State Aid Through IP Box Regimes

Abstract

The internal market is a tool in the creation of economic welfare in the European Union (hereafter EU) be-cause competition between companies in the internal market is expected to lead to increased productivity, innovation, and economic welfare. State aid can promote the development of economic welfare in society by catalyzing projects that otherwise would not be carried out. The purpose of this paper is to examine the effects of state aid directed to increase research and development by offering a tax benefit for income de-rived from Intellectual Property, also called an IP box regime.
The paper examines economic agent theory and the theory of externalities to establish the rationale behind states offering state aid for research and development. It also reviews the most common reasons for ineffi-cient investment in research and development including spillovers, risk, and uncertainty. Upon establishing the rationale for state aid and its positive effects, the paper analyses the negative effects of IP box regimes within the internal market, drawing upon economic theory of tax competition and the inherent risk of a race to the bottom. The negative effects are explained with game theory through a coordination problem and the principle that the states are self-utility maximizing.
Different organizations, including EU’s Code of Conduct Group and OECD have drawn measures to remedy the problem of state aid harming tax competition within the internal market. The paper draws upon Euro-pean legislation, including European-court cases, Commission cases and communications, to determine the legal compatibility of IP box regimes with the prohibition on state aid in TEUF art. 107, par. 1. The conditions of selectivity and the distortion of competition and trade in the internal market constitute the compatibility assessment, where selectivity is the focus of the legal analysis in this paper.
Ultimately, the paper’s economic and legal analyses lead to the conclusion that the selectivity criterion is preventing companies from investing efficiently in research and development. Through a discussion of cur-rent regulation on state aid and the development thereof, and whether this is a mean for harmonization, it is determined that the current legislation on tax area constitutes soft law, whereas hard law, specifically a minimum directive, is needed to overcome the coordination problem.