Communications - January 2011

comes less critical. To gain financial flexibility, a company might identify and isolate its IP. The rights to identified IP, as trademarks and technology, can be moved to a distinct subcorporation. Separating IP is an initial phase in setting up an offshored operation when significant IP is involved. 29 To be productive, the extant technology still must be made available to the creative workers, by having the productive corporate divisions pay license fees to the subcorporation holding the technology IP; see the sidebar “Property Rights” for an illustrative example clarifying the process of splitting rights from the property itself.

Such transfer-of-rights transactions are even simpler when applied to IP. The rights to a company’s IP or to an arbitrary fraction of that IP can be sold to a controlled foreign holding company (CFH) set up in a taxhaven. Once the rights to the IP are in the CFH the flow of income and expenses changes. The rights to the IP are bundled, so no specific patents, trade secrets, or documents are identified. The net income attributable to the fraction of the IP held in the CFH is collected in an account also held in the taxhaven. One way of collecting such income is to charge royalties or license fees for the use of the IP at the sites where the workers create saleable products, both at home and offshore. There is no risk of IP loss at the CFH, because nothing is actually kept there. To reduce the risk of IP loss where the work is performed, new offshore sites are set up as controlled foreign corporations (CFCs), rather than using contractors. 29 Since IP is crucial to making non-routine profits, the royalty license fees to be paid to the CFH can be substantial and greatly reduce the profitability at the parent and at the CFCs from worldwide software product sales (see Figure 2).

The consolidated enterprise thus
gains much strategic business flex-
ibility. Work can be shifted wherever it
appears to be effective, perhaps where
new incentives are provided, and
the needed IP can be made available
there, as long as the license fees are
paid to the CFH. 22 Paying these fees as
royalties on profits is preferred, since
profits reflect the ever-changing profit
margins due to sales variability and to
switching to cheaper labor.