How to Protect Your Intellectual Property Abroad and Minimize Tax Liabilities

WILL BILLOPS: Welcome, everybody, and thanks for joining us for one in a series of multiple podcasts that we're recording for companies in the technology industry, particularly for those that either have global operations or are considering international expansion.

My name is Will Billops. I lead our ASC 740 and IAS 12 practice firm-wide.

Today we have two wonderful guests joining us. We have Rajesh Tripathi and Kirk Hessert, both from our international tax practice.

Rajesh specializes in international planning, provision, and compliance. Kirk specializes in transfer pricing, transaction structuring, and planning. I'll kick it over to them for a quick introduction.

RAJESH TRIPATHI: Thank you, Will. This is Rajesh Tripathi. I'm part of the Cherry Bekaert family.

I've been doing U.S. international tax outbound and inbound for the last 25-plus years, helping technology companies with IP planning, cross-border M&A, due diligence, U.S. international tax compliance, and any provision-related matters. I'm going to hand it over to Kirk.

KIRK HESSERT: My name is Kirk Hessert. I am part of the Cherry Bekaert family as well and specialize in international tax, more specifically transfer pricing.

I've been with Cherry Bekaert for five-plus years and have been doing transfer pricing for 25-plus years.

I help technology companies structure their intercompany transactions, both from a planning perspective as well as a compliance perspective, particularly if something comes up in controversy or if they are audited from a transfer pricing perspective.

WILL BILLOPS: Excellent. Thank you both so much for that thorough introduction.

Today on the podcast series, we would like to go through some sets of facts that I have and get your thoughts on pieces that we should be integrating into our planning.

I have a company that has internally developed intellectual property and is primarily U.S.-based. This company is looking to expand their operations internationally in various jurisdictions, leveraging the intellectual property created and used in the U.S. business.

My first question for you both is: My client has acquired a foreign group. What things should be considered to protect their intellectual property?

RAJESH TRIPATHI: Why don't I go first, Will? I think this is one of the common questions that I have seen.

Whenever a U.S. company has IP sitting over here, whether it's a small or a mid-sized company, they have developed internal IP and are trying to see how they can expand globally. They want to target customers outside the U.S. and look at how they can serve and sell their products internationally.

This is where they have to start thinking about whether their IP is protected in a foreign country. They must consider how to protect their IP when customers start using it.

Most of the time, they are thinking that because their IP is protected in the U.S., it is universally protected, but that's not the case. In fact, there are certain steps that a company will have to take when they're going global and trying to expand internationally.

The company's biggest assets are their IP and goodwill, which can represent 90% of the value they own. Therefore, they have to start thinking about their first priority, which is the protection of IP globally.

The second thing they should consider is what their global tax position or global tax impact will be. If somebody is using the IP outside the U.S., what should be done as part of the tax impact for the use of that IP?

That is where you have to start thinking about strategic IP planning. Should you move your IP to a high-tax country, or should you look at a country where the IP can be used with lower withholding so your location is not a high-tax environment for you?

The second thing the company should think about is if they are setting up a legal entity in a foreign country with an R&D center and local customer support for sales and marketing. If you are going to be doing R&D services, it makes sense to consider putting transfer pricing in place.

You must make sure that the R&D parked in the foreign country does not lead the local country to claim rights to the IP because you are developing it there.

The next thing to consider is when you are licensing or sub-licensing your IP to a customer in a foreign country. How do you protect your IP, and what is the withholding tax that will be triggered?

This is where transfer pricing and the supply chain of IP planning are very important. The third thing I've seen is that companies often want to expand globally but are not ready to set up a legal entity.

They may think about having a consultant in a foreign country help develop the IP or act as an R&D center rather than having a legal entity. This is where the company should start thinking about Permanent Establishment (PE) exposure.

If there is a consultant sitting in a foreign country accessing your server and doing R&D development, how do you structure your ownership and transfer pricing?

At this point, I would like Kirk to step in and talk about what kind of transfer pricing planning they should consider when shifting IP or setting up a legal entity to mitigate risks and withholding tax implications.

KIRK HESSERT: In addition to everything Rajesh just stated, the company needs to think about its transfer pricing planning and compliance.

When you're talking about intellectual property and related parties using or benefiting from it, you're really talking about licensing the IP or entering into some type of cost-sharing framework.

Under a cost-sharing framework, related parties co-develop the IP going forward, which may eliminate the need for royalties. Otherwise, you're talking about licensing IP to related parties.

All of this has to be done on an arm's length basis. In the U.S., this must follow Section 482 regulations, and outside the U.S., it would generally be according to OECD guidelines.

We are talking about whether you want to centralize your IP ownership or decentralize it, depending on the company's tax and business objectives.

Along with protecting the IP, it is also important to put intercompany agreements in place that spell out the rights of the related parties in these intercompany transactions.

Transfer pricing must meet the standards in both the U.S. and outside the U.S. based on where the IP is being used.

WILL BILLOPS: This was very helpful. Thank you both for the thorough response.

There are some ASC 740 and IAS 12 implications regarding where intangibles and goodwill are parked for purchase accounting purposes. When you structure these transactions, you want the most tax-efficient structure in place.

There may be some liquidations or entity movements that need to occur as you're working through this deal. Sometimes actions can be taken prior to the actual close of the transaction, and sometimes they will be part of a post-close structuring.

It is vital to note that from an uncertain tax position perspective, we have to analyze the transfer pricing and use of IP across multiple cross-border jurisdictions.

It is important to understand what the position is, where we're going, and whether there's something uncertain related to those from a tax provision perspective.

My client currently has intellectual property situated in the U.S., but the development is happening in foreign countries by hiring independent consulting firms to act as the Employer of Record. What are the implications of this?

RAJESH TRIPATHI: Let me step back and talk about this. Whenever a U.S. company hires consultants in a foreign country and uses an Employer of Record, they often fail to address certain issues.

Even though the person they hire is through a third-party vendor in the local country, that consultant accessing your server is basically creating a fixed-place Permanent Establishment (PE) in the local country for the U.S. entity.

Because that person is working on software development under the direction and guidance of the U.S. entity, it could trigger a PE risk for the U.S. company in that country.

The second thing the company has to consider is that the person in the foreign country is writing code for the next generation of IP.

If that person is audited in the local country, the local government may claim that the development is happening in their country and therefore they have rights to that future IP.

Companies take a risk when a foreign country claims rights to IP on future development happening through a local consultant or PEO firm.

The company should also consider if it makes sense to set up a local entity. If you are going to hire multiple consultants in multiple countries, you should consider having a legal presence and hiring your own employees to mitigate that risk.

Lastly, I'm going to hand it over to Kirk to talk about the transfer pricing issues, because even though you're hiring a consultant, you're creating a risk for your U.S. IP that a foreign country could claim.

KIRK HESSERT: We see this often, particularly when you set up an entity in a foreign location that is participating in intellectual property development.

This is where we really need to talk about legal ownership of IP versus tax ownership of IP. While legal ownership is in the U.S., if you are developing IP in an entity offshore that is funding and managing the development or carrying the risk, tax authorities will claim ownership from a tax perspective.

You have to be very careful to ensure the development of IP is paid for and managed in the U.S. to maintain both legal and tax ownership there.

In most cases, you would pay that foreign entity some type of a cost-plus fee to develop that IP while you retain ownership in the U.S.

RAJESH TRIPATHI: I'll add one more thing. I have seen companies hire a Chief Technology Officer in a foreign country as a consultant through a PEO firm without having a legal presence.

That CTO will absolutely trigger an IP risk for you. The local country may come back and claim rights to the IP because the brainchild of that IP is sitting in the local country.

I've seen instances where companies are headquartered in the U.S. and claim IP is parked here because they are doing cost-sharing, but then they hire a CTO in a foreign country because they can't find that talent here.

This is another risk they have to mitigate to avoid IP ownership shifting to a foreign country just because the Chief Technology Officer is located there.

WILL BILLOPS: This is very helpful, Rajesh and Kirk. This is important from a tax perspective because a branch operation is very different from the treatment of a Controlled Foreign Corporation.

This can impact not only your financial statement reporting but also your income tax returns. There are also GILTI implications for your U.S. taxation.

It is very important that companies understand what risk is associated with Permanent Establishment and what risk exists if there is a claim of tax ownership by that jurisdiction.

Some companies inherit entities in other countries, and sometimes there's poorly planned or unplanned transfer pricing in place. What should be considered in the instance where a company inherits an entity in a foreign country?

KIRK HESSERT: We see this commonly as a result of acquisitions where you inherit a company in a foreign location which has IP that was one of the primary reasons you acquired the company.

Now you've got IP in multiple locations, such as the U.S. and a foreign jurisdiction. That might go against what the company is trying to do in terms of centralizing IP.

Post-acquisition, trying to move that IP from the foreign jurisdiction to the U.S. can be costly and very complex.

At the same time, if you don't move that IP, you may have royalties crossing jurisdictions in both ways since you have IP usage by multiple entities in the chain.

We try to get ahead of an acquisition by planning where you want the IP to be post-acquisition and solving that within the transaction itself, rather than trying to detangle it afterward when it becomes costly.

RAJESH TRIPATHI: From the international tax perspective, whenever you are acquiring a company with IP outside the U.S., make sure you understand the supply chain and how to protect your IP.

You may have IP in the U.S. and IP in Germany, and a customer in France could be using IP from both countries. You have to structure your withholding tax and sub-licensing to the customer in France correctly.

You must look at the double tax treaties the U.S. has with France and Germany and determine how you can minimize your withholding tax.

Proactively planning your IP supply chain helps minimize your tax liability and ensures you are not paying taxes in multiple jurisdictions.

WILL BILLOPS: That is very helpful, and that is obviously going to impact your overall ETR related to withholding taxes and your posture for shifting tax between jurisdictions.

What are the implications and risks associated with a multinational looking to leverage intellectual property for customer use?

RAJESH TRIPATHI: One risk I'm going to reiterate is that whenever a customer in a foreign country accesses the IP, you have to consider where the IP is parked and where the software development is happening.

If the IP is centered in the U.S. and a customer in India is accessing it, you must have proper agreements so the customer does not violate or copy the IP. You have to do proper ring-fencing around that.

Second, you should think about whether it makes sense to put a blocker or a holding company structure in between. The U.S. has a very good tax treaty network with countries like the Netherlands or the UK.

If you route your sub-licensing from the U.S. to the UK and then to India, you could minimize your withholding tax and have a more effective tax rate.

KIRK HESSERT: The main thing to consider when you have customers using IP or you put holding company structures in place to sub-license IP is that all of those cross-charges or royalties must be on an arm's length basis.

To accomplish all this, it is important to have proper intercompany agreements in place to spell out the rights of the usage.

Documentation and intercompany agreements are very important for demonstrating the arm's length nature of your transactions and for protecting your IP.

WILL BILLOPS: Rajesh, Kirk, thanks for this wonderful conversation. I know we just scratched the surface when it comes to intellectual property planning for tech companies and global operations.

I want to reiterate to our audience that we have a full team here at Cherry Bekaert that can help you address these issues.

You can find our contact information in the description of this episode or visit cbh.com/international. Thank you all for tuning in today. We hope you'll join us for the next episode.