Friday, 28 November 2014

The future of the UK Patent Box -- or is it the Nexus: what's the real story?

There's a very helpful client alert from Baker & McKenzie, "IP Tax Regimes (including the UK Patent Box) to be abolished and replaced by new "Nexus"- based regimes", which gives a good account on the fate of the UK's Patent Box. Has it been saved, killed, or modified, people ask. This alert gives the story:

On 11 November 2014, the UK and Germany made a joint announcement about a proposal they had developed to address some of the concerns raised over the OECD's suggested approach to dealing with preferential IP tax regimes.

The likely outcome is that the UK will need to modify its patent box rules, but there is a long grandfathering period, under which benefits from the patent box (and regimes in other countries) can continue to be claimed until June 2021. The regimes will close to new entrants from June 2016, and will be abolished in June 2021.

One of the Actions in the OECD's project to counter Base Erosion and Profit Shifting (BEPS) is on Countering Harmful Tax Practices More Effectively (Action 5). In September 2014, the OECD published a report on Action 5, stating that its Forum on Harmful Tax Practices (FHTP) would be focusing on ‘substantial activity’ in the context of IP tax regimes. The OECD's preferred approach, supported by a majority of OECD member countries, was to require a direct nexus between the income receiving tax benefits and the expenditure contributing to that income. This "Modified Nexus Approach" would require substantial economic activities to be undertaken in the jurisdiction in which the preferential regime exists, by requiring tax benefits to be connected directly to R&D expenditures.

The UK, Spain, Luxembourg and the Netherlands did not favour this approach. The nexus approach was also criticised on the basis that it would create a major compliance burden in tracking the relevant expenditure. Germany has long been a critic of IP tax regimes (including the UK patent box) on the basis that they distort competition. Germany does not have an IP tax regime of its own, although a German Government Minister did say recently that they might consider introducing one.
There's more in the alert, which end with a link to the joint UK-German proposal, which IP Finance reproduces here:
Proposals for New Rules for Preferential IP Regimes
The Governments of Germany and the United Kingdom are fully committed to ensuring that the G20/OECD Base Erosion and Profit Shifting (BEPS) project is successfully concluded by the end of 2015. This requires all countries involved in the negotiations to work to ensure that progress is made on all of the Actions set out in the BEPS Action Plan agreed by G20 Finance Ministers in July 2013. 
The OECD Forum on Harmful Tax Practices (FHTP) has led work in relation to BEPS Action 5, Countering Harmful Tax Practices More Effectively, Taking into Account
Transparency and Substance. Work within the FHTP has led to the development of proposals for new rules, known as the Modified Nexus approach, based on the location of the R&D expenditure incurred in developing the patent or product. This approach seeks to ensure that preferential regimes for intellectual property require substantial economic activities to be undertaken in the jurisdiction in which a preferential regime exists, by requiring tax benefits to be connected directly to R&D expenditures.
In order to take forward these negotiations, Germany and the UK have co-operated to develop a joint proposal for the consideration of the G20 and OECD member countries in the FHTP. This aims to resolve the concerns countries have expressed about some features of the Modified Nexus Approach, and identify what further work is required in order to enable agreement to be reached on this issue during 2015. Concerns have been expressed about how to calculate qualifying R&D expenditure, transitional arrangements between regimes and time allowed for this through grandfathering provisions, and the tracking and tracing methodology for R&D expenditure that will determine whether it qualifies.
The proposal is based on the following elements, which seek to address the concerns that have been raised, whilst reinforcing the nexus approach and providing safeguards against profit shifting. These also aim to ensure that the approach to implementing new rules is consistent with existing OECD rules on the phasing out of harmful regimes. 
 Uplift of Qualifying Expenditure - where related party outsourcing or acquisition costs are incurred, which do not constitute qualifying expenditure, companies will be able to obtain a maximum 30% uplift of their qualifying expenditure (subject to a cap based on actual expenditure) included within the formula; the 30% uplift refers to the overall expenses for both, outsourcing and acquisition costs;  
 Closure and Abolition of IP Regimes – to allow time for the legislative process, all existing regimes will be closed to new entrants (products and patents) in June 2016. These schemes will be abolished by June 2021. 
 Grandfathering – to allow time for transition to new regimes based on the Modified Nexus approach, IP within existing regimes will be able to retain the benefits of these until June 2021.  
 Tracking and Tracing – the FHTP should work to reach agreement by June 2015 on a practical and proportionate tracking and tracing approach that can be implemented by companies and tax authorities, which includes transitional mechanisms for intellectual property from existing into new regimes, and special rules for previous expenditure. The focus of this should be on developing practical methodologies that companies and tax authorities can adopt. 
Germany and the UK will submit this proposal to the Forum on Harmful Tax Practices, during its meeting on 17-19 November. It is our shared hope that countries will agree that this forms the basis for future negotiations and eventual agreement on this aspect of Action 5. We remain committed to working with all G20 and OECD partner countries to achieve this shared aim. 

Wednesday, 26 November 2014

Licensing mobile technologies becomes even more essential

Dramatic structural changes in mobile communications technology supply, with the demise of vertical integration, is forcing those who are developing standard-essential technologies for 4G and "5G" networks to monetise these efforts through patent licensing, as well as their own product sales. Exiting the handset business, as have most of the original major technology suppliers, including former market leader Nokia earlier this year, eliminates participation in the largest product market, and the need for cross-licensed patent protection there.

Under New Management

The market size for mobile standard-essential patent (SEP) royalties paid remains below 5 per cent ($19 billion [€15.2 billion]) of the $377 billion in annual smartphones sales.

Once upon a time, new mobile communications technologies such as 2G GSM were developed by small clutches of vertically integrated players. Mobile technology pioneers including Alcatel, Ericsson, Nokia, Nortel Networks, Motorola, Qualcomm and Siemens all manufactured handsets, as well as network equipment. Some of these companies also produced communications chips.

Business models were predominantly oriented towards generating income from product sales. Technology development costs and risks of failure (e.g. with demise of the rival U.S. 2G TDMA standard) were compensated for through product sales and in cross-licensing, for little or no cash royalty payments among these major players, to obtain access to all the SEP technologies required to make and sell products.

Vertical disintegration
Over the last decade or so, virtually all the diversified mobile technology manufacturers have exited the handset market. From among the above, brand names Alcatel, Motorola and Nokia live on in handsets, but ownership is now completely removed from the original parent companies. I tracked the demise of some of these in the face of new market entrant challengers in another of my recent postings. Some of them have also ceased sales of other mobile products, including network equipment and chips.

Consequently, all the above parents have lost their ability to obtain a financial return on their mobile technology R&D investments directly through sales of handsets, which is by far the largest product market in the mobile sector. Global market revenues in 2013 were $377 billion for handsets, according to Morgan Stanley; $61 billion for network equipment, including radio, IP & transport and core equipment, according to Ericsson; and around $20 billion in baseband modems (which are mostly embodied in handset products). Nevertheless, the pace of technology development is continuing relentlessly in standard-essential technologies and in mobile technologies in general.

R&D spending continues to increase
Despite so many mobile technology vendors no longer selling handsets, mobile R&D spending, of approximately $42 billion in 2013, has grown 50 per cent since 2008, as indicated in table below. The figures include 12 large technology companies with a predominant or exclusive focus on mobile communications, including several named above. Some of these are quite diversified and do not break out their wireless R&D expenditures in public disclosures, so these figures include some R&D related to other technologies and product markets. However, my total excludes many companies that also invest significantly in cellular R&D; so I believe the table provides a fair, yet approximate, and consistent representation of total R&D investments and their growth by the mobile technology industry as a whole.
 Total Sales and R&D for Leading Cellular Technology Companies

Total Sales
Total R&D
Sources: Includes public disclosures for Alcatel-Lucent, Apple, BlackBerry, Ericsson, Huawei, LG Electronics, MediaTek, Nokia, Qualcomm, Samsung, Electronics and ZTE.

New business model
Value is derived from standard-essential and other patented technologies through the manufacture and sale of one's own products, through cross-licensing to protect one's own product sales from infringement claims and through licensing for receipt of cash royalty payments.

Licensing value, in kind through cross-licensing or in cash, tends to correlate positively or proportionally with product sales revenues. Significantly for Alcatel-Lucent, Ericsson and Nokia, as indicated above, the network equipment business has only around one-sixth the market value of that for handsets. This means the value potential for royalty-generating licenses or royalty-mitigating cross-licenses is also likely to be correspondingly lower there for the mobile SEPs, which tend to apply to both networks and devices.
Therefore, in order to maintain R&D investment levels or increase them, technology developers are increasingly dependent on licensing others' handsets for cash royalties to recoup returns on their costly and risky R&D.

Qualcomm has been able to focus on developing its patent licensing while substantially growing its R&D. It needs to do so because R&D spending (e.g. $5 billion in 2013) exceeds the profit it makes on its chip sales. Qualcomm led the way in licensing with the company being the majority developer of CDMA technologies in the 1990s. Qualcomm's exit from network equipment and handset businesses around the turn of the millennium eliminated its need to patent-protect those operations through cross-licensing. Qualcomm's licensing revenues of $7.9 billion in 2013 are equivalent to a royalty rate yield of 1.77 per cent of total global handset revenues indicated above.

The opportunity to grow licensing income with SEPs and non-SEPs (also referred to as implementation patents) was presented as a significant strategic objective by Ericsson and Nokia at their recent Capital Markets Days in Stockholm and London. Ericsson's 2013 licensing income was around $1.6 billion, which corresponds to a royalty rate of 0.42 per cent on the same basis as for Qualcomm above. Corresponding figures for Nokia were $650 million and 0.17 per cent, respectively.

Nokia, in particular, has a history of handset patent licensing agreements which sought to minimize or eliminate royalty out-payments through cross-licensing, rather than to maximise royalty income. The company needs to unravel previous arrangements and substitute sales volume-dependent agreements for legacy sales volume-independent agreements. The latter were highly beneficial while handset market shares were up to around 40 per cent last decade. These two companies and Qualcomm are also including non-mobile SEPs and non-SEPs in some of their licensing. Ericsson, Nokia and others still need cross-licensing to provide "freedom to operate" in design, manufacture, sale and use of network equipment.

Low barriers with modest royalties paid
The mobile device business--including smartphones, feature phones, tablets and Internet of Things connectivity--has relatively low barriers to market entry through the freely available 3GPP standards. That is why there are so many new handset OEM names in recent years--with the most notable successes including Apple since 2007 and Xiaomi since 2011--seizing substantial market shares.

Ericsson, Nokia and Qualcomm are widely regarded as holding, in total, a substantial proportion, and quite likely the majority, of SEPs reading on 3GPP standards. On this basis, and the fact that Qualcomm has a far more well-developed patent licensing programme than any other company, a total aggregate SEP royalty across all handsets worldwide is most likely to be no more than a mid-single-digit percentage. Five per cent is conservatively more than double the total of 2.36 per cent in royalty rates I have calculated for Ericsson, Nokia and Qualcomm. Other significant SEP holders account for only relatively small licensing revenues. For example, InterDigital Communications, with a business model entirely focused on patent licensing, reported $264 million in patent licensing revenues in 2013. That corresponds to a comparable royalty rate of 0.07 per cent.

Smartphones designers also seek to include features which are subject to non-mobile SEPs and which might be subject to non-SEPs. But the latter are more easily ignored or worked around with alternative technologies, and some features might be omitted if this is not possible. In the case of SEPs, it is at least in theory not possible to implement the standard or part thereof without infringing.

On the basis of financially audited royalty incomes from leading licensors, my estimate that total mobile SEP royalties amount to less than a mid-single-digit percentage of handset revenues is in marked contrast to the erroneous aggregate royalty rate estimates of Intel and others. Elsewhere, I have published a detailed rebuttal of Intel's defective assessment that the smartphone "royalty stack" could amount to $120 on an average $400 smartphone, including SEPs and non-SEPs. That would correspond to a 30 per cent royalty rate, or around $100 billion per year in total royalties. This is more than five times my estimate of less than $19 billion, which includes all mobile SEPs, many non-cellular SEPs and many non-SEPs also thrown in to the licensing bundles. This figure is less than half the mobile industry's R&D spending.

Royalties paid on non-cellular SEPs (e.g. H.264 video and 802.11 Wi-Fi) and non-SEPs amount to no more than additional single-digit billions of dollars. It has been disclosed that Samsung, with 2013 smartphone revenue share of 34 per cent, paid Microsoft an annual $1 billion in licensing fees to implement Android. This is exceptional and accounts for a significant proportion of all non-SEP royalties paid.

I originally published this article in the mobile communications industry trade press with FierceWireless.

Trademarks and Homophones: The Selection of Marks and Should Trademark Law React?

Producers of products and services choose particular trademarks for a variety of reasons—most of those reasons are related to conveying a particular message about a product or service and ensuring they receive some legal protection through trademark law.  Of course, some particularly favorable words are not allowed legal trademark protection in the U.S. because to do so would impede the ability of competitors to fairly use words to describe their own products or refer to a product class.  Thus, the spectrum of distinctiveness has served to ensure that certain words are never protected or only protected when there is a substantial danger of consumer confusion, an investment in goodwill by the producer, and competitors will have some alternatives to describe their products and services.  The spectrum has worked well for word marks, but occasionally does not work well for non-word marks such as trade dress (or the get-up).  Aesthetic functionality could be applied to word marks the use of which would put competitors at a significant non-reputation related disadvantage.  However, aesthetic functionality is usually not needed for word marks because the spectrum should filter out words that would put competitors at a disadvantage.  Moreover, a defense of fair use may also protect a competitor’s ability to use a word mark. 

But, what about homophones?  Homophones are words that are essentially pronounced similarly, but have different meanings and are spelled differently.  An example of a homophone is the words “bye” and “buy.”  In a recent article, by Derick F. Davis and Paul M. Herr titled, “From Bye to Buy: Homophones as a Phonological Route toPriming,” published in the Journal of Consumer Research in April of 2014, the authors find that consumers experiencing heavy “cognitive load” are essentially influenced by homophones.  Thus, a consumer, for example, shopping and reading a lot of text on the Internet, is susceptible to influence from the usage of a homophone.  The article provides the example of a person reading the word “bye” on a page of text, turning the page and seeing an advertisement.  The consumer could be influenced to purchase the advertised product because of the meaning of the word “buy” even though they read the word “bye.”  If you add the word “good” to the “bye”, then you provide even more priming for the consumer.  Two other examples are the words “weight” and “wait,” which could be effective in the weight loss field, and the words “right” and “write,” which apparently made people write longer papers.  Importantly, the article makes a distinction between homophones and other word types, which may not result in the same effect:

An important conceptual distinction is warranted. Homophones are related to but different from (1) homographs (words with identical spellings but different pronunciation and meanings; e.g., “lead” the metal vs. to lead others), (2) stress homographs (stress on different syllables, e.g., “refuse” as in rubbish vs. to reject), and (3) homonyms, words that are both homophones and homographs (e.g., “bank” as in river vs. a financial institution). We suggest homophones’ ability to prime is rooted in shared phonology, not shared orthography.

Trademark law does take into account the multiple meanings of words, but does the spectrum of distinctiveness do a good job of that?  Would aesthetic functionality do better?  Do you put competitors at a significant non-reputation related disadvantage when you trademark a word with other positive meanings related to your particular word from a phonetic perspective, such as “good-bye”?  What if you misspell a word to create a fanciful mark to obtain a particular meaning, as pharmaceutical companies often do?  In a discussion concerning the article in Real Simple, Derick Davis, one of the authors of the study, notes that “Alli, a diet drug[‘s] name, . . . may be intended to remind you of an ally who will help you achieve weight loss.”  (I suppose it wouldn’t really be a fanciful mark then, but a suggestive or descriptive one.)

The article, for sure, provides some interesting and helpful information for selecting trademarks--certainly an important choice impacting the value of the mark and the success in marketing the product. 

Tuesday, 25 November 2014

Expanding Trademark Subject Matter and Overlapping Rights: a Website, Case and Conference

The issue concerning expanding trademark subject matter is a relatively hot one.  Trademark subject matter has continued to expand in the U.S. to cover everything from single colors alone to interesting forms of trade dress, such as a website or a restaurant's décor, to sounds to tastes to smells.  Indeed, motion marks are common now as well.  Attorney Michael Spinks has an interesting, helpful and entertaining blog titled, "Funky Marks."  (Well, I suppose these marks can be smelly, have a cool sound and are a little weird, but they don't all involve Mark Wahlberg.)   If you are interested in seeing just how far trademark subject matter is going, enjoy the website.
And, another new case on the subject of trademarks was just issued today.  The EU General Court in Luxemburg apparently upholds a three dimensional trademark over the Rubik's Cube despite the expiration of a patent.  The Simba Toys case can be found, here.  And, here is commentary by Bloomberg.  (Hat Tip to BNA). 
Couple expanding trademark protection with overlapping rights and you have a very hot topic.  With expanding trademark subject matter (and rights), you get the potential for conflict with other areas of intellectual property.  And, INTA (among others) is sponsoring an upcoming timely conference on the subject featuring our very own Neil Wilkof (Congratulations to Neil for his appointment to the board of INTA) and Jeremy Phillips.  (And, here is a link to an IPKat (Neil and Jeremy) post on the subject of the consumer protection function of trademarks.)
Here is information about the conference:

December 8–9 
Westin Grand Munich Hotel
Munich, Germany

The overlap between trademarks and other intellectual property rights is everywhere—whether in registration, enforcement or commercialization. For example:

  • A product design can be protected as a two- or three-dimensional mark, trade dress, design patent, registered design, unregistered design or a work of applied art under copyright law.
  • An artistic work can be registered as a trademark, whether or not it is protected under copyright law.
  • A geographical indication can be registered as such or protected as a collective or certification mark, under passing off or unfair competition law.
  • A trademark can be subject to unfair competition law, comparative advertising statutes or consumer protection laws. A trademark, as used in blogs and social media, can involve rights of privacy and rights of publicity.

It is essential that trademark and other IP practitioners have a solid understanding of the many opportunities and pitfalls of intersecting rights. The intersection of these rights also raises fundamental questions about the nature of trademark law and its relationship to the other areas of IP protection, and how policy should best address these overlaps.

Join the International Trademark Association (INTA) in Munich, Germany, on December 8–9, 2014, at the Westin Grand Munich Hotel for two days of information-packed, advanced-level sessions. Presented by leading authorities in their field, these sessions will deal with these and other emerging issues concerning the overlap of trademark rights with other IP rights.

This conference is cosponsored by the INTA’s Programs and Related Rights Committees and with the kind support of the German Association for the Protection of Intellectual Property (GRUR).

Thursday, 13 November 2014

UK patent box "watered down" -- but with a spot of grandfathering

"George Osborne waters down flagship controversial tax break" is the strident headline of this Guardian post by Simon Goodley, subtitled "Patent boxes allow firms to pay much lower taxes on profits from patented inventions, but critics say it gives UK too much of a fiscal advantage". According to this article, in relevant part:
"George Osborne has watered down one of his flagship policies following a long-running dispute with Germany over a controversial UK tax break. ...

The incentives were introduced last year to encourage hi-tech businesses to commercialise their intellectual property in the UK by charging just 10% tax on the resulting income. But Germany led numerous countries in arguing that the regime encouraged artificial shifting of profits to avoid tax elsewhere.

Osborne described the new agreement as “a great deal for Britain” that protected the UK’s vital scientific research while making sure there were international rules that stop aggressive tax avoidance. It would involve the UK winding down its patent box rebates and joining other OECD countries in only granting tax breaks for patents directly tied to research and innovation at home.

Germany’s finance minister, Wolfgang Schäuble, said: “We have reached an important agreement on patent boxes. Preferential tax treatment of intellectual property must be dependent on substantial economic activity. More and more countries are speaking out against allowing too much leeway for large multinationals to minimise their taxes. Just because something is legal, does not mean it is fair in tax terms. Multinationals must contribute their fair share to public budgets – just like any other company has to.”

The Treasury denied it had performed a U-turn on the issue, although it has previously defended its original policy ... [and] countered that it had won important concessions including so-called “grandfathering”, which will allow intellectual property within existing regimes to retain tax benefits until June 2021".
While the notion of the patent box will continue to attract support, not least among patent-exploiting tax-payers, it would be sad if countries were to engage in an unseemly rush to offer the lowest rate for the sake of attracting the relocation of patents alone: tying the tax break to patents grown within the jurisdiction is therefore a wise proposition.  

Mike Mireles' posts on US thinking about patent boxes can be found here and here
"Death of a Travelling Patent Box" by Rob Harrison can be accessed here
Rob's post on the OECD report which gave the UK's patent box scheme a reasonably clean bill of health is here

Thanks go to Chris Torrero for spotting this item