As announced earlier this year, a bill of law introducing a new Luxembourg intellectual property (IP) regime was submitted by the Luxembourg Government on 4 August 2007. The content of the bill is based on the modified nexus approach and thus reflects the content of the BEPS Action 5 report released by the OECD in 2015.
If this bill is enacted as such, its provisions, introduced via a new article, article 50ter of the Luxembourg Income Tax Law (LITL), would be applicable as from tax year 2018, alongside - without any combination possibility - the former IP regime set forth under article 50bis LITL (until 30 June 2021, ie, the end of the latter’s grandfathering period).
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), as well as a full exemption from net wealth tax on these assets.
To be considered as eligible, IP assets must:
- be of commercial character (IP assets of marketing character such as trademark are thus excluded);
- have been constituted, developed or improved on or after 1 January 2008 (based on the filing date of the registration request) in the context of research and development (R&D) activities carried out by the taxpayer directly or by a foreign permanent establishment (PE) of the taxpayer located within the European Economic Area (EEA) provided such PE is operational at the time income is received and does not benefit from a similar IP tax regime in the country where it is located; and,
- fall within one of two groups: (i) inventions protected in conformity with national or international norms by a patent, a utility model or other functionally equivalent IP or (ii) software protected by copyright in conformity with national or international norms.
As a general rule, the adjusted and compensated net eligible income should be determined on an asset-per-asset basis. Taypayers must be able to demonstrate the link between the costs incurred and the income received (or the capital gain realized). However, when facing numerous eligible IP assets and complex R&D activities (the taxpayer must be in a position to prove this), a product or service-/family of product or of services-based approach could be followed when computing the adjusted and compensated net eligible income.
The income eligible to the 80% exemption is determined according to the following formula:
To be considered as eligible, the income must be linked to an eligible IP asset and fall within one of the following categories: royalty income, income related to an eligible IP asset embedded in the sale price of a product or service, capital gains and indemnities in certain circumstances.
To obtain the adjusted and compensated net eligible income, the eligible income is then reduced by all expenses linked (directly or indirectly) to the eligible IP asset subject to specific adjustments. All income and expenses must be in line with the arm’s length principle.
For the purpose of delineating the specific ratio, eligible costs are defined as the sum of expenses, incurred during the current fiscal year or previous fiscal years, which are necessary to the R&D activities, directly linked to the constitution, development or improvement of the eligible IP asset whether they are incurred by the taxpayer or its PE located within the EEA (provided such PE is operational at the time income is received and does not benefit from a similar IP tax regime in the country where it is located) or outsourced to third parties (or to a related party in so far as this party pays the remuneration it receives to a third party without applying a margin). Acquisition costs, financing costs (including interest) and real estate costs are in particular specifically excluded from eligible costs.
A 30% uplift may apply to eligible costs, however, the uplift is capped at the amount of total costs incurred during the current fiscal year or previous fiscal years.
Finally, total costs include eligible costs, acquisition costs and R&D costs outsourced to related parties in relation to the eligible IP asset, incurred during the current fiscal year or previous fiscal years.
This new regime aims at complying with international standards and in particular the BEPS Action 5 report (Countering Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance) while ensuring Luxembourg remains an attractive center for intellectual property and research & development activities.
For taxpayers with existing IP assets, it will be necessary to consider which IP regime they wish to apply in the coming years. Indeed, when IP assets are eligible to both IP regimes set forth under article 50bis LITL and article 50ter LITL, the taxpayer will have to choose which regime it decides to apply until 30 June 2021, the choice being irrevocable as from the fiscal year where it is exercised.