The Luxembourg Government introduced a bill on the proposed new Intellectual Property (IP) regime on 4 August 2017. The proposal is meant to preserve Luxembourg’s tax attractiveness and boost the Research and Development (R&D) activities and expenditure in Luxembourg while complying with the new EU and international tax standards and more particularly, as far as IP regimes are concerned, with the conclusions of OECD BEPS report on Action 5 in relation to the substantial activity requirement.
The proposed new IP regime is in line with the “modified nexus approach” developed by the OECD in the final BEPS report of Action 5 “Countering Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance”. Under this approach, economic activity and value creation is measured by the expenditures which taxpayers incur for the creation, development or improvement of IP. Taxpayers are thus eligible for the tax exemption only if they can establish a direct nexus between the qualifying income, assets and expenditures. Broadly speaking, the proposal foresees an 80% corporate income tax and municipal business tax exemption on the adjusted and compensated net eligible income and capital gains derived from eligible IP assets multiplied by a specific ratio (eligible expenses with a possible uplift of up to 30% / total expenses) leading to an effective tax rate of approximately 5,2 percent, as well as a full exemption from net wealth tax on these assets.
The former IP regime (under article 50bis Luxembourg Income Tax Law) was repealed in 2016, but with a grandfathering period until 30 June 2021. Consequently, if enacted, the provisions of the bill will become effective as from tax year 2018 and will apply (non-cumulatively) in parallel with the former Luxembourg IP regime until expiry of the grandfathering period and taxpayers may choose which regime they prefer to apply. The choice being irrevocable as from the fiscal year where it is exercised.
Principal measures of the proposed new IP regime
1. Eligible IP Assets
The bill foresees that two main groups of IP assets can benefit from the new regime:
1.1 Inventions protected by:
- utility models;
- supplementary protection certificates for patents on pharmaceutical and on phytopharmaceutical products;
- supplementary protection certificate extensions for paediatric medicine;
- plant breeders’ rights (also known as plant variety rights); and
- orphan drug designations.
1.2 Copyrighted software
It should, however be noted that marketing-related IP assets, such as trademarks and domain names, are not eligible IP Assets.
The eligible IP assets can be the tax exempted provided that they have been constituted, developed or improved after 31 December 2007 within the framework of R&D activities of the taxpayer carried out by the taxpayer itself directly or through a foreign permanent establishment, to the extent that such permanent establishment is located within the European Economic Area (EEA) and does not benefit from a similar IP regime in its country of location.
2. Eligible expenditures
The Eligible expenditures are the ones that are needed for research and development activities, directly related to the constitution, development and improvement of an eligible IP asset.
However, this does not include acquisition costs as defined by the bill, interest and other financing costs as well as building costs. Any costs not directly linked to a specific IP asset are disregarded as well.
The costs must be incurred within the framework of a R&D activity undertaken by the taxpayer itself (directly or through a permanent establishment located in the EEA) or paid to unrelated outsourcing party.
3. Eligible income
Eligible income related to eligible IP rights includes inter alios royalties, capital gains and income from the sale of eligible IP assets and services as well as judicial indemnities related to an eligible IP.
4. Eligible “net” income
In order to determinate the eligible “net” income which serves as the basis for the calculation of the exemption, it is necessary to deduct from the eligible income the costs not directly linked to a specific IP asset as well as the total expenditure corresponding to the sum of eligible income, acquisition costs and expenditures needed for research and development activities, directly related to the constitution, development and improvement of an eligible IP asset incurred by a related company.
5. Eligible “net” income adjusted and compensated
After determining the eligible “net” income, this latter must be adjusted in imputing the negative net revenues from previous years on positive net income individually for each asset then compensated by offsetting the negative net income of another eligible IP asset held by a taxpayer with the adjusted eligible “net” income of the eligible IP asset concerned.
6. The nexus ratio
This “adjusted” and “compensated” eligible “net” income will then be subject to a “nexus ratio designed to ensure a sufficient link between research and development activities with Luxembourg”. This coefficient is determined as follows: (eligible expenditures x 1.3) / total expenditure.
7. The exemption
The “adjusted” and “compensated” eligible “net” income on which the nexus ratio was applied is exempt at 80%.