The Luxembourg Government has introduced a draft law, replacing the former "IP Box" tax regime, which aims to comply with Action 5 of the Base Erosion and Profit Shifting (BEPS) Action Plan. The aim of the new rules is to incentivise Luxembourg competitiveness while complying with the new international tax framework.
On 04 August 2017, the Luxembourg Government introduced draft law 7163 (Draft Law) which should comply with the OECD’s Final Report on Action 5 of the BEPS Action Plan: Countering Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance (Report). The Report sets out a minimum standard (based on a method approved by the OECD countries and the G20) that defines whether there is a "substantial activity" that would allow the application of preferential IP tax regimes determined by the "nexus approach".
In this respect, according to the Report, expenses made within a country help demonstrate the existence and extent of a "substantial activity". This follows the repeal of the former IP box regime (after a transitional period). In broad terms, the "nexus approach" uses certain qualifying expenses as the main variable when allocating tax benefits under an IP Box tax regime, to ensure that taxpayers who benefit from preferential regimes have carried out Research & Development (R&D) efforts in a particular tax jurisdiction.
The former IP Box rules
In broad terms, the former IP Box tax regime granted certain Luxembourg tax payers an exemption (of 80% in certain circumstances) for corporate income tax purposes on the net income resulting from the exploitation of certain intangible assets such as patents, trademarks, designs, copyrights on software or domain names acquired or created after 31 December 2007.
The former regime was repealed by the Luxembourg law of 18 December 2015, which introduced the 2016 Luxembourg budget. (For more information, please refer to our previous elexica article in this respect).
The new IP Box rules
Building on the above international standards, the new proposed IP Box tax regime includes (but is not limited to) the following key characteristics:
- The partial exemption should be available in relation to certain "eligible net income" received or accrued for the use of granting of user rights in respect of, "eligible assets", including remuneration for such activities or the sale of such assets.
- The calculation of "eligible net income" should be undertaken on a case-by-case basis and should take into account specific rules.
- The determination of "eligible net income" should, in principle, be undertaken asset by asset. However it should be possible to combine certain "eligible assets" into groups of products or services when such calculation becomes too complex in relation to certain R&D activity.
- In principle, the amount of the "eligible net income" benefitting from the partial exemption is determined by the ratio between "eligible expenses" amount (numerator) and total amount of expenses (denominator) in respect of the "eligible asset" or where applicable, group of assets (see above). The ratio is cumulative: each year, a new ratio must be calculated, which takes into account expenses from previous years in a cumulative way.
- To avoid excessively penalising taxpayers who have booked "acquisition costs" paid to a "related enterprise" (for example, to IP, or to R&D expenses directly linked to the creation, development or improvement of an "eligible asset"), it is possible to increase the numerator referred to above (ie "eligible expenses") by up to 30% of their amount. However, this is subject to the increased "eligible expenses" figure (numerator) not exceeding the denominator (ie total amount of expenses).
- 80 % of "eligible net income" (after calculations and compensations) may be exempt from Luxembourg corporate income tax.
- Where the "eligible assets" require registration, the above exemption is in principle granted only after the date of the filing of the registration request (subject to other conditions).
- The scope of "eligible assets" for the application of the tax advantages related to the regime is reduced to IP inherently linked to a business activity (eg patents). In contrast, other assets linked to marketing activities (such as trademarks) should no longer benefit from such tax advantages.
- Such "eligible assets" should be developed by a R&D activity taking place after 31 December 2007.
- The "aquisition cost" of the "eligible assets" may include recurring expenses such as royalties.
- The notion of "eligible expenses" includes expenses that are necessary for the R&D activities that allow the creation, development, and improvement of "eligible assets" and take the form of payments made to "non-affiliated enterprises" (in the sense of certain transfer pricing rules) for such R&D activities. Outsourcing of such R&D activities may benefit from the tax regime under certain conditions. The nature of the "eligible expenses" should also be properly documented to establish a proper link between the applicable expenses and the "eligible asset", and this should be monitored to ensure the application of the tax regime, with a total or proportionate allocation as the case may be.
- Tax payers are in charge of determining the "eligible net income" and should maintain proper documentation in this respect, including transfer pricing reports in relation to the valuation of the "eligible assets" (subject to certain conditions).
- Tax payers should be able to continue to apply the former IP Box tax regime until 30 June 2021 under the grandfathering clause contained in the Luxembourg law of 18 December 2015 referred to above (subject to certain conditions).
- "Eligible assets" should be exempt from Luxembourg net wealth tax.
- The new IP Box tax regime rules should apply as from the fiscal year 2018.
How do these rules impact Luxembourg tax payers?
The new IP Box rules offer opportunities to businesses willing to invest in R&D activities. A business decision in the sense of undertaking such innovation efforts should take into consideration this tax variable and ensure all such opportunities are taken.
It is recommended that the entry into force of the new rules is taken into account, whether by a company which already benefits from the former IP Box tax regime rules or by a tax payer anticipating undertaking such innovation efforts.
It should also be noted that proper documentation (including transfer pricing reports) should be prepared and maintained to ensure a smooth transition towards the new IP Box tax regime.
This document (and any information accessed through links in this document) is provided for information purposes only and does not constitute legal advice. Professional legal advice should be obtained before taking or refraining from any action as a result of the contents of this document.