Tax rules concerning intellectual property (IP) investments, and the level of deductions that can be claimed, have been changed and updated in recent years. EY Asean International Tax Services Leader, Chester Wee, summarises how companies should access existing tax perks to help optimise their tax positions.
Developing and acquiring ground-breaking patent and trade mark portfolios can be an expensive exercise. However, Singapore businesses have access to various IP-related tax perks that can help to defray some of these costs of investments. As Chester Wee, EY ASEAN International Tax Services Leader explains - it's important to start planning from the very start to avail of these potential tax benefits.
Chester has 20 years of experience in advising on cross-border tax issues, as well as managing tax controversy. He has deep knowledge in reviewing holding structures and operating models; managing tax residence issues; identifying and managing withholding tax issues and permanent establishment risks, and advising on IP strategies and migration, and tax-efficient repatriation of profits and cross-border financing.
"Even at the pre-commercialisation stage, it is important to maximise the tax deduction claims available under the law on your R&D costs and preserve the start-up losses you incur early on. If these are properly dealt with at the time of creation, they will stand you in good stead when you start to make taxable profits."
Making the most of your deductions
There are three key tax concessions of interest to all innovative companies, two of which particularly concern IP. The first of these (Section 14A of the Singapore Income Tax Act) provides an enhanced tax deduction of 200% for the first $100,000 of qualifying IP registration costs incurred in each year from the Year of Assessment 2019 to the Year of Assessment 2025 (i.e., for financial years ending 2018 to 2024). The expenditure above $100,000 for each year continues to qualify for a 100% deduction. This applies to costs such as official fees and professional fees incurred to register patents, trademarks, designs and plant varieties. Companies seeking to protect their IP portfolio as they venture overseas will find this particularly useful.
The second relates to buying legal and beneficial ownership rights to qualifying IP from other companies. Here, there is a ‘writing down’ allowance available (under Section 19B of the Singapore Income Tax Act), which works like a tax depreciation of the acquisition cost over a period of 5, 10 or 15 years. This applies to capital expenditure incurred in respect of specified IP rights acquired on or before the last date of the basis period for the year of assessment 2025. Generally, there is an exclusion of IP rights acquired from a related company in Singapore.
Thirdly, enhanced tax deductions are also available on R&D activities conducted in Singapore (independently of the IP component). Here, however, it is important to ensure that the project qualifies as R&D as defined in the Income Tax Act and that the claimant is the beneficiary of the R&D activities. As Chester explains,
"There is a 150% uplift available on tax deductions for qualifying R&D expenditure (such as staff costs and consumables) from Year of Assessment 2019 to Year of Assessment 2025 (i.e., for financial years ending 2018 to 2024). The main question will be whether the R&D activities being conducted satisfy the various criteria in aspects such as technical risk and novelty."
When applying for these tax concessions, taking professional advice is important as some specific rules and requirements need to be met before such concessions can be made available. Also, there are future tax consequences that businesses should be aware of when planning an IP footprint for the long-term.
"You need to think about your future business strategy. While there is no capital gains tax in Singapore, you may still find yourself with a tax bill if you intend to sell your acquired IP down the road. For example, you may be entitled to claim tax writing-down allowance against IP you have bought under Section 19B of the Singapore Income Tax Act. However, if you subsequently dispose of the IP, such tax reliefs could be subject to a recapture depending on how the disposal is structured."
Valuing IP for tax purposes
There are two main contexts in which it may be necessary to have a bundle of IP rights valued to determine their tax treatment. The first of these is when claiming the writing-down allowance for the acquisition of IP under the rules referenced above.
If the transaction amounts to more than $500,000 in value between related parties or $2 million in value between unrelated parties, IRAS will need to see a formal asset valuation conducted by a suitably qualified and experienced independent valuer. There are also restrictions including the areas of expenditure and types of IP that qualify for the writing-down allowance.
The second concerns transfer pricing—when IP assets are moved from one entity to another, and the two are linked. This is now under close scrutiny by many countries, and OECD has issued guidance in 2015 that impacts how profits are being allocated between related companies. According to OECD transfer pricing guidelines, profits associated with the transfer and use of intangibles should be appropriately allocated by value creation, i.e., to the entities that perform and control the important value-creating functions of developing, enhancing, maintaining, protecting and exploiting the intangibles (the DEMPE functions). The reward level for the mere ownership of IP will be low.
Chester has observed some recent developments in this field.
"There is a lot of interest being shown by companies looking at their IP footprint. Some have traditionally placed their IP in offshore jurisdictions like Bermuda, the British Virgin Islands or the Cayman Islands. However, new EU rules effective from January 2019 require any entities in these countries to have a certain level of substance. As multinationals seek growth opportunities, they are increasingly turning their attention to Asia, and see Singapore as an attractive location not only from a tax perspective but also from a commercial viewpoint due to the robust IP legal protection framework put in place."
Managing taxes on IP-related income
In Budget 2017, Singapore has introduced a new IP tax incentive regime, the IP Development Incentive (IDI), which aims to encourage the use and commercialisation of qualifying IP rights (i.e., patents and copyrights subsisting in software) arising from R&D activities. The IDI, while discretionary, follows similar rules to those found in other countries with ‘Patent Box’, ‘IP Box’ or ‘Innovation Box’ regimes, in that it reduces the rate of tax payable on IP income that is directly associated with these qualifying IP rights.
The IDI incorporates what has become known as the ‘modified nexus’ approach based on the guidelines issued by the OECD. At its heart, this approach ensures that taxpayers benefiting from IP regimes did, in fact, engage in substantial activities that generated the IP income, using R&D expenditure as a proxy for such activities. As Chester points out,
"This is valuable for companies that conduct R&D locally, but it limits the benefits available to companies who buy or transfer-in their IP with minimal local R&D activities."
It’s also important to be aware that export commercialisation strategy can have tax implications of its own, as Chester explains.
"If your business model involves licensing your IP, and earning royalties in other countries, these may be subject to withholding tax in these countries; not many of Singapore’s treaties reduce this to 0%.” On this front, proper planning to manage the Section 19B writing-down period can help companies to maximise the foreign tax credit claims, which should result in a better tax outcome."
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