Legislative update: Draft proposal for innovation box

Legislative update: Draft proposal for innovation box

Two senior members of the Ways and Means Committee—Rep. Charles Boustany (R-TX) and Rep. Richard Neal (D-MA)—have released for public comment a discussion draft and technical explanation of an "innovation box" proposal.

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The innovation box draft proposal [PDF 69 KB] would substantially lower the rate of tax for a corporation with respect to dispositions of intellectual property (IP) and products produced using IP. The proposal would establish a deduction for innovation box profits equal to 71% of the lesser of the:

  • "Innovation box profit" of the taxpayer for the tax year, or
  • Taxable income (determined without the 71% deduction) for the tax year

This would result in an effective tax rate of approximately 10% on innovation box profits.

The deduction could not be taken into account in computing any net operating loss or the amount of any operating loss carryback or carryover, and therefore could not create, or increase, the amount of a net operating loss deduction.

Terms defined

The "innovation box profit" of a taxpayer would be a fraction of the taxpayer’s gross receipts from the disposition of "qualified property" in the ordinary course of a trade or business.

"Qualified property" would be broadly defined as any: (1) patent, invention, formula, process, design pattern, or know-how (property described in section 936(h)(3)(B)(i)); (2) motion picture film or video tape; (3) computer software; and (4) property produced using any property described in (1).

Gross receipts to which the deduction would apply include only gross receipts from sales to an unrelated person, with one exception—if products produced using qualified property were sold to a related person outside the United States, gross receipts from the sale would be qualified gross receipts only if the products were resold to an unrelated person.

From qualified gross receipts, the taxpayer would deduct its cost of goods sold allocable to the qualifying gross receipts, as well as other properly allocable expenses, losses, or deductions, to determine its "tentative innovation profit."

Finally, to determine the "innovation box profit" from which the deduction would be determined, the taxpayer would multiply the “tentative innovation profit” by a fraction.

  • The numerator of the fraction would be the taxpayer’s expenditures for research and development performed in the United States for which a deduction is allowed under section 174 (determined without regard to sections 4 and 280(c)) for the five tax-year period ending with the tax year.
  • The denominator would be the taxpayer’s five-year total costs for the tax year. In general, a taxpayer’s five-year total costs would be the excess of all costs during the five-year period ending with the tax year over the sum of (1) cost of goods sold, (2) interest, and (3) taxes.
The technical explanation of the proposal contains examples of the calculation of the deduction.
The proposal also includes special rules for transfers of intangible property from controlled foreign corporations to U.S. shareholders.

KPMG observation

The innovation box proposal is not accompanied by an estimate of the revenue cost, which could be substantial, nor does it offer any indication of whether or how the revenue cost might be offset.

The international tax reform working group of the Senate Finance Committee, in its final report (July 7, 2015), included among its recommendations the adoption of an innovation box regime. The working group’s report noted that some 11 countries have adopted such regimes, and that an apparent consensus has been reached in connection with the OECD’s base erosion and profits shifting (BEPS) project around a modified nexus approach that would permit innovation box regimes. A change to U.S. tax policy is necessary, the authors of the working group’s report wrote, to prevent these shifts in the international landscape from leading to “…a significant detrimental impact on the creation and maintenance of intellectual property in the United States, as well as on the associated domestic manufacturing sector, jobs, and revenue base.” The innovation box concept was associated in the working group’s report, as it has been elsewhere, with broader reform of the international tax rules.

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