Xuan-Thao Nguyen, “Holding intellectual property,” Georgia Law Review, Vol. 39, No. 4, pp. 1157-1198, (2005) available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1493515.
Holding companies for intellectual property were involved in WorldCom, Inc’s tax avoidance system, revealed in recent filings by Dick Thornburgh, WorldCom’s bankruptcy court examiner. The author asserts that this type of scheme has been widely and quietly utilised in the last twenty years by many firms with intellectual property assets.
As state taxing authorities have become more aggressive in their auditing process, the spotlight is now on the IP holding company scheme. Due to numerous states’ slow recovery from the economic downturn and the shrinkage of state tax revenues in the last few years more and more states have directed their attention to inter-corporate transactions and income shifting schemes. In doing so, many states unearthed handsome amounts of royalty income generated by the licensing of intellectual property that had never been taxed. Utilising this taxing power, states are eager to reach the royalty income accumulated by companies holding intellectual property, but in taxing such income, states may encounter a potential constitutional stumbling block.The author argues that the IP holding company scheme is a complex tax avoidance program requiring states to devise an approach to taxation that reflects an understanding of intellectual property rights and of the interests of intellectual property rights holders. He discusses the transformation of intellectual property into valuable corporate assets, identifies and analyses the IP holding company scheme, discusses the constitutional reach of state taxing power to royalty income received by out-of-state holding companies in light of the US Supreme Court’s decision in Quill Corp v. North Dakota, and discusses how states attempted to evade constitutional requirements in their eagerness to tax the royalty income of out-of-state holding companies. He analyses the business situs approach to intellectual property rights as employed by states to justify their fulfilment of the constitutional requirements post-Quill and critiques the business situs approach by providing illustrative examples of how the approach reaches beyond constitutional limits. The author then examines how to balance the interests between states and holders of intellectual property, highlighting some fundamental aspects of intellectual property rights that may assist states in their efforts to reach royalty income received by out-of-state holding companies that license intellectual property rights for use within states and providing alternative approaches states may consider that pose less risk of constitutional challenges.
Finally, the author concludes with a call for guidance from Congress and for uniformity of state tax treatments.
Clocking in at a short (for US law review articles) 41 pages, this article is a careful survey of what it terms the “chaos” that followed the US Supreme Court’s decision in Quill Corp v. North Dakota. It provides a clear roadmap to the various approaches taken by the states in attempting to gain tax jurisdiction over IP holding companies after Quill. Although it mostly discusses domestic IP holding companies, many using Delaware as their ‘offshore’ location, the discussion is relevant to international IP holding companies as well. Notably, it provides an excellent summary of the business case for using IP holding companies.