Tax Treaty Networks
Using offshore structures to optimise profits on IP royalties
Tax treaty networks offer a unique financial planning tool for companies possessing rights in intellectual property including patents, trademarks and copyright. When such companies embark on a sales expansion plan into international markets, they have a distinct advantage because international treaties often provide for favourable tax treatment of royalties paid on intellectual property.
The main obstacles in designing an offshore structure are transfer pricing, and the so-called limitation of benefit clauses or anti-treaty shopping provisions. These provisions will generally treat the offshore structure as transparent for tax purposes where the intermediaries are under common ownership and control. To address these obstacles, a specialized royalty collection company can be introduced to the offshore structure.
Scenario: Softco is a domestic software development firm that has developed a new product. It plans market and sell its product globally. The company would like to minimize its tax burden on profits from its international sales.
Solution: Softco will sell the intellectual property rights in its new software product to a tax-exempt offshore company. The offshore company will then enter into a master licensing agreement with an independent royalty collection company in the Netherlands. The Dutch royalty collection company, which is beneficially owned by residents of the Netherlands, will in turn enter into sub-licensing agreements with various international customers.
The reason for choosing a Dutch intermediary is due to the extensive tax treaty network benefiting the Netherlands. The Netherlands’ treaty network will allow the Dutch royalty collection company to receive IP royalty payments free of withholding taxes.
Example: The UK tax authority would normally require tax to be withheld at a rate of 22% on any royalty payments being made to a non-UK resident.
However, based on the tax treaty between the UK and the Netherlands, no withholding tax will be withheld on IP royalty payments.
The UK purchaser will pay £1 million to the Dutch royalty collection company pursuant to the terms of their sub-license agreement.
The master license agreement requires a payment of £930,000 from the Dutch company to the offshore company. The only amount subject to tax is the margin of £70,000, which is retained by the Dutch company and is taxed in the Netherlands at an effective tax rate of 2%.