IP Box and transfer pricing – where do these two worlds meet?

The IP Box regime allows income derived from qualifying intellectual property rights to benefit from a preferential 5% income tax rate.

For the regime to be applied correctly, it is essential to determine what portion of the income earned is genuinely attributable to qualifying intellectual property rights. The more closely intellectual property is integrated into a company’s business operations, the more difficult it becomes to isolate its contribution to the overall financial results.

It is precisely at this stage that a natural connection between the IP Box regime and transfer pricing becomes apparent.

The biggest challenge? Not the IP, but the income

Identifying a qualifying intellectual property right is merely the starting point for applying the IP Box regime. To determine the IP Box tax base, it is necessary to establish both the amount of income that qualifies for the preference and the applicable nexus ratio.

This is not solely an economic exercise. IP Box regulations refer to both relationships between related parties (nexus) and the arm’s length principle (when determining the amount of income attributable to qualifying IP). As a result, transfer pricing principles and remuneration methodologies can often be useful in determining the income attributable to qualifying intellectual property.

At first glance, IP Box and transfer pricing may seem to address different issues. In practice, however, both areas are driven by similar questions:

• Where is the value related to qualifying IP created?
• Which functions contribute to the creation of that value?
• How should the related income be allocated?

When calculating the nexus ratio, it is also necessary to determine the extent to which qualifying IP or the results of research and development activities have been acquired from related parties.

Where does IP Box meet transfer pricing?

Once it has been established that a taxpayer earns qualifying income from qualifying IP, it is necessary to determine what portion of that income may benefit from the preferential regime.

After identifying the qualifying IP and the qualifying income from that IP, the next step is to determine what amount of income is directly attributable to that IP.

At this point, the tax legislation expressly refers to the transfer pricing provisions.

For example, a Polish company grants a group entity a licence to software constituting qualifying IP. The remuneration received covers not only the right to use the software, but also maintenance services, updates and technical support. To determine the amount of income that may benefit from the IP Box regime, it is necessary to establish what portion of the remuneration relates to the qualifying IP itself. In this respect, transfer pricing methods may be useful.

Accordingly, the amount of income subject to the preferential 5% CIT rate should be determined using the method that is most appropriate in the circumstances, selected from the following:

• Comparable uncontrolled price method (CUP);
• Resale price method;
• Cost plus method;
• Transactional net margin method (TNMM);
• Profit split method.

Where none of the above methods can be applied, another method that is appropriate in the circumstances should be used, including valuation techniques.

The proper determination of the nexus ratio is also of key importance. This requires assessing the relationships between the taxpayer and the entities whose services are used within the IP Box framework or from whom qualifying IP is acquired.

Key risks where IP Box meets transfer pricing

In practice, tax risks associated with IP Box and transfer pricing most commonly arise from inconsistencies between different elements of a taxpayer’s tax position.

The most common challenges include:

• lack of justification for the allocation of income to qualifying IP;
• inconsistencies between the IP Box calculation, the adopted remuneration model and the functional analysis;
• insufficient support for the arm’s length nature of arrangements involving qualifying IP;
• difficulties in isolating the impact of qualifying IP on the taxpayer’s results.

In practice, these are precisely the areas that most frequently attract the attention of tax authorities.

Why is consistency so important?

The ability to justify the method used to determine the income benefiting from the preferential regime has a direct impact on the sustainability of applying the reduced tax rate as an exception to the general taxation rules.

This is particularly relevant where qualifying IP is used within more complex business models or constitutes only one of several factors contributing to the taxpayer’s results.

In such cases, consistency between the IP Box calculation, the adopted remuneration model and the economic rationale for attributing income to qualifying IP is of key importance.

If the adopted approach to determining the IP Box tax base cannot be adequately supported, a tax audit may result in the assessment of additional tax liabilities.

Conclusions

The IP Box regime expressly refers to the arm’s length principle. However, the relationship between IP Box and transfer pricing extends beyond the mere technical application of transfer pricing rules.

In practice, what matters is not only the reference to transfer pricing regulations themselves, but also the similar economic rationale underlying both areas. Both IP Box and transfer pricing require an understanding of the factors that drive value creation and the manner in which income should be attributed to different elements of a business.

A key consideration is the ability to demonstrate how the income benefiting from the preferential regime has been determined and why the underlying assumptions are consistent with market conditions. It is precisely where these two areas meet that the connection between IP Box and transfer pricing becomes most apparent.