The Luxembourg Intellectual Property (“IP”) Regime blows out its first birthday candle
Applicable since January 2018, Luxembourg’s new IP box regime has blown out its first birthday candle.
Thierry Bovier - Partner - Cross-Border Tax - Deloitte
Nathalie Taranti - Senior - Cross-Border Tax - Deloitte
Raphaëlle Champailler - Junior - Cross-Border Tax - Deloitte
Published on April 2019
By setting out a new IP box regime (applicable as of January 2018) under article 50ter of the Luxembourg Income Tax Law (“LITL”) and §60ter Bewertungsgesetz (“BewG”), Luxembourg aligned its IP box regime with the international tax standards and more precisely with the requirements of OECD/G20 Base Erosion and Profit Shifting (“BEPS”) Action 5.
Indeed, BEPS Action 5, which prompted the review and assessment of preferential tax regimes by the Forum on Harmful Tax Practices, led to the agreement among member countries on the fact that the benefit from any preferential tax regimes should be subject to the existence of substantial activity (i.e., the “nexus approach”). The R&D expense is the chosen indicator of such substantial activity to benefit from the IP regime.
The key aspects of the Law are outlined below.
Five-year grandfathering period
Not compliant with the nexus approach, Luxembourg repealed its previous IP box regime as of 1 July 2016 with a five-year grandfathering period (i.e., ending on 30 June 2021). In terms of Luxembourg Net Wealth Tax (“NWT”) aspects, while §60bis BewG was repealed on 1 January 2017, it also remains applicable during a transitory period ending on 1 January 2021 (inclusive) for IP rights constituted or acquired prior to 1 July 2016 (including related improvements as long as they ended before 1 July 2016).
As the regimes are not cumulative, the taxpayer should irrevocably reflect its election to the transition in the new IP box regime through its tax returns.
The new IP box regime allows the taxpayer to benefit from an exemption of 80 percent from Corporate Income Tax ("CIT") and Municipal Business Tax ("MBT") on the net adjusted and compensated income generated by the qualifying IP asset. Besides, the eligible IP asset is fully exempt from NWT.
The new IP box regime applies for individuals, whether resident or non-resident in Luxembourg, carrying out a commercial activity in Luxembourg, Luxembourg joint-stock tax resident companies, and Luxembourg permanent establishments of foreign companies.
Qualifying IP assets
Article 50ter LITL provides a definition of eligible IP assets, which encompasses any patents (in the broad sense) and copyrighted software constituted, developed, or improved after 31 December 2007.
Compared with the previous IP box regime, the new IP box regime is no longer applicable to marketing intangibles such as trade names, trademarks, domain names, as well as designs and models.
Qualifying net adjusted and compensated income
Income qualifying for the new IP box regime is defined under article 50ter LITL.
The new IP box regime applies on a net-income basis meaning that the expenses related to the qualifying IP incurred during the year have to be deducted from the gross qualifying revenue.
Furthermore, the net eligible income should also be subject to potential adjustments. Concretely, this implies an exemption under the new IP box regime if the net eligible income is greater than the sum of the expenses linked to the qualifying IP asset and incurred during previous tax years.
Two adjustments are foreseen under article 50ter LITL:
- If the expenditure constituting the cost price is deducted from the taxable profit for the years during which it is incurred, the (positive) net qualifying income for the year is adjusted by the sum of negative net qualifying income realized in earlier years as long as it has not been offset against positive net qualifying income generated by the same IP asset.
- If the expenditure constituting the cost price has been capitalized in the balance sheet, the (positive) net qualifying income is adjusted by the annual depreciation as well as by the net asset value of the IP asset.
Other adjustments inspired by the above principles are also provided by the Law.
Finally, the net adjusted income should also be subject to compensation. If the taxpayer has more than one qualifying asset and one generates positive net qualifying income while the other generates negative net qualifying income, then the taxpayer should operate compensation between the adjusted negative eligible net income and the adjusted positive qualifying net income.
The new IP box regime will only apply if the aggregate amount of the compensated and adjusted net eligible income is positive.
Nexus ratio and qualifying expenses
As mentioned above, the nexus approach is one of the foundations of the new IP box regime.
Hence, the application of the nexus ratio is a necessary condition to determining the effective tax impact at taxpayer level depending on its R&D involvement. Indeed, the nexus ratio calculated as illustrated below, takes into account the qualifying expenditure (numerator) over the overall expenditure (denominator):
Qualifying expenditure refers to all R&D expenditure incurred by the taxpayer or an unrelated party within the meaning of article 56 LITL directly related to a qualifying IP right. In certain circumstances, the same expenditure incurred by a permanent establishment located in a European Economic Area country could qualify for the new IP box regime. In addition, a 30 percent up-lift applies on the qualifying expenses up to the amount of the overall expenditure.
Overall expenditure encompasses qualifying expenditure, IP acquisition costs, and outsourcing costs to related parties.
The nexus ratio is determined on a cumulative basis. In other words, the nexus ratio has to be calculated each year by taking into account the expenditure from previous tax years and thus requires rigorous monitoring and documentation of expenses (see “Documentation”).
The new IP box regime requires appropriate documentation in order to sustain the tracking of the eligible expense, total expense, and eligible income related to each qualifying IP asset. It should be noted that under certain conditions, the taxpayer can opt for tracking by product or service, or by family of products/services.
Within an intra-group context, in order to justify compliance with the arm’s length principle for all transactions occurred between related parties, the taxpayer must have supporting documentation in line with articles 56 and 56bis LITL, reflecting the transfer pricing guidelines foreseen under BEPS Actions 8 to 10.
While Luxembourg got its legislation aligned with the international standards promoted by Action 5, it would be appreciated that Luxembourg goes further by having the tax administration providing practical guidelines on the application of the preferential regime. This would grant the taxpayers more comfort on how to apply the new concepts of Article 50ter LITL.
Nevertheless, by its publication on 6 July 2018, the European code of conduct group confirmed that the Luxembourg new IP box regime was in line with the international tax standards, by declaring that this preferential tax regime was not harmful. This is a positive signal for Luxembourg economic diversification strategy and this will enable Luxembourg to reinforce its position as an attractive place in terms of innovation and R&D activities.
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