Is it Just Luring Reported Profit? The Case of European Patent Boxes

Innovative firms’ cash holdings, tax policies, and institutional environments

“…Then, we focus on innovative multinationals and find that their cash holdings significantly increase after the introduction of patent boxes. The result is consistent with previous evidence that patent boxes increase patent registrations, transfers, and inward profit shifting by multinationals and also improve their productivity and profitability (e.g., Ciaramella, 2017; Gaessler, Hall, & Harhoff, 2021; Griffith et al., 2014; Koethenbuerger et al., 2019). Hence, for more productive and innovative multinationals, the favorable tax treatment of income from patents could result in higher after‐tax profits and thereby larger cash balances.…”

“…They are designed to stimulate R&D investment and promote the commercialization of research. Prior research shows that patent boxes increase firms’ R&D investment and patentable invention and enhance productivity, profitability, and innovativeness of R&D projects (e.g., Bradley et al., 2015; Hassbring & Edwall, 2013; Koethenbuerger et al., 2019; Mohnen et al., 2017; Skeie et al., 2017).…”

“…Koethenbuerger et al. (2019) show that firms with access to the tax benefits of patent boxes in European countries have higher productivity and profit levels, which are related to intensified R&D and increased efforts to exploit the revenue potential of IP after patent box introduction. As higher innovativeness firms can produce more and better‐quality patents with high earnings potential (Hirshleifer, Hsu, & Li, 2018), they will be motivated to innovate more and achieve higher profits when they have access to the tax benefits of patent boxes; this results in larger cash holdings.…”

“…Moreover, patent boxes induce patent transfers to the country and reduce patent transfers out of the country (especially higher quality patents with more profit potential). They also attract patent income (e.g., more royalties and licensing fees) and inward profit shifting by multinationals and increase the productivity and profitability of multinational affiliates (e.g., Chen et al., 2019; Ciaramella, 2017; Gaessler, Hall, & Harhoff, 2021; Koethenbuerger et al., 2019). Hence, these activities will lead to higher after‐tax profits and bigger cash balances.…”

“…The tax advantages of patent boxes attract patent registrations, patent transfers, and profit shifting by multinationals, yielding substantial tax savings (e.g., Alstadsæter et al., 2018; Chen et al., 2019; Ciaramella, 2017; Gaessler et al., 2021). Patent boxes also raise the productivity and profit levels of multinational affiliates (Koethenbuerger et al., 2019). These could result in higher after‐tax profits and larger cash balances in innovative multinationals.…”