Finally, the new innovation income deduction (IID) has entered into force. Today, on 20 February 2017, the law with respect the IID has been published in the Belgian Official Gazette. The patent income deduction regime (PID) has been replaced with the IID regime in order to make it BEPS compliant, i.e. avoiding that business profits would be shifted artificially to a country with a beneficial regime for intellectual property (IP).
In contrast to the PID regime, the qualifying patent/innovation income will be calculated on a net basis. The percentage of this deduction will be raised from 80% under the PID regime to 85% under the IID regime resulting in an effective tax rate of 5.1% over the life time of the IP. The new regime entered into force on 1 July 2016.
Qualifying intellectual property
As from now, qualifying IP income is called ‘innovation income’, which reflects the broader scope of the qualifying income. The IID can apply to income derived from the following IP of which the company or branch has the full ownership, co-ownership, usufruct or licence of or right to use on:
- patents and supplementary protection certificates;
- breeders’ rights requested or acquired as from 1 July 2016;
- orphan drugs, i.e. a drug to treat rare diseases, (limited to first 10 years) requested or acquired as from 1 July 2016;
- data and market exclusivity granted by the competent authorities after 30 June 2016 (e.g. market exclusivity for orphan drugs or data exclusivity for reports with respect to pesticides, clinical studies of generic or animal drugs);
- IP of copyrighted software resulting from a research or development project as defined for the purposes of the partial exemption of wage withholding tax for research and development and which has not yet generated income before 1 July 2016.
Under the PID regime, the benefit was only available as from the year the patent was actually granted. The benefit under the IID will also be available by way of a temporary exemption (which will lead to a permanent exemption once the qualifying IP right has been granted) as from the date the qualifying IP right has been applied for. As the copyright of software automatically exists without request (provided conditions are met), there is no temporary exemption in this respect.
All marketing related intangibles such as trademarks do not qualify for tax benefits under the IID regime.
Innovation income
Without making any restrictions to SMEs, the following income will be considered as derived from the above qualifying IP in so far as the remuneration is included in the Belgian taxable result of the Belgian company or branch concerned:
- licence fees;
- IP income embedded in the sales price of own manufactured products for which a third party would be willing to pay a license (so-called ‘embedded’ royalties);
- IP income derived from process innovation;
- indemnities on the basis of a court/arbitral decision, an amicable settlement or an insurance settlement.
Furthermore, also the proceeds from a transfer of qualifying IP are in the scope of the deduction, subject to a reinvestment condition to be met within 5 years.
For the first taxable period during which the IID will be applied, the (net) innovation income should be decreased with the overall expenditure incurred during (preceding) taxable periods ending after 30 June 2016. Alternatively, one can opt to spread this recapture on a straight line basis during a period of maximum 7 years. In the case that the qualifying IP right terminates or is alienated before the end of this 7-year period, a correction will apply in order to limit the IID actually applied to the amount that would have been applied if no spread recapture had been opted for.
Modified nexus approach
In consideration of avoiding that the Belgian IID regime would appear to constitute a harmful tax practice, the modified nexus approach has to be taken into account. The nexus approach intends to ensure that, in order for a significant proportion of innovation income to qualify for benefits, a significant proportion of the actual research and development (R&D) activities must have been undertaken by the taxpayer itself.
As a matter of business practice, unlimited outsourcing to related parties or acquisition of IP from related parties should not provide many opportunities for taxpayers to receive benefits without themselves engaging in substantial activities.
Given the above, the IID will be determined by multiplying the innovation income with the below ratio. The fraction represents the ratio between the own R&D activities and the outsourced R&D activities/acquired IP (towards/from related parties). As such, the taxable result of a Belgian company or branch will be reduced by 85% of the total net innovation income after this fraction has been applied.
Important to note is that the ratio will be calculated on a net basis implying that (contrary to the PID regime) current-year deducted overall expenditure should be deducted from the current-year qualifying innovation income.
It is thereby also provided that any excess deduction that cannot be used due to insufficient taxable basis can be carried forward (without any limitation in amount or time) to be compensated with future taxable profits (contrary to the PID regime).
Furthermore, the law provides for continuity of the IID in the case of tax neutral reorganisations (e.g. contribution, merger or (partial) demerger). This continuity is also foreseen now for the PID.
Qualifying expenditure
The qualifying expenditure is the expenditure incurred by the company itself or the compensation for expenses of non-related companies in relation to outsourced R&D activities.
Qualifying expenditure must be directly connected with the qualifying IP. The expenditure does not include interest payments, costs related to immovable assets or any costs that could not be directly linked to a specific intangible. If R&D activities are outsourced to a non-related company via a related company, the related costs will qualify as qualifying expenditure on the condition that the compensation is charged without mark-up (i.e. as a disbursement). Based on the OECD Report on Action Point 5, the total acquisition cost related to qualifying intangible property should not be taken into account as qualifying expenditure but should be included in the overall expenditure.
Uplift of the qualifying expenditure
The qualifying expenditure may be uplifted by 30%, with a maximum of the overall expenditure. This means that the uplift may increase the qualifying expenditure but only to the extent that the taxpayer has non-qualifying expenditure. The purpose of this uplift is to ensure that the nexus approach does not penalise taxpayers excessively for acquiring IP or outsourcing R&D activities to related parties.
In exceptional circumstances, it can occur that although an uplift of 30% is added, the nexus ratio does not represent reality. As such, the modified nexus ratio can be rebutted by the taxpayer if the ratio as set out above (excluding the uplift) equals or exceeds 25%. A higher ratio may be applied in case the taxpayer proves that the outcome of the ratio between self-performed activities for R&D and the total R&D activities does not reflect reality. A ruling should be obtained in this respect.
Overall expenditure
The overall expenditure in the denominator of the ratio includes the qualifying expenditure increased with the acquisition costs related to qualifying intangible property and the expenditure for related-party outsourcing.
Tracking and tracing
Since the nexus approach depends on there being a nexus between expenditure and income, taxpayers will have to carefully track and trace the expenditure, qualifying IP and income. In this respect it is provided that supporting documentation will have to be kept available for the tax authorities (such as the gross amount of the income, the actual value of IP acquired from a related company, the overall expenditure of the current year and the qualifying and overall expenditures over the life time of the IP). In practice, it can be predicted that this will not be that easy to manage and may imply a cumbersome administrative burden for Belgian taxpayers. A transitional period is provided up to and including tax year 2019 (financials years ending as of 31 December 2018 until 30 December 2019, both dates inclusive). More detailed information with respect to this tracking and tracing and the timing thereof will be further determined by Royal Decree.
Grandfathering and entry into force
The new regime enters into force as of 1 July 2016, so a taxpayer may apply the PID in the first 6 months of 2016 and the IID in the last 6 months. Taxpayers benefitting from the PID regime or taxpayers that requested or acquired a patent prior to 1 July 2016, will be able to choose for the PID or the IID regime and will be able to receive the benefits under the PID for another five years (grandfathering until 30 June 2021). The choice for the PID is irrevocable and must (in principle) be made per IP right.
Hereafter, you will also find the link to our recorded Webinar ‘Exit patent income deduction, welcome innovation income deduction’ of 9 February 2017.
