law for the
taxation of royalties. From a comparative perspective the question is whether all
countries would agree on that rate as the level playing field.
The reactions above mentioned show that governmental positions towards IPB are
divided amongst countries believing that IPB would prevent the departure of enterprises
from their countries (defensive IPB), countries claiming that IPB foster innovation,
countries against IPB given their potential to encourage the migration of enterprises or of
their IP assets besides profit shifting to low tax jurisdictions and countries adopting
measures that attempt to implement an acceptable level playing field. Although these
reactions make evident the trust related issues, the fact that some scholars refer to IPB
jurisdictions as intellectual property havens (Schwab and Todtenhaupt, 2016) only
increases the concerns.
From the perspective of trust in trade the situation is not better. One of the main
issues is whether the behaviour of entrepreneurs engaging in global trade is trust-worthy
given a proven track of unreliable artificial commercial activities and transactions. In
addition to this, scholars argue that IPB are playing a role in ‘corporate’ tax competition
(Alstadsaeter et al., 2015). Although Alstadsaeter does not elaborate the concept, I submit
that tax competition amongst states also distort competition amongst corporations
challenging trust in governance and in trade as the state aid cases have made evident due
to the selective character of the measures related.
Furthermore, taxpayers, in particular MNEs have been blamed for abusing IPB to
increase their profits whilst eroding the tax bases of the countries where taxes are due
and, therefore, the states capacity to serve public goal. From this perspective, IPB add to
major concerns on abuse of tax laws, fraud, simulation, avoidance, aggressive tax
planning, evasion and behaviours ending up in the erosion of tax revenues. If
non-genuine and artificial activities underline trade with the intention to obtain tax
advantages or to avoid taxes, such schemes would also mean a potential abuse of the
multilateral trading system and of the IP system. This however needs to be analysed and
balanced in view of the arguments I submit in Section 4.3.
Likewise, while economic theory plea in favour of incentives to R&D and Innovation,
scholars argue that MNE maximise funding available for R&D, benefiting from other
incentives or tax deductions available in the country where the R&D was developed as
well as in the IPB country. Besides this, the scepticism is increased with the criticism
towards MNE’s lobbying capacity to reach concessions and preferential tax treatment.
Some scholars even ask whether MNE’s would have engaged in R&D activities if no
incentives are granted.
As a result of all above mentioned, restoring trust became a priority. The standards
approved have as main addressees the countries on the one hand and, the taxpayers
(enterprises) on the other. IPB are one example of preferential regimes that have been
related to harmful tax practices, increasing the distrust of the society on tax structures
leading to little taxes being paid by MNEs to governments. A look into the situation
before the BEPS Action 5 was approved show societal concerns for enterprises
sidestepping taxation [e.g., NY Times by Duhigg and Kocieniewski (2012), in BBC
News by Barford and Holt (2013) and in Forbes by Gleckamn (2013)]. The tax scandals
related to data stolen or leak just increased the mistrust in the behaviour of taxpayers and
the use of sophisticated but abusive tax planning structures (Swiss leaks – the HSBC
case, Liechtenstein – LGT ex-employee, Panama Papers, Paradise Papers, etc.).
Although not directly related to IPB, the erosion of trust in trade became more acute
with the leakage of tax information to the society and the awareness of enterprises
evading or avoiding taxes by using low tax jurisdictions or tax havens. This is a structural
issue. As to Saint Amans, “to restore trust, it is not the only tax issue to address. Just as
citizens are not prepared to accept large-scale tax avoidance by global businesses, they
will not tolerate a situation in which the wealthy few can hide their money with impunity
in tax havens” (OECD, 2014).
While a big cloud of distrust in tax havens grew up, harmful preferential regimes and
tax planning emerged; enterprises also feared the boycotting of products and companies.
This even resulted in immediate payments to the revenue services without challenging the
claims, as Starbucks did in 2013 (Barford and Holt, 2013). The naming and shaming of
companies resulted in an undesirable bad reputational effect. Social shaming for issues
related to taxes started to influence corporate behaviour to the point that enterprises
started claiming in their annual reports full compliance with their code of conduct or with
international standards on transparency, collaboration and mutual trust (with the revenue
services) and fairness, including prices at arm’s length conditions amongst the members
of a group1.
2.2 The link to the nexus

IPB have been criticised as harmful tax competition devices more related to abusive or
aggressive tax planning and profit shifting by taxpayers – mainly MNEs, rather than to
innovation. The OECD and the EU based their criticism in the lack of ‘nexus’ between
the income covered by the IPB and the underlying R&D (OECD, 2015a, 2015b;
Directorate-General for Research and Innovation, 2017). Many IPB regimes lacked such
nexus until 2016. The new standards agreed to restore trust lead to a post BEPS
generation of IPB, with the idea of aligning taxation with substantial activities, as a mean
to restore trust (OECD, 2015a, 2015b). For IPB that is the nexus to R&D, the exclusion
of expenses related to marketing intangibles and limits to expenses for acquired property
(the modified nexus approach).
IPB have a direct impact on the CIT worldwide given its capacity to encourage the
relocation of IP assets and/or the investment on either innovation, R&D or IP in a specific
location. Such an effect was very clear in the pre BEPS IPB regimes since the special low
tax rate was granted to income derived from the development or exploitation of IP
(qualified income), IP in general or specific, self-developed and/or acquired forms of IP,
with or without a link to the research and development prior to the intangible. Before
BEPS and the EU Anti-avoidance Directive 2016/1164 (ATAD), such features, in
combination to other tax tools made the migration of intangibles very attractive.
The IPB regulations display a number of asymmetries. Comparisons made before
BEPS by legal scholars (Evers et al., 2013; as well as Evers et al., 2015) show that the
low tax rate granted for IPB contrast with the ordinary CIT. For IPB tax rates vary from 0
to 15.5%. EU member states have been adjusting the regulations to the nexus approach
since 2014 (Schwab and Todtenhaupt, 2016) and the ATAD directive has a big impact on
abuse and the use of the EU directives. According to a comparative study released
recently by PWC, the corporate tax rate on qualifying intellectual property (IP) income
got reduced to a nominal rate of 0–22% with lower effective tax rates (PWC, 2017).
Other aspects subject to regulation include the type of qualifying income (gross, net,
capital gains, royalties), acquired property, existing IP, embedded royalties, gains on sale
of qualified income, the treatment of expenses, whether R&D can be performed abroad,
etc. The main features relate to the need to control the IP and to receive the monetary
benefits (but not necessarily as the final or ultimate beneficiary).
The standards adopted in BEPS Action 5 by the G-20 and the OECD set up an
unprecedented solution for an output incentive: the introduction of a standard requiring,
on the one hand the nexus between an IPB regime and the performance in situ of research
and development (R&D) by the taxpayer itself; and on the other, the limitation of benefits
from such schemes to qualified expenses and qualified income from patents and
functionally equivalent IP assets, excluding marketing intangibles (trademarks, logos and
brand names), as well as expenses for acquired intangibles exceeding the uplift provided
by Action 5. These solutions are known as the nexus approach and the modified nexus
approach, respectively.
BEPS Action 5 helps to track the existence of sound commercial reasons (substance)
and to avoid profit shifting, mainly by linking the tax benefits to the proportion of
qualifying – R&D – expenditure of the taxpayer, whereas BEPS Actions 8 to 10 does it
through the so called arm’s length standard, a principle demanding that the prices agreed
between associated enterprises on their internal dealings is equivalent to those reached by
independent parties. Both sets of actions seek to align value creation: with substance in
the case of Action 5, and with transfer pricing outcomes in regard to Actions 8 to 10. To
sum up, whilst the nexus approach relates to governance and to trade (for the standards
expected from countries in the issuance of IPB), substantial activities (linked to the
proportion of qualifying expenditure by the taxpayer itself) appear as a standard to restore
trust in trade.
The situation described above shows that current attempts to restore trust in the
international tax system respond to distrust amongst and towards States concerning their
requirements and standards for IPB, but also from States against taxpayers (on the trade
of IP). In the fierce competition for investments, IP assets and revenues, the OECD-G20
linked the restoration of trust to the requirement of a certain degree of R&D as substantial
activity to be included whenever an IPB regime is enacted. In a nutshell, the most
important contribution of BEPS Action 5 to the debate on trust is that the nexus approach
became a standard in the restoration of trust in governance. Furthermore, given that the
ultimate rationale of Action 5 is the alignment of taxation with substantial activities
(OECD, 2015a), substantial activities appear as a standard to restore trust in trade.
The modified nexus approach -the standard approved under Action 5, attempts to
assure that preferential IP tax regimes require substantial economic activities in the
jurisdiction offering the IPB. For this purpose, the tax benefits are directly linked to the
proportion of actual R&D expenditures of a taxpayer in that jurisdiction. Furthermore, the
benefits can be granted only to qualified income (from certain IP) if the taxpayer carried
himself the R&D activity, excluding expenses for acquired IP above the uplift agreed
[OECD, (2015a), p24]. This has an impact on undertakings by related parties since their
expenditures won’t be seen as qualifying expenditures, contrary to what would happen if
unrelated parties were involved. At the EU level, however, a certain threshold of
activities in other EU member states is allowed, as an attempt to comply with the EU’s
fundamental freedoms.
In addition to the above, marketing-related IP assets (trademarks, logos and brand

names) are not considered qualifying expenditures and therefore the expenditures
associated to them will not benefit from the incentive. Only income related to industrial
IP assets (patents and functionally equivalent GRP) could qualify for tax benefits under
an IP regime. As to the OECD: “IP assets that are functionally equivalent to patents are
(i) patents defined broadly, (ii) copyrighted software, and (iii) in certain circumstances set
out below, other IP assets that are non-obvious, useful, and novel” (OECD, 2015a). The
nexus approach as it reads nowadays (the modified nexus approach) focuses on
establishing a direct connection between expenditures, IP assets and the income
benefiting from the regime. The underlying rationale is the requirement of substantial
activity for any preferential regime.
The European Commission endorsed the nexus approach. According to studies
performed at the commission’s request, until very recently many of the IPB legislation in
force in a number of EU member states did not contribute to foster R&D (Alstadsaeter
et al., 2015). Furthermore, about a year ago the European Commission released a
working paper on R&D tax incentives in which the main policy message is that “patent
boxes do not stimulate R&D and may rather be used as a profit-shifting instrument
leading to high revenue losses” (Directorate-General for Research and Innovation, 2017).
3 IPB, trust and the law
If tax is all about trust and the BEPS project attempts to restore it, the main question
remains whether the standards and related measures adopted with BEPS are suitable to
reach the goal. Although issues related to IP strategies are covered by a number of
actions, in this paper I only address Action 5 for its direct impact on the IPB. In this
section I approach the regulatory framework setting the standards, considering the stages
of law making, implementation, compliance and enforcement in respect of BEPS
Action 5. This topic is important considering the novelty of the approach to deal with an
old issue through:
1 the link to trust
2 the nature and multilateral character of the measures adopted by to restore it, as well
as the later involvement of non-OECD and non-G-20 members
3 the peer review and monitoring system of the implementation and compliance with
the standards.
3.1 The OECD soft law approach

Action 5 was released as a part of the G-20/OECD BEPS package, a project mapping and
finding solutions to tax-planning strategies leading to the erosion of tax bases through
profit shifting practices. The BEPS action plan is an agreement decided by ‘consensus’ of
the G-20 and the OECD. While some of its Actions became positive law through the
MLI, some are neither binding, nor directly enforceable. Instead, they are considered as
soft law, though countries adhering to the consensus are expected to implement them in
their domestic laws and tax treaties. The latter is the case of Action 5.
The implementation of BEPS came to life in 2016 via a multilateral forum called
inclusive framework (IF). At the present, about 116 countries and jurisdictions are
members. As a consequence of the membership they are expected to comply with
Action 5 given that the OECD and the G-20 set it up as a minimum standard, in order to
ensure timely and accurate implementation and thus safeguard the level playing field.
The IF members are also invited to develop a monitoring process for the minimum
standards adopted. Other actions are addressed by the OECD Multilateral Convention to
Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting
(MLI) that entered in force in July 2018.
The information available concerning how the countries join the OECD multilateral
forums in practice is scarce. The best of my knowledge, the OECD sends an invitation
letter to the country. Upon signature by a (finance) Minister of the country invited, the
OECD releases the new using the OECD channels. The IF resembles similar OECD
forums such as global transparency or responsible business conduct. Member countries of
the forums do not become members of the international organisation and the signature of
an international convention is not required.
The IF implements a new way of international cooperation and engagements.
Participants to the meetings are experts at the service of tax administrations or finance
ministers, without capacity to bind states. The forums however end up in state
commitments having an impact on domestic law. This is because all IF members commit
to the comprehensive BEPS package and its consistent implementation. Concerning
Action 5, countries undertake:
1 participation in the peer review process performed by the Forum on Harmful Tax
Practices according to the terms of reference and methodology agreed with all
members to identify features of regimes that could facilitate base erosion and profit
shifting
2 transparency, through the compulsory spontaneous exchange of relevant information
on taxpayer-specific rulings.
The countries joining the IF pay an annual fee to cover the costs of the framework
(OECD, 2017). As a result of the peer review process, the IF approves a progress report
indicating the regimes analysed or under analysis, and classifies them as harmful or not
harmful. The report indicates whether the regime is under review, out of the scope, is not
harmful, abolished, amended or in the process of being amended by the country (OECD,
2017).
The implementation of the forums and the MLI is asymmetrical. This may be related
to the many options granted, but also to the different country views on the measures.
Neither all OECD members agreed on implementing BEPS nor they have signed the
MLI. The USA, for instance is a member of the IF but not of the MLI. EU member states
belong to the IF and have also signed the MLI. The EU have followed closely the
developments and implemented related measures in its own way. Given that at least
14 EU member states offer IPB regimes, in these cases the consensus reached as well as
the EU approaches are vital because the success of the measures is related to it.
Considering that the accomplishment of the BEPS actions also depends of the
implementation by many countries as possible, and in an attempt to restore trust in the so
called international tax system, the IF was open to non-OECD, non-G-20 countries in
2016. The countries targeted with the measures are as a consequence of a wide variety
and a uniform approach may not fit best their own interests creating a scenario of
conflictive policies and outcomes.
The above mentioned show a story of apparent inclusion and of a good relation
among countries with the expectation of restoring trust in the so called international tax
system through the fast legalisation of anti-abuse provisions (the BEPS package in
general) under the direction of the OECD and the G-20. Undoubtedly, the IF and BEPS
place the OECD as a top world tax policy designer and reviewer via the peer review and
monitoring mechanism. Its works are also a source of interpretation on other aspects of
international taxation, as reflected with the OECD commentaries to the model tax
convention and of the OECD transfer pricing rules, amongst other.
Notwithstanding all above, it is however worth questioning whether all the works and
the tools used through the multilateral forums would also lead to trust and to a sustainable
situation. As already mentioned and considering the features of BEPS, Action 5 and of
the IF, the main tool has been soft law. The power of soft law became more evident with
the BEPS project and the legalisation of many of its provisions by a good number of
non-OECD countries worldwide. Several OECD member countries but also third states
have converted many of the BEPS actions into hard law, although not always aligned, or
not on a 100% basis. As a consequence of the peer review, a number of regimes has been
abolished, reformed and reissued (OECD, 2017).
The use of soft law in taxation is not new. The features of tax law have exposed this
field to a higher influence of soft law (Buitrago, 2016). Taxes are a main source of
revenues, at least for developed nations and this makes it difficult for countries to resign
revenues derived from cross border transactions. This has also made it difficult to reach
agreements on the allocation of income, in a multilateral context in addition to other
issues. Besides, the provisions to alleviate the potential burden of over taxation of global
enterprises are quite limited due to the many imperfections related to the limited and
unlimited tax liability in the taxation of enterprises at the domestic level but also to the
shortages of tax treaties whilst dealing with the allocation rules and the distribution of
profits. Domestic tax law and bilateral tax treaties are designs for the enterprise model of
about hundred years ago and soft law has contributed to progress difficult to achieve with
hard law, I mean, in a multilateral context.
A global tax policy is still far from true considering that tax laws depend mainly on
domestic policy and national interests. International organisations such as the United
Nations (UN) and the OECD have given a lot of input through soft law. Although the
power of soft law seems strong, the Achilles’ heel is also pretty obvious considering that
countries may prefer to steer themselves the wheel and it may be really difficult to reach
an international consensus. Regions such as the EU reacted quite fast, enacting their own
policies and measures whilst showing sympathy to the OECD works. Not all countries
are happy with the BEPS outcome, however. Big countries such as the United States of
America and Brazil did not sign the MLI. And developing countries continue trying to
find a way under the umbrella of the United Nations without many resources available
but the good intentions of the many participants from the developed and the developing
world, some of them maybe defending their own interests.
As to the OECD, the extensive number of IF members and the ability to review any
non-members identified as ‘jurisdiction of relevance’ makes the standards on harmful tax
practices a truly global standard (OECD, 2017). Action 5 is a minimum standard of the IF
and over 115 countries and jurisdictions are moving forward in the implementation of the
standards described. I submit that the global standards agreed by the OECD/G20 and
introduced by soft law may not fit the needs of countries with different degrees of
development, different economies or economic and cultural exchange, or simply with
different interests. Furthermore, such standards may not be even good for the purposes
intended.
Concerning Action 5, the need to consider the circumstances of each country and
region have not passed unnoticed. Faulhaber criticises how the nexus approach has a
tailored made version for EU countries (entity version), hidden in the footnotes of the
2015 OECD Final Report on Action 5, deviating from the location version targeting the
rest of the world. As to her, the only explanation for this selective and more favourable
treatment for EU IPB is that EU countries participating in the BEPS Project believed that
the EU treaty freedoms would not permit EU member states to adopt an IPB that focused
on jurisdiction (Faulhaber, 2016). As a consequence, EU IPB and EU law appear
suspicious for non-Europeans since it creates more distortions and more opportunities for
profit shifting. In any case, even if Faulhaber approach were not correct, it shows that the
interest of countries and jurisdictions issuing the standards – steering the soft law wheel –
is warranted, while other countries should look carefully on how to warrant their own.
The above mentioned is fundamental also in the peer review and monitoring process
described, in particular concerning non-OECD, non-G-20 countries. Action 5 included a
number of regimes that in the view of the Forum on Harmful Tax Practices (FHTP) are in
contravention of the standards set for IPB. The FHTP has reviewed the compliance to
Action 5 by more than 170 regimes until now. The methodology and all relevant aspects
concerning the manner in which the per review is conducted, documents to be used, etc.,
were set in advanced and known by all interested parties. However, it is not clear whether
the BEPS standards for IPB also apply to other output incentives.
In the above-mentioned scenario, the G-20 and the OECD claim that IF member
countries work on equal footing. A clarification to this needs to be made since this is true
only in regard the implementation of measures previously adopted by selective countries.
I wonder whether this system helps to reach a better system of consensus and to restore
trust. A review of the elements given at the beginning of this section allows me to
conclude that a positive answer to the question is unlikely. Countries were invited to
implement decisions already made and on which only the political and economic
situation of the G-20 and OECD members were considered. Non-OECD and non-G20
members were not invited to discuss the standards resulting from their analysis or
discussions. Furthermore, countries joining the Forums get the impact of engagements
made by experts non-representing officially their states or jurisdictions, nor acting as
subjects of international law. The representation required in order to define taxes and the
policy behind, also in the choices for direct funding or via tax incentives is missing. This
situation challenges old principles of taxation and representation in view of globalisation
and the so-called global policies.
As in Plato’s ‘symposium’, developing non-OECD countries were also invited to the
BEPS party. They were allowed to participate in the discussions of the BEPS package,
but they had to wait in the garden while OECD member countries decided behind closed
doors. Such a system of participation and lawmaking is a bit strange if the objective is to
restore trust in an ‘international tax system’. It is also worrying given that the conditions
and interests of more knowledge-based countries differ from others. This can be already
noticed since the implementation of the BEPS standards is not standardised showing that
countries tend to deviate from the actions proposed.
Surprisingly, many developing countries (in terms of knowledge as well as of

scientific, technical and/or technological development) agreed to the new standards set by
BEPS Action 5, without much research at the domestic level and without policy
considerations beyond potential abuse. The policy considerations for the abolishment of
the incentive are not always clear and the number of societal actors involved in the
decision-making unknown. The lack of such debates and the shortage of information
about the economic research supporting the decision may create suspicion and mistrust in
tax governance. It may also lead to unsound tax policy.
3.2 The EU soft and hard law approaches

The EU Commission takes part in the OECD works and also cooperates to achieve its
goals. The council welcomed the BEPS works already in 2013. In line with it, the
Council Directive 2016/1164 acknowledged as an imperative the need to restore trust in
the fairness of tax systems and allow governments to effectively exercise their tax
sovereignty. The EU has taken steps forward by also making use of hard law, for instance
with the Antiavoidance Directive and its amendments, known as ATAD 1 and 2, in the
understanding that the BEPS actions are soft law (European Parliament, 2017). In this
vein, there is also a proposal pending for a decision of the Parliament on a Directive on a
Common Consolidated Corporate Tax Base (CCCTB) that makes a choice for super
incentives for R&D rather than for IPB. While a decision has to be made, the
Commission does not recommend the IPB as a policy instrument to its member countries.
In the heterogeneous scenario of incentives existing at the EU level, it is to be seen
whether this second attempt for a proposal to establish a common corporate tax base will
succeed and also reach its goals. So far, there is a lot of scepticism about its future2.
Apart from the above, the G-20/OECD tailored made measures to restore trust, the
EU displays a broader legal framework to combat the erosion of tax bases caused by
profit shifting and avoidance with ATAD 1 and 2, the Code of Conduct and State Aid.
While BEPS have reached more than 80 jurisdictions around the globe, the EU provisions
have effect within the EU but with a global reach, in particular with State Aid. The
European approach is unique and maybe the most important example of commitment
from a world region in the combat against tax competition and abuse of tax laws.
3.2.1 Anti-abuse measures

ATAD set a number of rules against tax avoidance practices (from trade) that directly
affect the functioning of the internal market. Such measures include, amongst other, a
general anti-abuse rule, a CFC rule making taxable in the EU the profits shifted to low
tax jurisdictions, exit taxation on assets before they are moved out of the EU, an interest
limitation, rules on hybrids (extended to third countries), and a general anti-abuse rule.
The BEPS provisions and ATAD address structures that also involve benefits granted by
the directive on interest and royalties and, the parent subsidiary directive with an exit tax
before the asset is moved to and IPB (EU) and with the requirement of ‘nexus’ by BEPS
(Council of the European Union, 2016a).
3.2.2 State aid

Other provisions related to competition and EU Governments regard state aid. In the EU
overstating or understating licensing fees or royalty payments may be subject to state aid
control, should tax authorities not use any transfer pricing instruments available to them
to address these issues. State aid focuses on the selective treatment granted to companies
by tailored made rulings (Evers, 2015). The commission is also tackling particular group
of companies (European Commission, 2014b) given indications of special tax regimes
mainly benefiting highly mobile businesses without triggering significant additional
research and development activity. Although an analysis of state aid exceeds the purpose
of this paper it is worth mentioning that the compliance with such rules has been subject
of investigation already, as in the case of the Spanish IPB that the European Commission
(EC) found compliant (European Commission, 2008). There are also famous cases
against Ireland and Luxemburg involving the use of preferential IP regimes in which the
commission requested information. Investigations do not always end up confirming the
existence of state aid, as in the case of a tax ruling granted by Luxembourg to
McDonald’s Europe Franchising decided last 19 September 2018 (IP-18-5831).
Main difficulties that arise for enterprises reaching rulings in violation of state aid
rules regard high monetary compensations. Ireland for instance is not willing to enforce
the EC decision. Indeed, following a state aid procedure, the EC concluded that Ireland
granted undue tax benefits of up to €13 billion to Apple. As a consequence Apple was
allowed to pay substantially less tax than other businesses. According to the EC this is
illegal under EU state aid rules and Ireland must recover the illegal aid. Since Ireland
failed to do so, the commission referred Ireland to court (European Commission, 2016).
Although Ireland paid the disputed Irish tax bill, the commission has not withdrawn the
court action. Such a controversy shows the distrust in trade and governance as well as the
many aspects and subjects involved. So far some countries are still under investigation by
the European Commission (e.g., France). The analysis of IPB under state aid exceeds the
purpose of this paper, however.
3.2.3 The code of conduct

Other measures regard the political commitments of EU member states to curb harmful
tax competition. In this respect, the code of conduct on business taxation has played an
important role in the reform of the IPB regimes within the EU, stating for instance that
tax measures providing for a significantly lower effective level of taxation, including zero
taxation, than those levels which generally apply in the member state in question are to be
regarded as potentially harmful and therefore covered by this code. The code of conduct
group agreed on the modified nexus approach as the appropriate method to ensure that
IPB require sufficient substance. After the Council of the European Union (2014, 2015)
invited EU member states to adjust to this method, the group monitors the legal reforms
and examines member states compliance with the rollback commitment of the modified
nexus agreement. In 2016, the group reported to ECOFIN the need to evaluate all IPB
against the criteria and concluded that all member states with the exception of France and
Italy were broadly in compliance with the rollback commitment of the modified nexus
approach (Council of the European Union, 2016b).
4 Restoring trust, a review of arguments in the light of innovation policy
As already mentioned, if tax is all about trust and the BEPS project attempts to restore it,
the main question remains whether the standards and related measures adopted are
suitable for that purpose. Furthermore, the R&D new standard raises the question of
whether post BEPS IPB would promote R&D and Innovation (R&D&I). Action 5
assumes that without such nexus IPB will not encourage R&D or innovation. In this
section I challenged this approach. By making a review of the legal and micro economic
analysis and arguments used I attempt to establish whether trust would stem from the
quality of the rules, their ability to serve their intended purpose and to appropriately
balance conflicting interests of stakeholders, in particular between revenue collection and
innovation policy towards the enhancement of a knowledge-based society.
The stated aim is not of theoretical character. The new BEPS standards and related
per review procedures lead to the reform or abolishment of IPB. For instance, the Irish
and the Colombian IPB were abolished. Majority of IPB regimes were modified and/or
set again (e.g., Ireland) based on the assumption that:
1 without a nexus to R&D, IPB will not foster innovation
2 acquired patents and marketing intangibles play an important role on profit shifting
rather than on innovation.
As indicated, although both, governments and enterprises claimed that the IPB would
foster R&D&I, many IPB regimes did not require such nexus. And many IPB were used
only as conduit companies. Both circumstances lead to mistrust in governance and in
trade. Given the impact expected, a review of the arguments used from an
interdisciplinary perspective may help to establish the ability of the measures to achieve
trust. I accomplish this task in this section.
4.1 The nexus approach, innovation and entrepreneurship

A number of economic studies claim that IPB without a nexus to R&D did not foster
R&D&I (for instance, Ernst and Spengel, 2011; Ernst et al., 2014; Evers et al., 2013;
Evers, 2015; Alstadsaeter et al., 2015). It is argued that the tax advantage is related to the
profits that result from R&D rather than to R&D expenditure. As to Evers et al. “IP boxes
are poorly-targeted at incentivising firms to undertake additional R&D investments. IP
boxes may work to attract mobile investments, and in theory could increase tax revenues.
However, any positive effects might be eroded by the operation of similar policies by
other countries” [Evers et al, (2013), p.39]. Furthermore, scholars claim that the nexus
approach offers some potential to mitigate the role of patent boxes as tax competition
tools (Alstadsaeter et al., 2017).
The arguments used by scholars but also by the OECD and the EU are of interest. For
instance, they claim that:
1 there is no correspondence between an IPB and the number of inventors or a
relocation of R&D activities
2 high-quality patents tend to be located in jurisdictions with lower corporate taxation
and with a larger gap between the standard CIT rate and the effective tax rate
(Alstadsaeter et al., 2015).
In addition to that, that IPB generate negative spillovers on average patent quality
(Schwab and Todtenhaupt, 2016; Ernst et al., 2014). The methods and arguments used
are not always satisfactory. Although issues related to abuse have to be considered,
scholars agree that such aspect should not interfere with a legitimate R&D policy (Danon,
2015). An interdisciplinary approach to the standards approved leaves a big concern
given the potential of the measures to hinder innovation.
I submit that the nexus approach is not really in line with current insights on
innovation. The BEPS standards tackle output incentives through the lens of the early
linear model of innovation. According to that model, R&D is the wholly grail of
entrepreneurial success playing down the role of further stages in the innovation chain.
As a result, BEPS Action 5 and the modified nexus approach placed the emphasis on
input incentives, mainly R&D. According to some scholars, “the same principles should
apply to evaluating an output R&D incentive as for an input R&D incentive” [Shay et al.,
(2016), p.441]. This approach tends to disregard the back end of the innovation chain
(output) and its influence on the creation of income. As far as innovation policies are
concerned, a view limited to R&D is insufficient, however. This is because innovation
policy is not limited to R&D and the question is whether the commercialisation phase
should be incentivised or not.
Even in the linear model of innovation, the process involves basic research, followed
by applied research and development, and ends with production and diffusion (Godin,
2005). Although it is important to consider the link to R&D, innovation is not just about
inventions, discoveries or the creation of new products but also being able to bring them
to the markets, and preferably to the global markets. From this perspective, the limitation
made, in particular of expenses related to marketing intangibles raises the question on
whether this is worth of an incentive or not.
Furthermore, assuming that R&D and/or patents lead to entrepreneurial success is a
fallacy. The history is plenty of examples in which inventions did not prevent
entrepreneurs from failing (Pisano and Teece, 2007). Neither a patent, nor technological
innovation assures business success. This has been extensively analysed in the literature
on IP and on innovation (Teece, 2010). Remarkable innovation is not always rewarded by
economic profit. According to this, the transformation of an output incentive into an input
incentive is questionable. While enterprises should balance input and outputs, the
question remains whether governments should offer tax incentives to one or both
extremes of the innovation chain. The vast majority of the economic and legal literature
focuses on incentives to R&D. But, even in this field there are more questions than
answers given the scepticism towards fiscal and financial investment incentives in
general and for FDI in particular, though it is considered that those “are relevant for
internalizing positive spillovers effects, for easing credit constrains, and for fine-tuning
the macroeconomic situation” [Bellak and Leibrecht, (2016), p.70].
Systematic studies on output IP incentives are limited. Although it is true that IPB
face difficulties related to the temporal gap between the future realisation of IP income
and R&D expenses incurred in the creation of the intangible (Danon, 2015), I submit that
both moments are not always tide and current approaches ignore the corporate strategies
of R&D decentralisation, for instance by having R&D teams working in parallel in
various countries as well as R&D outcomes to be used worldwide, requiring in all cases
the decentralisation of IP as well. The BEPS current standards ignore this legitimate and
risky way of structuring global business and its impact on the development of a global
knowledge based society (not only of global trade).
In a similar vein, Cameron et al. plea in favour of IP output incentives in a domestic

economy. They argue that the rational of IP commercialisation resembles the one for
offering the tax incentives to the R&D, and for allowing the tax concessions to the capital
gains. As to them, both cases are subject to unusually high levels of business and
financial risk and in the absence of tax concessions “private firms will tend to allocate
less than socially optimal levels of investment of labour and capital to intellectual
property development” [Cameron et al., (2006), p.20].
Cameron et al. also argue that lower tax rates on IP may encourage individuals to
higher risk self-employed entrepreneurial activity in industries associated with IP (Idem).
The United Nations Economic Commission for Europe also highlights the connection
between entrepreneurial encouragement of researchers and incentives to the
commercialisation of IP [United Nations Economic Commission for Europe, (2011),
p.39]. For the European Commission, however, “it is not clear why especially
innovations for which clear property rights are defined should receive a tax incentive”
[European Commission, (2014a), p.45]. While this statement by the EC regard IPB,
empirical studies concerning the relation between output incentives and entrepreneurship,
also in connection to IPB are limited.
The studies performed until 2015 show the immediate effect of the IPB in the
attraction of patent ownership and high quality patents, the number of patents, attraction
of royalties inflows for acquired IP (Ernst et al., 2014; Griffith et al., 2014; Alstadsaeter
et al., 2015; Dudar et al., 2015; Bradley et al., 2015). However, according to some
scholars, there is no robust evidence to show that an increase in the real R&D activity is
caused by the introduction of an IP Box (Pfeiffer and Spengel, 2017). As to these authors,
this means that multinationals might view output-oriented R&D tax incentives not only as
a way of fostering research and development but also as a means of tax planning. Dudar
et al. confirm the influence of IPB in the international flows of royalty payments,
demonstrating that on average a one percentage point decrease in the tax differential
between a given recipient country and alternative recipient locations leads to a 2.7–3.2%
increase in royalty flows from a source state to this recipient. As to them, the BEPS
Nexus approach is likely to trigger a decrease in royalty inflows into countries offering IP
Boxes covering acquired IP under its scope and has a potential to restrict the flows of
non-legitimate royalty flows and is thus likely to limit the use of intangibles as a channel
of profit shifting (Dudar et al., 2015).
The study of Cameron et al. demonstrates that the Australian income tax law in force
in 2006 inhibited and discouraged the commercialisation of IP revealing effects that are
worth of analysis in regard output incentives in other countries, amongst other:
1 a tendency to impose taxes on unrealised gains
2 double taxation of realised gains
3 up front tax liabilities on the initial contribution of IP to commercialisation vehicles
4 unfavourable tax treatment of start-up losses where the commercialisation vehicle is
a limited liability company
5 denial of tax deductions to many IP commercialisation cost items
6 tendencies in the tax law to encourage relocation of IP ownership and control to
more favourable overseas jurisdiction [Cameron et al., (2006), p.2].
The need remains to establish if and how to grant output incentives is also a priority from
a public policy perspective in particular in the EU, the effects of current provisions, the
requirements that should be associated to incentives to the back end of the innovation
chain as well as the degree of proportionality and coordination required between patent
boxes and input incentives [the later pointed by Danon (2015, p.43)]. Given that studies
and measuring of IP output investment/innovation incentives – tax and non-tax related –
in a comprehensive manner are also missing, the challenge is enormous. From this
perspective, the BEPS standards to restore trust need a review and balance while defining
policy in order to avoid hindering innovation and entrepreneurship.
4.2 Nexus and its extension to other IP regimes

While BEPS Action 5 deals with situations of harmful tax competition the question
remains whether countering harmful tax practices is sufficient as a proxy in the adoption
of R&D&I policy. A review of Action 5 shows that the requirement of substantial
activity – R&D – does not only apply on individual cases of taxpayers seeking the
benefits of an IPB but also implies a modification/abolishment of the ‘back-end’ tax
regimes that apply to the income earned after the creation and exploitation of the IP
lacking such R&D nexus (OECD, 2015a), with the nuances added by the modified nexus
approach (the 30% uplifts already explained). In this way, the standards set by Action 5
apply to IPB but also to other output incentives and to any preferential regime IP related.
Such an approach ends up influencing policy on R&D&I.
While the OECD seeks to apply to output incentives the same rational of input
incentives by granting the benefits conditional to the proportion of R&D expenditures
made by the taxpayer himself in that jurisdiction, there is no evidence that the same
rational should apply to incentives granted to the commercialisation of R&D outcomes or
of IP assets related to them. Although the nexus approach also permits jurisdictions to
provide benefits to the income arising out of that IP, so long as there is a direct nexus
between the income receiving benefits and the expenditures contributing to that income
(OECD, 2015a), the studies leading to the change focused on IPB but did not focus on all
kind of incentives related to the commercialisation of IP. These questions the suitability
of BEPS Action 5 to serve as the only policy proxy to the modification or abolishment of
incentives related to IP, in particular in countries that are building their knowledge
capital. The example below exemplifies this situation.
The 2015 list of harmful tax practices under Action 5 included a ‘software regime’
granted by Colombia. According to the 2017 report, the regime was abolished (OECD,
2017). Colombia is an OECD member since 2018. In 2002, Colombia granted an
exemption for the income derived from the commercialisation of software:
1 made in Colombia
2 with a high level content of substantial scientific or technological research in
Colombia, to enterprises incorporated and liable to tax in Colombia (Article 207-2,8
of the Income Tax Law).
Amongst other, the software had to be the result of substantial scientific or technological
research in Colombia3. The incentive was granted initially up to 2017.
In 2016 the Congress abolished the incentive. According to the debates to the draft
law 178/2016 – issued by the Chamber of Representatives and 173/2016 of the Senate –
one of the arguments to abolish it was its listing in BEPS Action 54. With this
background, and the lack of further information in the OECD monitoring reports – even
if the initial validity period granted to the incentive was about to expire, I find it difficult
to agree on the outcome reached by the FHTP. Given that the software had to be made in
Colombia and be the result of Colombian R&D, it is not clear to me why the regime was
listed. Given that the OECD prefers the application of the standard – the nexus approach
– to regimes benefiting income from IP (OECD, 2015a; OECD/G20, 2017), the question
remains on whether such approach would promote innovation, in particular in countries
that would like their own industry to flourish. Besides, it is worth considering that the
spillovers of IP to the society normally happen after the outcome is reached and the IP
asset is formed, either via the products placed in the market, the knowledge spread via the
researchers, etc. Expenses related to this could also be acknowledged. Empirical studies
on this respect would be good to also establish the need for output incentives such as the
Colombian one above mentioned.
Apart from the above, if the attempt is to restore trust in the international tax system,
an analysis restricted to the BEPS practices may be narrow (in a similar vein, Danon,
2015). The world of IP and taxation is a pretty big one. Anti abuse and anti avoidance
provisions with a direct impact on trade involving IP cover, but are not limited to the
principal purpose test, limitation of benefits, control foreign corporations (CFCs), transfer
pricing rules, including the new guidance on the application of the OECD approach to
hard to value intangibles released last 21 June 2018. BEPS governance-related measures
for IP boxes and preferential regimes are set in Action 5 (the nexus and the modified
nexus approach). Action 5 has already been implemented by a number of countries. The
OECD lists a number of harmful regimes and monitors the implementation of Action 5,
as part of the BEPS package already for a number of years (OECD/G20, 2017; OECD,
2017).
In addition to the above, there are old approaches to tax avoidance and tax evasion
still available, e.g. general and specific anti-abuse provisions from domestic and tax
treaty law, including the beneficial ownership requirement in double taxation conventions
(DTCs)5. Although such terminology targets the final beneficiary of the payments,
irrespective of legal ownership and formal or contractual obligations, it has been
insufficient to address the abuse of tax planning, not only in regard to IP assets. Over the
last years, the term is also playing an important role to uncover the identity of the
ultimate beneficial owners of entities, properties, and third-party business partners in
criminal investigations (LexisNexis, 2016). In the field of intangibles, although not much
explored, issues related to the valuation of intangibles play a role in money laundering.
Given such link, patent and trade mark attorneys are required to have procedures in place
to detect and prevent money laundering, for instance in the UK. These measures show an
increased distrust in IP.
BEPS introduced some standards, new terminology and dogmas. As Schön points
concerning the BEPS action related to digital economy, new dogmas are confronting the
current approaches without much research supporting the solutions offered (Schön,
2018). I cannot agree more with this statement since the same applies to the standards
applicable to output incentives. In this field the new dogmas require a closer analysis, for
instance on the BEPS dogma of taxation where value is created (different for the
purposes of Action 5 and Actions 8 to 10). Although the intention of BEPS was to skip
issues related to the allocation rules, the standards adopted are already having an impact
in the way countries want to apply the provisions related to value creation. In the terms of
Action 5 and for the purposes of IPB the proxy for value creation and alignment to
taxation brings us to the country wherein the R&D takes place and where the qualifying
income and proportional expenditures will be considered. This rational disregards
particular circumstances related to the commercialisation of IP assets and potential
spillovers, as will be analysed in Section 4.
For intangible assets, in BEPS value creation could have different meanings and links
to different locations, mainly in application of Actions 5, and 8 to 10. As to the OECD,
aligning taxation with value creation in Action 5 means that the jurisdiction granting
benefits for income from IP have to link them to the performance of R&D activities in
that jurisdiction by the taxpayer himself (OECD, 2017). For the purposes of action 8 to
10 the meaning of value creation is not clear. MNEs need to capture value in the majority
of the territories from which they derive profits before they succeed in that attempt. Does
it mean that the place of consumption (the market for an intangible) have a tax priority
over the one of residence of the beneficial owner of the GRP?
Whilst management specialists emphasise the need to capture value in local markets,
tax experts are trying to figure out the meaning of value creation. Is the tax world lost in
the translation from economic or management approaches or the like? Do the tax lawyers
need interpretation from the economists leading transfer-pricing approaches? The new
dogmas have different ways to read them. On the one hand, they may help source –
developing – countries to justify the tax claims over income from the intangible GRP
used in their territories, while the residence countries will stick to the residence approach
as set in the OECD model tax convention. All policy issues involved are worth of more
research before implementing decisions such as the ones brought by BEPS.
4.3 The role of IP and microeconomic analyses

Scholars making microeconomic analyses of IPB base their studies on patent data
available (e.g. Schwab and Todtenhaupt, 2016; Alstadsaeter et al., 2017). This is
understandable given that patents play a very important role in balancing the public and
the private interests involved by making knowledge available to the society whilst the
exclusive exploitation is assured. The issue is that the IP system does not always achieve
its public objective given an increased move towards secrecy (Anton and Yao, 2004;
Wajsman and García-Valero, 2017). Even if scholars claim that enterprises would always
invest on innovation and incentives may entail a useless loss of tax revenues (Evers,
2013), it is also important to gain more trust in the IP system and to lower the trend
towards secrecy to assure that the new knowledge reach the society and is absorbed as
bases for new knowledge and developments. A balance and better performance of output
incentives is necessary, I mean of tax and non-tax incentives. Whether IPB help or could
help to reach this purpose would depend of its design.
4.3.1 Patent location

Whilst criticising IPB for influencing patent location, scholars making research at the
microeconomic level also link ‘domestic’ patents to the place where the inventors are
located (Alstadsaeter et al., 2017; Schwab and Todtenhaupt, 2016). They also pointed out
the lack of correspondence between patents and the number of inventors or a relocation
of R&D activities (Ibid). Some even emphasise in the benefits for inventors rather than to
the owners of the invention or patent as the case may be (Alstadsaeter et al., 2017). The
issue is that inventors are rarely the economic owners of a patent, because the patent itself
is an output incentive for the economic exploitation of the invention protected. More
important, current R&D organisation in MNE’s involve researchers, developers and
project managers located in different jurisdictions, working on a number of projects
leading to the R&D outcomes. Furthermore, it is not unusual that inventors do not even
know where the patent is claimed, since the rights on the GRP normally belong to the
enterprise or investor by virtue of contractual arrangements or even by law in some cases.
In addition to the above, IP has to be registered in all jurisdictions wherein the
intangible is going to be exploited. For instance, patents should be registered with the
patent office where protection is sought: national, regional (EPO for instance) or
international (PCT). The ZEW/PWC survey confirms that companies locate their R&D
activity and the associated IP rights in different places (PWC, 2015). Tracking the profits
and the ownership of IP assets as well as allocating and attributing the income derived in
cross-border transactions is something different. Likewise, the decisions on the IP
strategy and the control related. From an innovation perspective enterprises need to
capture value from different jurisdictions in order to be successful, but it is not clear how
to align taxation to value creation and the relationship to capturing value and output
market potential. A major issue regards the location of IP in low tax jurisdictions that are
not considered as R&D countries.
While one could argue that the main issue is the location of IP, one should
acknowledge that IPB attempt to influence the location of enterprises and in particular of
IP ownership or of the direct beneficiaries of the economic – tax – incentive. As
previously indicated, scholars have emphasised such an active role of IPB (Schwab and
Todtenhaupt, 2016). This shows the close relationship to investment incentives and a
specific problem of the developed world to attract but also to – mainly? – retain
enterprises. Developed countries are normally knowledge and capital exporters but for a
number of years they are facing the migration of ‘their’ enterprises, experiencing the
effect of a race North-North. From this perspective, IPB are only one more aspect of the
competition issue.
Global activities and decentralisation imply operations and assets around the globe as
well as internal and external transactions. Current legal rules set basic international
standards in a number of fields related to output incentives. Such standards normally
leave high burdens of compliance at the domestic level, in each jurisdiction. As far as IP
is concerned (since IP is also an output incentive), multilateral treaties set basic standards
of protection, release somehow international procedures but in all cases force the
adoption of steps at the national level: registrations or validations (in the EU member
states for instance) may be necessary and protective measures are required in every place
in which the IP is going to be used. From a tax perspective apart from the risk of multiple
taxation, compliance obligations are also demanding, requiring the involvement of
accountants, transfer pricing and tax specialists (in addition to other specialists in the
fields of trade, investment, labour, IP law, etc.). IPB only released part of the tax burden
by lowering the – tax – cost.
4.3.2 Patent quality

Another aspect worth of analysis regards the quality of the patents and IPB. While some
argue that high-quality patents tend to be located in jurisdictions with lower corporate
taxation and with a larger gap between the standard CIT rate and the effective tax rate
(Alstadsaeter et al., 2015), other claimed that IPB generate negative spillovers on average
patent quality (Schwab and Todtenhaupt, 2016; Ernst et al., 2014). However, a patent
won’t be granted if the invention does not meet the requirements, i.e., if it is a new,
inventive and industrially applicable technical solution to a given technical problem.
From an innovation perspective, the issue is different: high-quality patents do not work in
isolation, a product normally requires both, far breaking innovations and small
innovations also subject to patents or other IP registrations. The role of supplementary
patents – and also complementarity of intangibles created by different enterprises – has
been analysed in the theories on innovation (Teece, 2012), and tax experts should not
disregard it.
4.4 Qualifying IPB, business models, marketing intangibles and the modified
nexus approach
As an effect of the modified nexus approach, countries should restrain of granting the
benefits of an IPB to income from marketing intangibles but also from acquired
intangibles. This follows the idea that the PRE BEPS IPB was not suitable to reach the
goal of enhancing R&D claimed by countries offering them. Such a global policy is a
step forward in the establishment of coherence to incentives on R&D. From an
innovation perspective, the situation needs further analysis in regard both, marketing and
acquired intangibles but also concerning business models. Although the latter are not
mentioned in BEPS Action 5, the asymmetries related to its protection are worth
mentioning them given its connection to the corporate strategy but also to the qualifying
expenses.
A questionable issue, at least from a tax perspective concerns the exclusion of
revenues related to the so-called trading/marketing intangibles (brands, trademarks and
the like), from the scope of IPB. Danon explains how the criticism in this case relates to
the lack of a link to any development conditions and therefore as a tool serving to attract
capital rather than to promote R&D. This was the case of the PRE-BEPS IPB offered by,
e.g., Cyprus, Hungary, Lichtenstein, Luxembourg and Malta (Danon, 2015). Marketing
intangibles are also at the back end of the innovation chain; in order to reach diffusion
and to achieve the best output market potential. Without the latter, enterprises may not
even invest.
Both, the trading intangibles and the IPB are incentives at the back end of the
innovation chain (diffusion). The role of marketing intangibles in achieving timely a
good marketing position is a fundamental one. The exclusion seems related to a policy
consideration (R&D) for an exceptional incentivising regime6, but also to mistrust on the
deductions claimed for outbound royalties after the migration of the intangible occurs.
Revenue services tend to believe that such payments are an old practice to shift profits
leading to abuse by taxpayers. The difficulties related to valuation make this fear bigger.
Microeconomic analysis of the impact of the protection of business methods and
other trading intangibles is missing, especially irrespective of abuse. Although the EU
justifies the lack of protection for business methods on a technical explanation (i.e.,
patent requirements), Europeans are confronted not only to the so-called European
paradox but also to the potential migration of their enterprises and of its intangible assets.
A regulatory framework highly fragmented into disciplinary fields and complex
multilevel legal competences between the EU and the member states also affects
Europeans. IP and tax law are a part of such complexities.
4.5 Innovation and growth vs. the entrepreneur’s view: decentralisation of IP

assets, IPB and the enterprise freedom to organise its business
From both, a public policy and a private interest perspective, the challenge is to translate
innovation into growth. As Pisano and Teece point out, from an entrepreneur point of
view, “the challenge is not just creating value from innovation, but capturing that value as
well. Insufficient capture will not only hurt the enterprise but society as well. In a private
enterprise economy, it is necessary for innovators (as a class) to over time earn sufficient
profits to warrant further investment in research and development and related innovative
activity” [Pisano and Teece, (2007), p. 278].
A survey of PWC global clients7 on taxation and corporate innovation carried by the
Center for European Economic Research (ZEW) and PWC in 2015 confirmed that, from
a business perspective, “the availability of internal funds is the most important factor in
the decision of how much is spent on R&D”, and that taxes are not important or not
decisive in both the location decision of R&D activity and the location decision of IP
(PWC, 2015). The role that decentralisation of intangible plays in this respect, as
corporate strategy, is not to be disregarded. IPB may help to reach the desired level of
liquidity given the setting in which IPB normally operate (holdings, with access to
domestic, regional and treaty tax planning tools). The issue of how to tax an enterprise
with global operations, global earnings and losses, is a different one. The same regards
the allocation of income and the attribution of profits in cross-border transactions.
IP decentralisation as an IP strategy is part of corporate strategies and could follow
different ways. A number of alternatives include a centralised structure, a purely
decentralized IP structure, a compromise structure involving a divisional assignment
where a multi-business unit or division committee oversees IP, and IP donations
(Carlsson et al., 2008). Decentralised structures also include integrated and
non-integrated business models, i.e., relying on licenses from non-related enterprises.
Each strategy has different IP and tax consequences. The focus in this paper is on
decentralisation and IPB. This is because of the role of IPB in the migration and
decentralisation of IP rights in a number of jurisdictions over the last 40 years.
Migration and decentralisation relate to strategies of mobilisation of resources or
GRP associated to all or to part of the stages involved in the innovation process, i.e., the
creation, development, enhancement, maintenance, protection and/ or exploitation of the
GRP. It could also imply that the management and/or exploitation of the intangible
resulting and the IP rights on it are concentrated in entities located in jurisdictions
different to the ones of creation (nowadays more than one) and or of the place in which
the main decisions over the intangible take place or are just implemented.
Furthermore, depending of the enterprise and its strategy, it can also happen that the
enterprise cooperates in open innovative models with other enterprises and engages in
acquiring or licensing part of the intangibles or knowledge needed to make its own
creations or inventions to work. The literature on business and economics relate to many
experiences in this respect. This is because companies are faced with a multi-invention
problem requiring the combination of a larger number of inventions (Somaya et al., 2012;
Teece, 2012). The issue relates to the capacity to generate all inventions needed or the
possibility to acquire it from non-related parties. Although the later option is called an
open model, it relates to non-integrated business models (Somaya et al., 2012). This type
of industry collaboration is interesting and also questions the role of open access and
potential spillovers to the society. Furthermore, it also shows that it is important to
consider whether such collaborations should be incentivised in both scenarios of open
access (with entrepreneurial and societal reach each). Under the new IPB standards the
possibility to benefit from such open models, in particular concerning acquired property,
is limited in the BEPS scenario, however. In this regard the modified nexus approach
made clearer that the intention is that the taxpayer undertakes itself a significant
proportion of the actual R&D activities and uplift is possible up to a 30% of the
qualifying expenses of the respective company. Acquisition costs and expenditures for
outsourcing to related parties are not included in qualifying expenditures, but are taken
into account in determining the 30% limitation set (OECD, 2015).
The migration of IP assets does not imply, per se, the existence of abuse or avoidance.
In a globalised economy, the portioning and spreading of activities and intangible assets
around the world are not surprising. The demand and the supply of the production factors
and the need for enterprises to accomplish the challenges of globalisation and
digitalisation justify the decentralisation of the intangibles as well. In fact,
decentralisation throughout the enterprise and incorporation into new or improved
products appeared as a need for firms already in the ‘80s and ‘90s, allowing a better
direction and connection to the needs of users and costumers whilst demanding to capture
value therefrom (Teece, 2012). Such a move relates in time to the release of IPB by
European countries. Ireland issued the first IPB known in the seventies and from that
time we count at least 20 IPB regimes, though most of them are from the last two
decades.
Business models are challenging from different perspectives including IP and
taxation. Whilst it is acknowledged that “technological innovation does not guarantee
business success –new product development efforts should be coupled with a business
model defining their ‘go to market’ and ‘capturing value’ strategies” (Teece, 2012). The
long history of failed remarkable innovations makes management, entrepreneurship and
business model design and implementation as important to economic growth as is
technological innovation itself (Teece, 2010). The market potential will not materialise
without business model and methods. Some countries believe that patenting business
methods will also boost innovation. This allows me to raise the question of how much
connection and coordination should exist between output incentives (tax and non-tax
related). For instance, in the USA business methods could be the subject of a patent while
in the EU methods for doing business are excluded from such a protection, unless the
subject matter specifies an apparatus or a technical process for carrying out at least some
part of the scheme (Section G-II, 3.5 Guidelines for Examination in the EPO). Such small
differences may have a big impact at the moment of deciding where to locate the
enterprises in order to reach markets.
Although it remains in the freedom of the enterprise to arrange its own business, IP
strategies also create a major room for disputes. From a tax perspective, the different
stages involved in the creation and exploitation of the GRP may create a link to the
countries where the activities/functions take place. Tax laws all over the world confront
trade with a number of tax dilemmas and issues arising from the asymmetric approaches
related to such link and further provisions, in particular the taxation level, the degree of
acknowledgment of expenses and losses, the activity (and omissions) related to the
intangibles, as well as the allocation of income and distribution of benefits in

cross-border transactions. Further discussions are related to internal transactions of
Multinational Enterprises (MNE). The magnitude of the issues in this respect is huge and
of high relevance given that, according to scholars, 80% of all trade flows across borders
take place as internal transactions within MNEs or through supply chains supervised by
them (Moran, 2016).
Enterprises with global operations, or just cross border transactions, face a number of
tax issues increasing not only their cost but also their risk exposure. For instance,
countries where the R&D is performed, wherein the intangibles are managed and where
the IP rights are used will most likely claim a link to the income sufficient to trigger
taxation. This creates:
1 a number of tax risks for international trade but also for the revenue services
2 a burden of compliance associated to it in each country (from a tax and a non-tax
perspective).
4.6 Innovation and growth, a public policy view

From a policy perspective, translating innovation into growth requires to balance
spillovers to the society. Such spillovers may have consequences in knowledge flows but
also capital flows and revenues. The correlation between ‘national’ enterprises and
revenues has been highlighted in the context of new measures of intellectual capital. In
this respect, Edvinsson highlights the correlation between famous Finish MNE’s with
global operations, using Nokia as example, with little revenues accruing to the country
and the impact on the Finish intellectual capital (Lin and Edvinsson, 2011). In a
globalised world, the traditional approach to ‘national enterprises’ has vanished,
however. Concerns like the one from Edvinsson need to be reevaluated in view of
shortages of the international tax system to address global enterprises (with global
operations, global revenues and global losses). Furthermore, each case would need a
close and individual analysis, also from the perspective of potential abuses.
Enterprises that decentralise the IP assets were in many cases engaging in abusive tax
practices while making use of the tax advantages offered by countries. This is the
scenario in which BEPS aroused: state’s tax competition for revenues, governments’
competition for foreign investment and practices from trade perceived by Revenue
Services as abusive. The use of an IPB should not lead to the conclusion that abuse
follows, however. But many IPB were created only as conduit companies to maximise
profits, only for pure tax purposes. The possibility to shift the income from IP to other
jurisdictions through mysterious tax royalty routing to heavens is one amongst the
alternatives. The reliance on tax havens is however under a lot of pressure.
Whilst abuse needs to be addressed, an innovation policy cannot be defined based on
abuse only. Public funding on innovation is fundamental to the achievement of policy
goals related to the enhancement of knowledge-based economies and economic growth.
Whilst there is no agreement on the best way to finance innovation, no doubt surrounds
the need to invest in public and private efforts for more innovative societies. The
justification comes from the need to overcome market failures related to the low levels of
investment in R&D and innovation by industry and the spillovers to society. Economists
relate such underinvestment to the difficulties faced by entrepreneurs to fully appropriate
the returns from their investments and the many risks associated to it. Innovation
underlines an overriding policy interest in the knowledge and economic growth resulting
therefrom.
Tax incentives attempt to boost activities in order to achieve specific goals, deviating
from the regular tax treatment granted to other activities. Whether tax incentives are the
best way of funding R&D is highly debatable and scholars views tend to either favour
public funding through subsidies, tax credits or other incentives or a combined approach,
but also to doubt of the expected outcome. As to Shay et al., a review of the R&D
literature shows “uncertain empirical support for a conclusion that R&D incentives for
private sector development R&D are cost effective in the sense of increasing social
welfare and economic growth when compared with alternative public uses of funds”
(Shay et al., 2016). Their scepticism of open-ended tax benefits for private R&D is
accompanied by the proposal to direct resources directly into basic R&D. And if it is
proven that tax incentives are effective, they suggest relying on input incentives only.
On the contrary, other scholars argue the need to adjust taxation strategies to ensure
sufficient capital allocation for productive investments and innovative activities
(Rasmussen and Redi, 2016). They also pointed out that the traditional role of taxation to
fund welfare must be complemented with a stronger focus on the promotion of
innovation (Rasmussen and Redi, 2016). Although tax incentives in general have been
criticised by the doubts concerning its effectiveness, recent economic research shows that
tax incentives could increase R&D and patenting. It demonstrates that R&D tax relieves
do seem effective in increasing innovation (European Commission, 2017 thought not
focused on IPB; Dechezleprêtre et al., 2016).
Output tax incentives, in particular, IPB are controversial, however. Only a few
economic studies deal with the spillovers from the box from an economic and
microeconomic perspective. Schwab and Todtenhaupt (2016) argue that an IPB without
nexus requirement in a foreign affiliate location allows domestic firms to reduce the user
cost of capital by shifting patent profits abroad. Their results indicate that a foreign IPB
tax incentive transmits to the domestic firm, which increases its research activity by
approximately 74% or 2% per percentage point of induced tax rate differential. They
demonstrate that, at least for intangible assets, the presence of low-tax countries reduces
the user cost of capital for investment in high-tax countries. Furthermore, their research
also concluded that if IPB regimes include non-domestically developed patents (i.e., from
researchers located in different countries), other countries without IPB regimes may
indirectly benefit because the implicit tax reduction for multinational companies
increases corporate R&D activity there.
If IPB help to lower the cost of capital, the question is if the tax incentive reaches its
policy objectives of:
1 boosting technological progress and innovation as important factors in long-term
economic growth
2 overcome the risk of ‘market failure’ of private underinvestment in R&D leading to
less ‘social’ or public welfare returns from those investments.
If the decisive factor to incentive R&D is liquidity, as the PWC/ZEW survey indicates,
IPB are an effective incentive. This however does not imply per se that such an advantage
also benefits the society.
In an evaluation of the innovation box in the Netherlands, for the period 2007–2013,
Mohnen et al., found that the Dutch innovation box has a positive effect on R&D
investment, but the average firm that uses the policy tends to use only a part of the tax
advantage for extra R&D investment. They concluded that firms that use the policy
instrument tend to have higher R&D activities after they start using the IPB. It is
important to highlight that the Dutch IPB under analysis is linked to the firm’s own R&D
local activity (Mohnen et al., 2017).
Knowing that IPB could have a positive input on R&D investments, which is
conditioned to the IPB features, the question arises whether similar effects could be
achieved without the IPB. The USA, a knowledge-based economy, offers an interesting
scenario. As to A. Shay et al., the US tax rules achieve a similar objective in a different
manner8. Before the 2017 US Tax Reform they pointed out that “U.S. international tax
rules have much of the effect of an output incentive by reducing the effective tax rate on
deferred earnings attributable to intangibles resulting from U.S. R&D activity” [Shay
et al., (2016), p.441]. The 2017 US tax reform brought more explicit benefits whenever
the IP stays in the USA (IRC Sec. 250A) while also tackles Issues related to global
intangible low tax income (IRC Sec 951A). The reform created a very attractive
deduction of 37.5% on all foreign-derived intangible income (FDII) received by a US
corporation in a taxable year. As a consequence, a 13.125% effective tax rate applies,
instead of the 21% CIT rate representing a huge incentive to locate the IP in the USA.
Measuring the benefits of output incentives is complex. In fact, measures on
innovation are very recent and just evolving. The OECD released the first set of measures
in 2010, and Deloitte published in 2017 a Survey of global investment and innovation
incentives. A cross-analysis of such surveys and tax provisions is missing, in particular in
the field of knowledge flows and knowledge-based and innovative societies. It is striking,
however, that many of the countries offering IPB are developed countries. Furthermore,
as the table below shows, a number of these countries are not only developed, but also
score high in the rankings of intellectual capital NICI409.
Table 1 Rankings of intellectual capital NICI40: country positions
Country Ranking Country Ranking

Austria 12 Portugal 26
Belgium 16 Spain 22
Cyprus N/A Switzerland 3
France 20 Colombia N/A
Hungary 23 China 36
Italy 24 Israel
Ireland 13 Singapore 6
Luxembourg N/A South Korea 21
Malta N/A Turkey 34
Netherlands 8
The introduction of IPB by non-European developing countries is quite recent, and

maybe the result of an imitation effect. IPB were for a long time a European
phenomenon. Apart from domestic policy, this could be an effect of regulatory issues.
Since the EU lacks competences on direct taxation, the palliative effects of the directives
may not help to incentivise investment in specific countries. In fact, member states
display big asymmetries in the incentives offered to R&D (and the fiscal regime in
general). This may explain also the Luxembourg (and the Brussels) effect and the
situation within the OECD whilst agreeing on the standards set by Action 5 with a nexus
approach tailored made for the EU, as Faulhaber (2016) claims. A potential regional
approach however does not solve competition -including tax competition- amongst EU
member states, in particular with an offer of at least 14 IPB regimes within the union.
5 Conclusions and final considerations
Restoring trust in the international tax system became a priority in the works of the G-20,
the OECD and the EU recently. They found out that, amongst other, IPB are tools ending
up in the erosion of tax bases by artificially shifting profits and causing distrust:
1 amongst states due to apparently low standards for the concession of the IPB
benefits, that end up in harmful tax competition
2 amongst states and taxpayers for corporate strategies related to the migration of
intangible assets and enterprises only driven by tax purposes.
BEPS Action 5 attempts to tackle the situation by establishing some requirements that
may help to rebuild trust in governance and in trade.
Although trust is the overarching BEPS goal, there is no clear understanding of its
meaning, scope or methods to address the challenge. Instead, in the fierce competition for
investments, IP assets and revenues, BEPS Action 5 requires from IPB countries or
jurisdictions, but also from any regime IP related to demand from the taxpayer a certain
degree of R&D, as substantial activity taking place at the country or jurisdiction granting
the incentive. As such, the requirements to countries issuing IPB of a nexus to R&D (the
proportional expenses related to it) became a standard in the restoration of trust in global
governance. In addition to this, given that the ultimate rationale of Action 5 is the
alignment of taxation with substantial activities, substantial activities (from the taxpayer
perspective) appear as a standard to restore trust in trade.
The existence of an agreement on standards to restore trust is a step forward in the
search for coherence in the concession of tax incentives and in the so-called global race
to the bottom, but also in a more reliable behaviour from enterprises claiming the benefits
of IPB and of IP. This is why I submit that the requirements set serve as a proxy for the
restoration of trust in governance and in trade. As a consequence of the standards agreed,
the scope of qualified income and expenditures benefiting from IPB was narrowed.
Expenses related to marketing intangibles do not qualify and the ones concerning
acquired intangibles are limited.
The main mechanism to implement the standards agreed by the G-20 and the OECD
under Action 5 is soft law, including monitoring and per review mainly through the IF
and the FHTP. The way the system works demonstrate that the standards agreed to tackle
harmful IP tax schemes are not only helping to tackle harmful tax competition but also
influencing R&D&I policy. As such, the effect is far beyond soft, not only on G-20 and
OECD members but in all IF members and even on non-members. From a policy
perspective the outcome is challenging. Given the way the standards were approved (By
G-20 and OECD members) and implemented (on all IF members and even non-members)
it is difficult to forecast the sustainability of the IF measures, in particular lacking the

representation due in order to define policy and the potential of the measures to hinder
innovation in countries wanting to enhance the commercialisation of their IP.
Whilst the implementation of the standards may work better in the countries steering
the wheel and being able to balance their interest when the standards were set, i.e., the
G-20 and OECD members, it is difficult to assure the same in the rest of the world. The
history of IPB and of tax tools surrounding the taxation of IP assets is one of conflict and
competition between developed countries for capital flows and revenues, but also for
knowledge flows. The situation of big players such as the USA and the EU, including
about 14 IP in the EU member countries show some of the complexities involved in tax
competition in the developed world. The entity version of the tailored made nexus for the
EU, and the deferral effect in the USA reveals how big players make available different
tools to compete in the global market. The race is for the savvy.
Given the unknown implications of the BEPS standards on innovation and
entrepreneurship it is also difficult to forecast their sustainability, in particular in
developed countries. The EU endorsed the standards and it remains to be seen whether
the post-BEPS measures on IP would help to also enhance innovation. It is however
worth highlighting that the EU Commission recommended EU member states to avoid
IPB as policy instruments, instead of referring to all kind of output incentives IP related,
as BEPS Action 5 seems to suggest. EU measures however go beyond soft law with the
approach taken under state aid and the code of conduct. Difficulties remain for a
harmonised solution given the lack of competence of the union over direct taxes and
therefore the domestic policies of EU member states matter.
On the other hand, the way developing countries are invited to participate in the
‘global’ discussions, without involving them in the fundamental decision making is far
from fair or ideal. The way decisions on the standards were made but also the criteria
applied in the monitoring mechanism are worrying. The formal quality of the rules, even
if they are soft law rules is dubious because it places countries on equal footing to apply
provisions for which they did not have the opportunity to decide on equal footing. Given
the way countries join the IF one cannot even argue that such equal footing is warranted
since there is no representation backing the implementation of the decisions made. As a
consequence of these circumstances, one should also question the ability of the IF and
mechanisms implemented in regard BEPS Action 5 to serve their intended purpose and to
appropriately balance conflicting interests of stakeholders, in particular in relation to
countries with different degrees of development.
The inclusion in the list of harmful tax practices of the tax incentive granted by
Colombia to the commercialisation of software made in Colombia and with a high level
of scientific research shows that under the OECD approach output incentives are not
welcomed even if there is nexus. This case also demonstrates the impact that the
standards are having in the definition of policies and questions the ability of the peer
review and monitoring mechanism to serve their intended purpose. Although it is true
that appropriate measures are required to combat profit shifting to low or non-tax
jurisdictions, the definition of public policies, and in particular of R&D&I policy requires
considerations beyond tax competition, avoidance or abuse.
A review of the arguments used in the microeconomic studies justifying the standards
set by BEPS Action 5 for IP boxes make more evident some shortages of the current
approach and of a couple of arguments used while adopting the new standards. The
interdisciplinary approach of this research allows me to argue that the Nexus, as a

standard, is not really in line with current insights on innovation. What scholars did was
to analyse output incentives through the lens of the early linear model of innovation,
playing down the role of further stages in the innovation chain. As a result, BEPS Action
5 and the modified nexus approach placed the emphasis on input incentives, mainly
R&D.
Given that the standards are applied not only on individual cases but also end up in
the change or abolishment of the IPB regimes, the OECD approach had an unimaginable
effect on policy. Such approach disregard the back end of the innovation chain (output)
but also questions whether incentives should also target globalisation and have an impact
on the freedom to organise global business and to adopt corporate strategies of
decentralisation. An interesting aspect to explore with empirical research regards
entrepreneurship and incentives to the creation of income in activities related to the
commercialisation of IP. As a result, an answer to the question of whether output
incentives are needed; its scope and coordination with input incentives should be a
priority.
While the intention to foster R&D&I through IPB seems to be good, it is also worth
questioning the rational of output incentives and if the standards adopted to restore trust
will not hinder innovation and entrepreneurship. So far, my analysis of the
microeconomic arguments used to justify the reform of IPB and the introduction of the
new standards shows that:
1 the linear model is insufficient to understand innovation
2 innovation goes beyond R&D
3 acquired intangibles are also a need to foster innovation or to create new intangibles
propitiating other spillovers
4 the quality of patents is not really affected by patent boxes since all patents need to
meet certain requirements
5 the location of patents is related to the exploitation of the GRP rather than to the
R&D giving origin to it
6 patents do not assure entrepreneurial success but only offer an alternative to secrecy
7 the location of researchers in MNE is not always centralised in one country
8 the role of trading and marketing intangibles, acquired intangibles as well as of
business models is apparently underestimated (in relation to substantial activities)
9 incentives to the commercialisation of IP may also encourage entrepreneurship
10 IPB influence to location of IP ownership.
The impact of these findings on the decision concerning whether output incentives should
be granted and the degree of coordination with input incentives (in particular to attract
investments) deserves further research.
The impact of the new standards on innovation still remains to be seen. A
requirement of R&D taking place in the IPB country could incentivise R&D in such
countries. However, the cycle of innovation and the role-played by IP assets and revenues
need to be analysed and balanced:
1 in the context of existing incentives to innovation without restraining them to R&D

2 in regard the global commercialisation of IP.
While growth is important for enterprises, it is also fundamental for countries, as long as
they can benefit from the flows of knowledge and of income. Governments are however
confronted with a number of dilemmas:
1 tax revenues and tax competition
2 the market failure and the cycle of creative destruction in which technologies and
knowledge are rapidly out-dated and new flows are required for the enterprise but
also for the society, in particular for innovative and entrepreneurial societies
3 global enterprises and domestic tax laws not prepared for global operations
4 the difficulties to measure the expected spillovers to the society and the scarce
indicators and measures related to innovation and to the effects of the
commercialisation of IP.
In the establishment of local, regional and global tax policies, more research and
measures of intellectual capital and spillovers to the society are needed, in particular of
expenditures concerning R&D&I but also to the ones related to the commercialisation of
its outputs, including IP assets. Additionally, it is necessary to establish obstacles or
disincentives to the commercialisation that could discourage investment in IP. In both
cases multidisciplinary and interdisciplinary analysis are necessary to also understand the
impact of input and output incentives to innovation and the flows of knowledge, capital
and revenues.
Trust in trade needs to be restored as well. Taxpayers have been blamed for abusing
IPB, by using them to increase profits whilst eroding the tax bases of the countries where
the value was created. As a result, they can be blamed for affecting the state capacity of
serving the public goal. Furthermore, MNEs are also criticised for lobbying governments
to introduce incentives, to use the ones available to the maximum in particular in
different jurisdictions, also for benefiting from advantages for activities that they would
have engaged in even if incentives were not granted. Although they have a big part on
such responsibilities, taxpayers are not obliged to choose for the heaviest tax burden, are
free to set a corporate and IP strategy appropriate to attend the needs of a global market
but they are accountable for abuse.
The BEPS actions are a step forward to influence a more accountable behaviour
within the freedom enjoyed by enterprises to organise their business and reach their
goals. However, BEPS Action 5 also made evident the multiple tax dilemmas we are
facing, and the need for greater responsibility of States in the definition of policy, not
only of tax policy. The role of taxes as a source of revenue needs to be balanced with a
more coherent and fair system of taxation for enterprises with global operations. It is
urgent to find more and appropriate solutions to tax competition, not only on the abuse by
taxpayers. These dilemmas and the interest involved need to be considered to reach trust
in trade and in governance. When it comes to trust and innovation, a better world could
be achieved if standards to restore trust help to build more innovative societies, to
encourage entrepreneurship, and to shorten the distance between more and less
knowledge based societies. So far, this is missing in the works studied. The role of
taxation and of output tax incentives in this regard still has to be analysed and measured.
Acknowledgements
The author expresses her gratitude to the Max Planck Institute for Taxation and Public
Finance for the grants and the research stays allowed to accomplish this research in the
summer of 2017 and 2018; to the Collaborative Project on Trust in Trade of the Faculty
of Law at the University of Maastricht as well as the New Melun Fiscal School of the
University of Paris, Panthéon Assas, for the invitation to discuss some of the ideas
underlying this work in the Spring 2018; last but not least, to the Maastricht Centre for
Taxation for the unconditional support to her research activities and the comments to the
early drafts of this paper by Rainer Prokisch, Hans van den Hurk and Raymond Luja. All
statements are however the author’s views and responsibility.
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Notes
1 For an example, see http://static.inditex.com/annual_report_2015/en/sustainability-balance/
tax-contribution-2015.php.
2 Apparently, the CCCTB in its current form will not make it. Bulgaria, Denmark, Ireland,
Luxembourg, Malta, the Netherlands, Poland and Sweden are against it because they do not
agree with the allocation formula (Huibregtse et al., 2017). However, there is a remote
possibility if at least nine EU member states agree on an enhanced cooperation procedure
based on article 192(2) TFEU.
3 The Colombian agency for science development, Colciencias, had the power to decide
on the incentive. Information concerning further procedures and documentation
required are available at http://colciencias.gov.co/sites/default/files/ckeditor_files/M303PR01-
beneficiostributarios.pdf.
4 See http://leyes.senado.gov.co/proyectos/index.php/proyectos-ley/periodo-legislativo-2014-
2018/2016-2017/article/163.
5 The concept of beneficial owner has been extensively analysed in the context of royalties in
DTCs (Du Toit, 1999); also in the interaction of the two treaty concepts, royalties and
beneficial owner, for tax treaty characterisation purposes given the connection between the
income, the beneficial owner and the powers exerted on the IP under the scope of article 12
DTCs, [Buitrago, (2007), pp.92, 117].
6 Given its deviation from the general CIT rules and the narrow application to specific streams
of income and expenditures.
7 Twenty-five German enterprises, seven US, six Swiss, and nine from eight different countries,
all related to different types of industry.
8 As to Shay et al. (2016, p.429) “the interaction of intangible development with deferral under
the U.S. international tax system is similar in effect to an output incentive that, while not
targeted at intangible income, may disproportionately benefit intangible income”.
9 According to the NICI40 measurement model [Lin and Edvinsson, (2011), p.21]. Interestingly,
this method considers corporate tax encouragement amongst the indicator of market capital, IP
rights protection in the process capital, and in the renewal capital includes business R&D
spending, basic research, R&D spending/GDP, R&D researchers (Ibid, p.18ff).

Patent Boxes and The Erosion of Trust in Trade and in Governance

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Patent Boxes and The Erosion of Trust in Trade and in Governance

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270 Int. J. Public Law and Policy, Vol. 6, No.

Patent boxes and the erosion of trust in trade and in

Esperanza Buitrago Diaz

Keywords: patent boxes; output incentives; input incentives; IP regimes; nexus

Reference to this paper should be made as follows: Buitrago Diaz, E. (2019)

Biographical notes: Esperanza Buitrago Diaz is a researcher of the Maastricht

Copyright © 2019 Inderscience Enterprises Ltd.

economical world conditions, competition and a tax global scenario, plenty of

2 Mapping trust, distrust and the new standards for IPB

2.1 The link to trust

2.2 The link to the nexus

In addition to the above, marketing-related IP assets (trademarks, logos and brand

3 IPB, trust and the law

3.1 The OECD soft law approach

Surprisingly, many developing countries (in terms of knowledge as well as of

3.2 The EU soft and hard law approaches

3.2.1 Anti-abuse measures

3.2.2 State aid

3.2.3 The code of conduct

4 Restoring trust, a review of arguments in the light of innovation policy

4.1 The nexus approach, innovation and entrepreneurship

In a similar vein, Cameron et al. plea in favour of IP output incentives in a domestic

4.2 Nexus and its extension to other IP regimes

4.3 The role of IP and microeconomic analyses

4.3.1 Patent location

4.3.2 Patent quality

4.5 Innovation and growth vs. the entrepreneur’s view: decentralisation of IP

intangibles, as well as the allocation of income and distribution of benefits in

4.6 Innovation and growth, a public policy view

Country Ranking Country Ranking

The introduction of IPB by non-European developing countries is quite recent, and

5 Conclusions and final considerations

it is difficult to forecast the sustainability of the IF measures, in particular lacking the

interdisciplinary approach of this research allows me to argue that the Nexus, as a

1 in the context of existing incentives to innovation without restraining them to R&D

Reports and normative provisions

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