Innovation Promotion Act
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Understanding the Innovation Promotion Act of 2015
Under the act, companies will be allowed up to a 71% deduction of the lessor of their taxable income or their innovation box profit.
Innovation box profit = Tentative innovation profit x (5yr R&D expenditure / 5yr total costs)
5yr R&D costs are those that allowed under Section 174(a) and 174(b), without regard to sections 41 (R&D tax credit definition) or 280(C)(e).
5yr total costs are the excess of all costs over COGS + Interest + Taxes, using a rolling five year window including the current tax year. Reading the ‘over’ as a ‘less’, this would make total costs as all of those not directly related to production, capital costs, and taxes. R&D expenses for testing in foreign countries (if conducted because required by law or there is insufficient testers in the US) are not included in 5yr total costs.
Tentative Innovation Profit = excess of qualified gross receipts after COGS + Expenses, losses, and deductions
Qualified gross receipts are those attributable to qualified property. This includes revenue from the sale, lease, licence or “other disposition of” (which includes compensation for infringement) qualified property. Note that sales “to related persons” has a special treatment. It is unclear how the sale of a finished product embodying qualified property will be accounted for – that is, what fraction of revenue should be attributed to qualified property and how this fraction will be determined. Determining optimal fractions is very tricky problem in economics. This is passed over in the act in Section 250(b)(1)(C) “Allocation Method”, which says merely that “The Secretary will prescribe rules”. This section also notes that “such rules will provide the proper allocation of items whether or not such items are directly allocable” (emphasis added).
Qualified property means intangible property described in: • Section 936(h)(3)(B)(i) (this includes any “patent, invention, formula, process, design, pattern, or know-how”) • Section 168(f)(3) (this seems to be films and video tape!) • Computer software described in Section 197(e)(3)(B) (which is actually computer software ) • Products produced using the above items. Unfortunately the act is vague on “products produced”, referring readers to section A, which in turn relies on a definition of qualified property and the allocation method – essentially including anything the Secretary allows. It should be noted that copyright (936(h)(3)(B)(ii) and trademarks (iii) aren’t included.
Revenue from sales to related persons is generally excluded in the Act, except when qualified property is sold to a subsidiary etc. outside of the United States if it is then resold to an unrelated person outside the United States. Related persons are those that are treated as a single employer under Sections 52(a) or 52(b) (without regard to section 1563(b)), or Sections 414(m) or 414(o). When determining COGS for items exported from and/or brought into the United States there are special rules. The cost used must not be less than its value immediately after entry or the difference between the export value and the import value. Affiliated groups are treated as a single company. A group is affiliated when the US parent owns at least 80% of the subsidiary/affiliate. The deduction is allocated within affiliated groups in proportion to each’s innovation box profit amount. There are also rules for firms that haven’t been existence for at least 5 years, and the Act empowers the Secretary to provide for deductions in the instance of acquisitions and dispositions. A material section of the Act is concerned with special rules for the transfer of Intangible property (see Sections 936(h)(3)(B)(i), 168(f)(3), and 197(e)(3)(B)) from controlled foreign corporations to US shareholders.
Link to Ways & Means Draft
Ways and Means Committee has a draft of the legislation here.