Applying Eminent Domain to IP Transfer Pricing
The concept of eminent domain dates back to biblical times, and is even highlighted in the U.S. Constitution's Fifth Amendment: "… nor shall private property be taken for public use, without just compensation."
The application of eminent domain has sparked recent interest with discussions about ownership and migration of intellectual property ("IP") under the Organisation for Economic Co-operation and Development ("OECD") base erosion and profit shifting ("BEPS") project. Tax planning strategies have allowed many multinationals to move IP off shore and into low-tax jurisdictions, allowing them to benefit substantially from lower tax rates. Researchers have long recognized that governments could eliminate dead-weight losses by making IP available to the public. The main concern is determining "just compensation" under the Fifth Amendment's "Takings Clause."
If just compensation under eminent domain is defined as the price paid to transfer IP, the threat of applying eminent domain creates a mechanism that eliminates dead-weight losses to society. IP owners must attest that the price chosen for such IP transfers meets the arm's-length standard, and such price mirrors the Takings Clause standard for determining just compensation. As such, a country's ability to take IP is a sufficient threat to deter tax avoidance through IP shifting.
Two sources could potentially provide U.S. states with the authority to take a privately owned patent. First, a government's eminent domain power may be extended to intellectual property, such as prescription drug patents. According to law professor Kevin Outterson, "[s]tates may exercise this power against pharmaceutical patents, just as they have always exercised eminent domain over real property."
Second, in Florida Prepaid Postsecondary Education Expense Board v. College Savings Bank, the U.S. Supreme Court held that states are generally immune from patent infringement if due process via just compensation is afforded to the patent owner. The Court indicated that a state's infringement of a patent is not by itself unconstitutional as long as some remedy is provided. In fact, "only where the State provides no remedy, or only inadequate remedies, to injured patent owners for its infringement of their patents could a deprivation of property without due process result." This provides states the ability to take privately held patents, provided just compensation is paid to patent owners.
IP proponents argue that patents, copyrights and trademarks should be called intellectual property in order to be covered by eminent domain protections. The Supreme Court has supported this argument, and states can take private property provided they pay just compensation.
EisnerAmper Trends & Developments - June 2016