Structuring Patent Royalties
A Hong Kong resident, Mr. K, has developed software that he wishes to patent, trademark and sell throughout the world. Generally, Mr. K's income stream will consist of royalties from every sale of his software.
Most high tax countries require tax to be withheld at source on a royalty before payment. Hong Kong has only one double tax treaty with Belgium so generally this withholding tax could not be reduced or eliminated.
And, as Hong Kong would not generally subject the royalty to tax upon arrival, Mr. K would be unable to credit the tax withheld against tax due in Hong Kong.
Mr. K should set up an intermediate licensing company in a country that does have tax treaties with the countries from which payments emanate. The Netherlands is generally considered the country of choice, but other jurisdictions with tax treaties, such as Malta, Cyprus or the UK, may also be suitable. In this example, Mr. K would license a Dutch company to exploit his software, which would in turn sub-license the end user. Royalty payments would be made to the Netherlands rather than directly to Hong Kong, thereby reducing or eliminating the
withholding tax because the Netherlands has a treaty with the country of payment. The Dutch company would receive the royalty income, but also has a duty to pay out royalty income under the master licence agreement with Hong Kong. Only the margin between the two would represent a profit and be subject to tax in the Netherlands. Dutch withholding tax is set at between 0% and 7%, so the maximum tax suffered on the gross royalty payment would be 7% of 33% (the Dutch rate of tax), or just 2.1%.
Many tax treaties now contain "limitation of benefits" clauses, which provide that, if the recipient company is not majority-owned by Dutch residents, then the tax treaty cannot apply. In such cases, using a collection service can be highly effective. In other words Dutch residents would beneficially own the Netherlands company and their fees would be a proportion of or the entire margin that must be maintained in the Netherlands. UJ can provide this service.
A number of other high tax countries might be used as a base for the intermediary licensing company because only the margin would normally be taxable. But there may be transfer-pricing issues to consider in countries where there is no statutory margin. Transfer prices are supposed to be set according to the arm's length principle:
that is the same as would be charged if the sale were to an unconnected business. Using a collection service would generally overcome such concerns because the intermediary company and the end recipient would not have common ownership.
Any trading group can create Intellectual Property (IP) by registering a brand, logo, patent, device or name in an offshore jurisdiction. It could then license the use of these to its own group of companies, enabling the group to extract an element of pre-tax profits from high tax areas and move them to a low tax jurisdiction. Too little attention is paid to protecting IP and it can present tremendous tax planning opportunities.