When withholding tax is patently absurd

I have always wondered why there should be a withholding tax on UK patent royalties which currently arises from treating them as a charge on income.

I cannot see why a royalty for the right to use a patented product or process should be treated any differently from the purchase of any other goods or services.

A royalty is just a convenient means of paying for a valuable service, and if I pay a management consultant for his advice, or buy the raw materials out of which to make my products, I do not deduct tax at source from the amount paid.

The current situation is even stranger, in that there is a withholding tax on UK patent royalties whether paid to another UK resident or to a non-resident – with the exception that if the non-resident lives in a treaty country, it may be possible to pay the royalty gross with the permission of the Revenue’s financial intermediaries and claims office.

Hitting close to home

There is not normally a withholding tax in respect of other forms of intellectual property, such as copyright, computer programs, trademarks, service marks, know-how and so on.

There is, however, a withholding tax on copyright royalties paid to the recipient whose normal place of abode is outside the UK, although this does not currently apply to authors normally living abroad because the source of their income is their brain, which is exercised in the overseas country, and not the license agreement itself.

Why there should be a withholding tax on copyright royalties paid to a licensor who is not the original author is not immediately apparent.

The purchase of books abroad which are then imported into the UK is not subject to any withholding tax.

The good news is that the government, through the Inland Revenue and the DTI, has recognised the system is an illogical mess and should be radically overhauled.

The bad news is that, far from doing away with withholding taxes on royalties altogether – which would reduce the complications involved in international transfers of intellectual property – one of the proposals is to extend the current withholding taxes to cover all forms of intellectual property where royalties are paid from the UK, irrespective of the source of the income.

The requirement for a withholding tax is apparently two-fold. The first reason is to have something to give up as a necessary part of negotiating a double-taxation treaty – although if this were true rather than just the perceived wisdom, it is difficult to see how countries such as Norway, the Netherlands and others that do not levy a withholding tax on royalties, could negotiate satisfactory double-taxation treaties, but they do.

The other reason is the dreaded tax haven, and the Revenue’s apparent paranoia concerning matters out of their jurisdiction.

The reality is that the attraction of tax havens for holding intellectual property is overstated in the real commercial world, as a result of transfer pricing and controlled foreign company legislation.

There is no way in which this country can be competitive in many areas such as labour-intensive manufacture, so it ill behoves us to kill off those areas where we can use our commercial and creative skills to generate income, as in the field of intellectual property, by putting in place a fiscal regime which makes it unnecessarily difficult or expensive to route such activities through the UK.

I have always argued that tax planning is not about saving the maximum amount of UK tax, but about maximising the profits available after tax.

The converse argument is that a fixation with anti-avoidance should not inhibit business to the point where there is no avoidance of UK tax because the business bypasses the UK altogether.

Nigel Eastaway of Chiltern TaxServe is chairman of the technical committee of the Chartered Institute of Taxation

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