IP and Tax— Managing Competing Considerations Greg Barton – Mayer Brown LLP (312) 701 -7200 James Ferguson – Mayer Brown LLP (312) 701 -7282 The views expressed in this presentation are not intended as, and should not be relied on, as legal or tax advice. The outcome of any independent situation depends on the specific facts and circumstances in which the issue arises and laws and regulations in effect at the time. © 2008 James Ferguson / Greg Barton / Mayer Brown LLP 2008 OFII Tax Conference La Quinta, CA
Introduction • Development and management of IP (patents and trademarks) obviously creates significant tax and IP legal issues foreign-based multinational • Tax and IP departments may be able to improve a company’s position in both areas through close coordination, not only in the U. S. , but with the foreign parent. • Worldwide coordination is essential to achieve a consistent approach 2008 OFII Tax Conference La Quinta, CA 2
Tax and IP Coordination is Critical for Foreign-Owned Companies • • • Companies often have significant high-value IP IP may be developed in many locations Long time horizons and multiple business options for product-specific IP mean that early decisions may become important Business pressures may require companies to implement acquisitions and other strategic decisions quickly Tax and IP management teams are often large, influential, and unrelated 2008 OFII Tax Conference La Quinta, CA 3
Identifying IP • Understanding company-wide IP is critical to tax and IP departments – IP Considerations • Identification and scope of protectable IP • Required registrations and maintenance worldwide – Tax Considerations • Cross-affiliate IP use • Relative value of IP across company functions • Licensing • IP affecting restructuring transactions • Identification of possible infringement • Treatment of maintenance and other costs 2008 OFII Tax Conference La Quinta, CA 4
Managing IP--Separate Ownership and Sales • Many companies separate IP ownership and product sales for one or more reasons – Concentration in an IP holding company (often in foreign parent or in foreign holding company) – Licensing – Co-promotions and joint ventures – U. S. Acquisitions – Other business or corporate reasons 2008 OFII Tax Conference La Quinta, CA 5
Tax Considerations in IP • Use of IP by multiple affiliates across jurisdictions raises ongoing transfer pricing concerns – Tax exposures for royalties – Cross-affiliate use of IP must be documented – Adjustments by IRS can lead to 40% penalties, in addition to tax due • Tax departments frequently responsible for intercompany licenses and may reallocate IP ownership or use • IP department activities may affect tax treatment – Inconsistent IP use or licensing terms – Management of IP: Coordination of U. S. and foreign roles – Determinations of “significant” IP-which IP is valuable? • Inconsistent or incorrect management of IP can compromise tax positions and undermine company IP 2008 OFII Tax Conference La Quinta, CA 6
IP Holding Companies Foreign Parent Transfer Price 2 Subsidiary A: Patent Owner (U. S. or foreign) License Transfer Price 1 • Subsidiary B: U. S. Manufacturer/ Seller Sales Transfer Price 3 Tax considerations – Exclusivity of license – IP licensed (patents, TMs, know-how, other intangibles) – Royalties and other consideration – Maintenance and subsequently developed IP 2008 OFII Tax Conference La Quinta, CA 7
In-Licensing Third Party Patent Owner Third Party License Foreign Parent (Licensee) Intercompany License U. S. Subsidiary Sales Transfer Price 1 Third Party License Transfer Price Avoided • Tax considerations – Appropriate party for in-license – Comparability of third party license and other licenses (the inadvertent comparable) • Royalty rates • Terms – Familiarity of tax department with third party licensing practices 2008 OFII Tax Conference La Quinta, CA 8
Out-Licensing Foreign Parent (IP Owner) Intercompany License U. S. Subsidiary IP Licensee Third Party License Transfer Price 1 Third Party Patent Owner Third Party License Potentially Inconsistent • Tax considerations – Appropriate party for out-license – Consistency with intercompany license (exclusivity constraints) – Scope of IP licensed – Inadvertent comparables • Royalty rates • Terms 2008 OFII Tax Conference La Quinta, CA 9
Acquisitions Foreign Parent Intercompany License Transfer Price 2 Acquired Subsidiary (IP Owner) • Intercompany License U. S. Subsidiary IP Licensee Sales Transfer Price 1 Tax considerations – Business pressure for rapid integration of target – Differences in licensing terms in existing structure and target • Rates and terms • Use of IP (licenses, transfers, sales and distribution agreements – Scope of IP licensed 2008 OFII Tax Conference La Quinta, CA 10
Other Business or Corporate Considerations • IP Considerations – IP complexity must be tracked and managed – Subsidiaries may jointly use and develop IP • Tax Considerations – Consistency between subsidiary licenses and transfer pricing policies – Cross-subsidiary transfer pricing concerns 2008 OFII Tax Conference Parent (IP Owner) Sales Subsidiary La Quinta, CA 11
Cost Sharing US IP Holder Manufacturing and Distribution Agreements Foreign IP Holder Cost Sharing Agreement Transfer Price 1 Transfer Price 2 Subsidiary Distributor--US Manufacturing and Distribution Agreements Subsidiary Distributor—Foreign Sales • • Cost sharing is a specific creature of tax Cost sharing participants “buy-in” to others’ IP Both have rights to use IP in respective territories Each uses or licenses IP to other affiliates 2008 OFII Tax Conference La Quinta, CA 12
Litigation—Protecting the Value of IP Intercompany IP structures raise at least three critical issues in defending a pharmaceutical IP portfolio 1. Standing to Sue 2. Recovery of Lost Profits 3. Computation of Damages 2008 OFII Tax Conference La Quinta, CA 13
Basic Suit Requirements • Patent owner must be a plaintiff • Trademark owner must play an active role in maintaining trademark • Exclusive licensee can be a co-plaintiff • Exclusive distributor can be a co-plaintiff • Non-exclusive licensees or distributors cannot be a co-plaintiff 2008 OFII Tax Conference La Quinta, CA 14
Poly-America Parent Subsidiary A: Patent Owner (U. S. or foreign) • • License Subsidiary B: U. S. Manufacturer/ Seller Sales If the patent owner does not sell the product, the patent owner cannot recover “lost profits” from the sale of the product Here, separation of ownership and sales limited damages Poly-America L. P. v. GSE Lining Technology, Inc. , 383 F. 3 d 1303, 1311 (Fed. Cir. 2004) 2008 OFII Tax Conference La Quinta, CA 15
Lost Profits • Issue: To what extent can a corporate organization recover lost profits when patent ownership is separated from the sale of the patented product or service? 2008 OFII Tax Conference La Quinta, CA 16
Lost Profits—Potential Solutions 1. Structure the relationship so that the sales made by the “selling company” are booked to the IP-owning company – Service Agreement – IP-owning company is the only plaintiff – These may not be consistent with company’s tax treatment 2. Name both the IP-owning company and the selling company as co-plaintiffs in the patent infringement suit 2008 OFII Tax Conference La Quinta, CA 17
Lost Profits Recovery—Scenario One • No Agreement – No recovery of lost profits unless implied exclusive license can be shown Parent (Patent Owner) Subsidiary 2008 OFII Tax Conference Sales La Quinta, CA 18
Lost Profits Recovery—Scenario Two • Non-Exclusive License – No recovery of lost profits (Poly-America) – Note that nonexclusivity is also potentially inconsistent with the parent’s transfer pricing positions Parent (IP Owner) Royalty Non-Exclusive License Subsidiary Sales (Manufacturer/ Seller) 2008 OFII Tax Conference La Quinta, CA 19
Lost Profits Recovery—Scenario Three • Exclusive License – Patent owner and exclusive licensee are co-plaintiffs – Co-plaintiffs can jointly recover full damages – Note that exclusivity is also often more consistent with the Parent’s transfer pricing positions 2008 OFII Tax Conference Parent (IP Owner) Royalty Exclusive License Subsidiary Sales (Manufacturer/ Seller) La Quinta, CA 20
Lost Profits Recovery—Scenario Four • Non-Exclusive Distribution Agreement – Patent owner is only plaintiff – Patent owner can arguably recover “lost profits” from sale to subsidiary (but not from subsidiary to third party) 2008 OFII Tax Conference Parent (IP Owner/ Manufacturer) Non-exclusive Distribution Agreement Sale Subsidiary (Distributor) Re-sale La Quinta, CA 21
Lost Profits Recovery—Scenario Five • Exclusive Distribution Agreement – Patent owner and exclusive distributor are co-plaintiffs – Co-plaintiffs can jointly recover full damages Parent (IP Owner/ Manufacturer) Exclusive Distribution Agreement Sale Subsidiary (Distributor) 2008 OFII Tax Conference Re-sale La Quinta, CA 22
Lost Profits Recovery—Scenario Six • Service Agreement Parent – All sales are booked to the patent owner – IP owner is the only plaintiff – Sales of infringing product cause losses to patent owner 2008 OFII Tax Conference (IP Owner) Contract Service Fee Subsidiary Sales (Manufacturer/ Seller) La Quinta, CA 23
Determining Damages 1. IP owner’s intercompany royalty rates may be used by other side to limit “reasonable royalty” damages 2. Similarly, IP owner’s distribution relationships may be used to limit “lost profits” claims 2008 OFII Tax Conference La Quinta, CA 24
The Internal IP and Tax Audit Understand Strategy Portfolio Review Documentation and Ongoing Processes Three overall goals for the IP and Tax Audit: 1. Identifying the uses of the IP portfolio 2. Managing portfolio’s tax and IP positions 3. Protecting the value of IP in litigation 2008 OFII Tax Conference La Quinta, CA 25
IP and Tax— Managing Competing Considerations C. David Swenson – Pricewaterhouse. Coopers LLP (202) 414 -4650 The views expressed in this presentation are not intended as, and should not be relied on, as legal or tax advice. The outcome of any independent situation depends on the specific facts and circumstances in which the issue arises and laws and regulations in effect at the time. © 2008 C. David Swenson – Pw. C LLP 2008 OFII Tax Conference La Quinta, CA
Intangible Property: The Intersection of Intellectual Property and Tax Concepts • The Owner of an Intangible is Entitled to the Income Attributable to the Intangible for Tax Purposes. • If the Owner of an Intangible Obtains Its Ownership Interest From a Related Party (e. g. , a licensee), It must Pay Arm’s Length Consideration for the Transfer. • If a Related Party Provides Services that Enhance the Value of the Owner’s Intangible Property Interest, the Owner must Pay the Service Provider Arm’s Length Consideration for those Services. 2008 OFII Tax Conference La Quinta, CA 27
Intangible Property: The Intersection of Intellectual Property and Tax Concepts • The Treasury Regulations Contain Rules for Determining the Owner of Intangible Property for Tax Purposes. • The Owner for Tax Purposes is the “Legal Owner” of All “Legally Protected” Intangibles (the Owner of “Legal Title”). • A Party can be the Owner of a Limited Right in the Intangible (e. g. , a licensee is the Owner of its Licensed Interest). 2008 OFII Tax Conference La Quinta, CA 28
Intangible Property: The Intersection of Intellectual Property and Tax Concepts • The Party with “Control” Over “Non-Legally Protected” Intangibles is the “Owner” for Tax Purposes. • The Tax Ownership Rules can be Disregarded Where the Legal Ownership is Inconsistent with the “Economic Substance” of the Transactions. • Intercompany Contracts will be Respected Provided They are Consistent with the Economic Substance of the Transactions. • The IRS may “Impute” Legal Ownership of an Intangible, if the Conduct of the Parties Indicates the Existence of such Ownership. 2008 OFII Tax Conference La Quinta, CA 29
Intangible Property: The Intersection of Intellectual Property and Tax Concepts • How is “Practical Control” Determined for IP and Tax Purposes? • What are “Non-Legally Protected” Intangibles: Know-how? Trade Secrets? Customer Lists? Human Capital (Workforce-in-Place)? Market Power? “First Mover” Advantage? Network Effects? Barriers to Entry? Business Opportunity? Goodwill? Going Concern Value? • Is a “Workforce-in-Place” an Intangible for IP Purposes? Is it a Separate Intangible, or is it part of Goodwill or Going Concern value? • Secondment of Employees – Can it Constitute a Transfer of an Intangible for IP or Tax Purposes? 2008 OFII Tax Conference La Quinta, CA 30
Intangible Property: The Intersection of Intellectual Property and Tax Concepts • Cost-Sharing Agreements and Buy-Ins: Valuation Approaches and IRS Published Positions in Recent CIPs and IDDs. • Impact of Refusal to Recognize Bona Fide Cost-Sharing Agreements by Certain Developed and Emerging Countries. • Impact of a Recessionary Economy on Certain Profit-Based Pricing Methods and Intangible Property Valuation. 2008 OFII Tax Conference La Quinta, CA 31
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