The U.S. government offers two tax incentives for R&D investment: a tax credit under Section 41 of the federal tax code and the option to expense qualified research expenditures under Section 174. In light of these concerns with the Section 41 tax credit and uncertainty about the effectiveness of the Section 174 expensing option, some argue that a better way to spur increased domestic investment in innovation is to adopt a different kind of tax subsidy altogether; one that would target the profits from business R&D investments instead of the cost of inputs: a patent box (which is also known as an innovation or intellectual property (IP) box). This report looks at several aspects of patent boxes, including their general purpose. Existing patent boxes seek to promote one or more of the following aims: (1) increase tax revenues by luring IP income to a host country from abroad or keeping such income inside the host country, (2) prevent or stem a shrinkage in the host country's tax base from the transfer of intangible assets to other countries, (3) expand investment in innovation in a host country, and (4) stimulate growth in the number of well-paying jobs in a host country. R&D tax incentives basically come in two forms: (1) those that operate at the back-end of the innovation process by lowering the after-tax cost of key inputs into R&D such as direct labor and materials and (2) those that operate at the front-end of the process by lowering the tax burden on the returns to successful R&D investments. There are two basic options among the patent boxes now in use. Qualifying Intellectual Property

IP that qualifies for a patent box has several dimensions, which are illustrated in current patent boxes. Key Questions in Designing a Patent Box

Lawmakers interested in adopting a patent box might consider the following questions, which address a variety of significant issues in the design of such a tax incentive:
Should a patent box apply to income from patents only, or should it include income from other kinds of IP as well? Of the 16 countries that offered a patent box at the end of 2015, all but three were members of the Organization of Economic Cooperation and Development (OECD). In the ongoing debate over whether the United States should adopt a patent box, some lawmakers may find it useful to know which patent-box countries are among the leading locations for business R&D investment. Gross income is the basis for the patent box tax incentive in Switzerland and Belgium. Since investment in R&D is closely associated with the creation of patented innovations, it seems reasonable to assume that research-intensive industries, which are likely to benefit the most from research tax incentives like the Section 41 research tax credit and the Section 174 expensing allowance for research expenditures, would be likely to benefit the most from a patent box. A 2012 report by the Economic & Statistics Administration at the U.S. Department of Commerce and the U.S. Patent and Trademark Office (USPTO) identified the U.S. industries that are the most intensive users of patents, trademarks, and copyrights. Two industries are well-represented: chemicals (including pharmaceuticals) and electronic equipment (including computers). Under the terms of the Boustany-Neal proposal, the effective tax rate on qualified IP income held in the United States for a corporation taxed at a rate of 35% can be determined using the following formula: ETR = 0.35[(1 – 0.71) (SRD/STC)], where ETR is the effective tax rate, 0.71 is the share of each dollar of qualified IP profit that can be deducted from a company's total income, SRD refers to the sum of a company's total R&D expenditures in the five previous years, and STC denotes the sum of the company's total costs in the same period. Have Patent Boxes Been Effective? Some patent boxes are intended to achieve all three. Still, there is a small (but growing) body of empirical research on the actual or likely economic effects of patent boxes. In addition, they unexpectedly found that patent boxes tended to deter local inventive activity, perhaps because they offered no incentives for domestic companies to invest in the development of new technologies. Economic Rationale for a Patent Box

Another policy issue raised by a patent box is whether it can be justified on economic grounds. The failure arises because the average company investing in R&D is unlikely to capture all the returns to that investment, even if the R&D results in intangible assets with intellectual property protection.
Economists generally agree that government support for private investment in research and development (R&D) is useful in correcting a market failure that predisposes most companies to invest less for that purpose than the overall economic benefits from R&D investments would warrant. The market failure stems from a company's inability to capture all the returns to its R&D investments as a result of the spillover effects of successful R&D investments.
Most governments offer some kind of support for R&D, including tax incentives for business R&D investments. The U.S. government provides a tax credit for qualified research under Section 41 of the federal tax code and a full expensing allowance for qualified research expenditures under Section 174, but no patent box.
As part of the debate in Congress over reforming the federal income tax, some have expressed support for the adoption of a patent box. Such a box is a tax subsidy that applies to the returns to successful R&D investments. In effect, a patent box partially compensates companies for the returns that spill over to other actors, such as competing companies.
Countries typically adopt patent boxes with three key goals in mind: (1) increasing tax revenue by encouraging the repatriation of intellectual property (IP) held abroad and discouraging domestic companies from transferring IP to foreign subsidiaries in low-tax countries; (2) expanding domestic innovative activities; and (3) stimulating growth in domestic high-paying jobs.
Every patent box now in use is built around two key elements: the nature of the tax subsidy it offers and the scope of its application. The tax subsidy typically comes in two forms: a deduction or exemption from a company's gross income or a separate, preferential tax rate for qualified intellectual property (IP) income. A patent box's scope addresses such issues as the kinds of IP and IP-related income that qualify for the tax subsidy.
At the end of 2015, 16 countries offered a patent box; all but three of them were members of the Organization of Economic Cooperation and Development. Among the nine largest patent-box countries as a location for business R&D investment, effective patent-box tax rates ranged from 5.0% to 17.1%. Each patent box applied to existing and new patented innovations. Only one of the nine countries did not offer separate tax incentives for domestic R&D investment.
It stands to reason that the industries most likely to benefit from patent boxes are those that use patents intensively. According to a 2016 report by the U.S. Patent and Trademark Office and the U. S. Department of Commerce, two industries are the most intensive users of patents, as measured by the number of patents granted to them per 1,000 full-time employees: chemical manufacturing (including pharmaceuticals) and computer and electronic equipment.
The prospect of the United States adopting a patent box raises several policy issues. One issue concerns the effectiveness of patent boxes in achieving their goals. The empirical literature on patent boxes is relatively meager, since most existing patent boxes have come into use since 2007. Nonetheless, a handful of academic studies have looked at the actual or probable effects of patent boxes on several indicators of success. They found that patent registration was responsive to cuts in tax rates on the income from patents; there is no evidence that patent boxes increase host-country revenues; and patent boxes have done little to boost investment in innovation in host countries.
Patent boxes also raise questions about the cost to companies of complying with the rules and the cost to tax authorities of issuing regulations and enforcing them; whether a patent box is warranted on economic grounds; and their incentive effect, especially when coupled with R&D tax incentives.