On 2 December 2016, the Council of Ministers approved the draft Bill on the new Innovation Income Deduction regime. This pre-draft law still has to be approved by Parliament, so the below is still subject to changes.
In contrast to the previous Patent Income Deduction (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 existing PID regime to 85% under the proposed regime resulting in an effective tax rate of 5.1% over the life time of the intellectual property. The new regime would enter into force on 1 July 2016.
Qualifying intellectual property
Going forward, the patent income will be called ‘innovation income’, which reflects the broader scope of the qualifying income. The Innovation Income Deduction (IID) can apply to income derived from the following intellectual property (IP) of which the company or branch has the full ownership, co-ownership, usufruct or license or exclusive rights:
- 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 (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.
Under the PID regime, the benefit was only available as from the year the patent was actually granted. Going forward, the benefit will also become available as from the date the patent has been applied for, provided that the patent is also actually granted afterwards.
All marketing related intangibles such as trademarks will still not qualify for tax benefits under the IID regime.
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:
- license 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;
- damages on the basis of a court decision, an amicable settlement or an insurance settlement.
Furthermore, also capital gains on qualifying IP will be included in the scope of the deduction going forward, 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 can 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 7-year 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, going forward, 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 to be compensated with future taxable profits (contrary to the previous PID regime).
Furthermore, the draft Bill provides for continuity of the IID in the case of tax neutral reorganisations (e.g. contribution, merger or (partial) demerger).
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 to 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 one condition that the compensation is charged without mark-up (i.e. as a disbursement). Based on the OECD Report on Action Point 5, acquisition costs 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, provided that the ratio as set out above (excluding the uplift) equals or exceeds 25%, a higher ratio may be applied. In that case, the taxpayer must prove that the outcome of the ratio between self-performed activities for R&D and the total R&D activities does not reflect reality.
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, going forward, 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, an expenditure overview and the link between the costs and income). 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).
Grandfathering and entry into force
The new regime would enter into force as from assessment year 2016, meaning it would apply to financial years ending on or after 1 July 2016. No new entrants can benefit from the previous PID regime since 1 July 2016. Taxpayers benefitting from the previous PID regime will be able to choose for the PID or the new IID regime and will be able to receive these benefits for five years (grandfathering until 30 June 2021). The choice for the new IID regime is irrevocable.