On August 4th 2017, the Minister of Finance submitted a draft law to the Luxembourg Parliament, which intends to introduce a new intellectual property regime. The draft law introduces a new Article 50ter in the Luxembourg income tax law in order to fill the void caused by the staggered withdrawal of the former Article 50bis. If enacted as such, the new Article 50ter would be applicable as of the tax year 2018.
The new Article 50ter, akin to the previous regime, would provide for a 80% exemption on the adjusted and compensated net eligible income (including royalty income, capital gains, income embedded in the sale price of products and services as well as indemnities) derived from certain intellectual property rights and a full net wealth tax exemption of the qualifying intellectual property rights. Additionally, an uplift of up to 30% of the eligible expenses is foreseen.
The scope of the Article 50ter is, however, more restrictive than the one of the previously existing regime, in order to ensure its compliance with the Organisation for Economic Co-operation and Development’s Base Erosion and Profit Shifting Action 5.
The restrictions are two-fold, a narrower scope of qualifying assets and the introduction of a nexus ratio.
Under Article 50ter, solely
- software protected by copyright, or
- patents and functionally equivalent intellectual property rights protected in conformity with national or international norms (i.e. marketing related intellectual property assets such as trademarks and domain names are excluded)
can benefit from the regime, provided that they are developed or improved (a) after December 31st 2007, (b) by the taxpayer directly or by a foreign permanent establishment located within the European Economic Area of a taxpayer, if such permanent establishment remains in place and does not benefit from a similar tax regime in its country of location; and (c) they result from effective research & development activities (“R&D”).
The nexus ratio, in its turn, is introduced in order to limit the partial exemption to the value creation effectively undertaken by the taxpayer. The adjusted and compensated net eligible income (as further detailed below) which may benefit from the 80% exemption is, therefore, determined on the basis of the ratio between the eligible expenses (with up to 30% uplift) and the total costs of the intellectual property right. The eligible expenses include all expenditures incurred by the taxpayer for the creation, development or improvement (R&D) of the qualifying intellectual property as well as the fees paid to unrelated parties to which the R&D is outsourced.
The adjusted and compensated net eligible income is, akin to the previous regime, computed by taking into account the gross income from which the directly related expenses are deducted. As a novelty however, the eligible income has to be adjusted for previous year expenses related to the intellectual property rights (the draft law provides for different options depending on whether the costs were deducted or capitalized from an accounting perspective), in order to ensure that losses incurred by intellectual property rights benefiting from the partial exemption regime cannot be used to offset other types of income that would have been taxable. Lastly, the eligible income from all qualifying intellectual property rights has to be aggregated, in order to ensure that solely the “global net income” is effectively partially exempted.
The draft law introduces stringent documentation obligations, which require the taxpayers to track and provide sufficient evidence with regard to all (qualifying and total) expenses incurred and income earned on a per asset basis or a per product family basis in case of complex businesses, thus effectively reversing the burden of proof. Of course, all intra-group related transactions will continue to be covered by the existing transfer pricing documentation requirements.