Luxembourg new tax regime designed to increase intellectual property (“IP”) developments has entered into force in April 2018 and is effective as of 1 January 2018. The new regime (the “IP Law”) follows after the Luxembourg government abolished its former IP regime as from 30 June 2016 (subject to grandfathering rules in effect until no later than 30 June 2021).
The introduction of a new IP regime supports the Luxembourg Government’s strategy to maintain a competitive tax system while being fully compliant with OECD BEPS Action 5, a standard built on the modified nexus approach, requiring substantial activity and investments in R&D expenditures to be line with value creation.
To further support Luxembourg as a hub for IP activities, the Luxembourg government also introduced a series of measures providing financial and logistic support to R&D activities in May 2017.
Qualifying IP assets
Under the new regime, qualifying IP (“Eligible Asset”) include (a) patents, (b) utility models, (c) complementary protection certificates for patents for medicine and plant protection products, (d) extensions of a complementary protection certificate for pediatric medicines, (e) plant variety certificates, (f) orphan drug designations and (g) software protected by national copyrights, provided such Eligible Asset was constituted, developed or improved after 31 December 2007.
Modified nexus approach
According to the IP Law, 80% of the Adjusted Net Eligible Income derived from an Eligible Asset qualifies for a tax exemption. Furthermore, such Eligible Asset are fully exempt from the annual (0.5%) net wealth tax. The Adjusted Net Eligible Income is determined by applying the following formula:
Net Eligible Income is defined as Eligible Income reduced by Total Costs and further reduced by Other Related Costs
Eligible Income includes (a) royalties, (b) income in direct relation with Eligible Assets which are embedded into the sale price of services or products (and which can be determined through transfer pricing methods such as the CUP and/or Residual Profit method in general), (c) income arising from the sale of an eligible asset and (d) indemnities obtained within the framework of a legal proceeding or of an arbitrage concerning eligible assets
Other Related Costs constitutes all costs that are indirectly linked to the Eligible Asset and which are attributable to the same accounting / tax year
Total Costs equals Eligible Costs increased by the Eligible Asset acquisitions costs and the Related R&D Costs
Related R&D costs includes all costs from activities carried out in direct relation to the constitution, the development or the improvement of an Eligible Asset which have been outsourced to related parties
Eligible Costs (as and when incurred, irrespective of accounting or tax treatment) equals the sum of
(i) costs from activities carried out in direct relation to the constitution, the development or the improvement of an Eligible Asset (excluding Eligible Asset acquisition costs, interest expenses, financing costs and real estate costs)
(ii) expenses incurred by a permanent establishment located in the European Economic Area other than Luxembourg (which is operational at the time the income is derived and does not itself benefit of a tax regime similar to the IP tax regime in the country of its establishment) and
(iii) costs of R&D outsourced directly or indirectly (without any mark-up) to third parties.