Tax Issues in the Use or Disposition of International Intangibles: The Good, the Bad, and the Ugly (Part II)
By Ken Levinson
Last week, part one of this article focused on international transactions involved in the “sale” of e-commerce and intangibles, including the somewhat unexpected exposure of a US “seller” to continuing foreign withholding taxes on “sales proceeds” from a foreign buyer of intangibles that are based on future contingencies, such as seller proceeds that are “contingent on the productivity, use or disposition.”
This week, continuing where we left off with the last two major categories of tax issues (the fourth and fifth) involved in the international transfers or use of e-commerce or intangibles, we turn to international transactions that involve licenses or the provision or performance of e-commerce services.
Fourth, what if it’s a license? License fees (however calculated, even if they are payable as a single lump-sum up front) are generally ordinary income to the licensor. If the licensing income stream (i.e., a royalty) is received by a US licensor from a non-US licensee, the initial complication is whether local (i.e., foreign) tax is imposed on such royalty payments. Royalties generally are sourced, and hence allowed to be taxed, where the intangible right is used. It is axiomatic that the payor (the non-US licensee here) has the local obligation to properly withhold and pay over the requisite amount of taxes due or face severe penalties in their home country.
A key question then is: where are the intangible rights allowed to be used? If just in a single country, the answer is straightforward–that country is where the royalty payable can be taxed. If there is an applicable tax treaty in force between the US and that “payor” country, the treaty’s royalty provision will control the rate of withholding tax to be collected and paid over locally by the licensee/payor. If there is no applicable tax treaty, then local (i.e., foreign) law will determine the applicable tax consequences and withholding rates.
But, what if the license to use the intangible right extends to a region or to multiple countries? Then the parties have a more complex compliance process facing them, since each country in which the intangible is used may claim a right to receive taxes at their respective tax rate based on the income derived from the pro rata use of the right in their country.
There is also the added nuance of whether the licensing rights run directly to the various foreign licensees/affiliates in each such country or whether there is a single regional license to one principal licensee who then is allowed to use or let its permitted affiliates in other countries also use (or sublicense) the intangible rights in other countries. This latter situation produces a possible sequential or “cascade” payment structure that creates further compliance issues on a per country basis. The contracting parties to the arrangement will need to keep good records to ensure proper allocation to, and timely tax compliance in, the relevant jurisdictions, and the original licensor will have to determine in its original license whether it or the licensee(s) bears the economic impact of such possible “cascade” taxes imposed in the other permitted use countries on the license fees payable ultimately to the original licensor.
Fifth, what if a “service” is being engaged? In this situation, for example, the expertise being engaged is for the contractor to write custom software or a computer program which the “customer” gets to keep and use, or consulting services providing business or financial advice (e.g., know how) to the customer. (This latter situation is where Mr. Eastwood comes in…) The provider of the services has income to report and may or may not trigger foreign income tax exposure (and/or VAT) since services are taxed generally where they are performed. When payment for services is involved, analysis of possible tax liabilities can trigger contract and travel inquiries regarding time spent abroad to perform the services.
There are, however, nuances in various US tax treaties involving the exposure to local taxation for the services provider entity itself, rather than just the particular income stream or contract involved. Some tricky “permanent establishment” or nexus provisions may apply with respect to services performed locally for customers there, or even if they are provided to related parties (the Canada and India treaties, respectively, come to mind). So, look carefully at applicable tax treaties or foreign law for unexpected tax consequences at the entity level, not just with respect to the particular contract payment, if the services in question are provided, even in part, in a foreign jurisdiction.
You may have to decide what is really “the good,” “the bad,” and “the ugly” in all this. There is plenty to go around for all three categories.
Cue the Ennio Morricone music for Clint Eastwood…