Luxembourg has announced a new regime that offers a special tax incentive for certain income from intellectual property rights and will come into effect as of the 2018 tax year.
In accordance with Luxembourg’s tax relief, the following constitute intellectual property rights (IP): patents; copyright; software; trademarks; industrial designs and utility models; models; domain names; brands for services and goods such as production and marketing know-how.
Until June 30, 2016, Luxembourg taxpayers could enter, under certain conditions, into the so-called IP box scheme. This scheme allowed taxpayers to enjoy an exemption for 80 percent of their income from certain intellectual property rights.
As part of the OECD / G20 BEPS Action Plan, however, countries agreed that any IP box regime offering preferential tax treatment should only be available for IP income to the extent that there are corresponding substance requirements, in order to align the taxation of profits with the place of origin of economic activities. For IP box regimes, consensus was reached to adopt the nexus approach, which considers R&D activities and their associated expenditures as pre-conditions that taxpayers need to meet in order to benefit from a specific low tax regime.
Proposed IP box regime
The proposed Luxembourg IP box regime has been developed to conform with the nexus approach under the BEPS guidelines. The 80 percent exemption rate under the old rules remains unchanged, leading to an effective tax rate of approximately 5.2 percent % (based on the 26.01% aggregate income tax rate for companies with a registered office in Luxembourg City, applicable as from 2018). However, under the proposed rules, the conditions regarding eligible assets and income have been amended.
Under the proposed rules, a wider set of patents and copyrights on computer software will be eligible assets for the preferential tax treatment. On the other hand, contrary to the previous regime, trademarks and designs will no longer be eligible.
Eligible revenue that will qualify for preferential tax treatment include net income from direct use, royalties from the granting of licenses, or income from the sale, of eligible IP assets. It should be noted here that the notion of “net income” is used – thus, expenses for the year and, if applicable, prior tax losses in relation to eligible IP assets will be deducted to determine the net amount eligible for the exemption.
The proportion of net income qualifies for preferential tax treatment will be determined based on the nexus ratio, which is the proportion of eligible expenditure to total expenditure.
Computation of the IP income benefiting from the exemption
Based on the nexus approach, the IP income benefiting from a tax exemption is calculated based on a ratio taking into account the R&D costs incurred by the taxpayer, which can be summarised as follows:
Eligible expenditure includes R&D expenditure directly related to eligible IP assets incurred by the taxpayer. It should be noted that outsourcing costs for R&D are eligible, as long as these activities are carried out by unrelated parties.
All costs not directly related to an eligible IP asset, as well as certain expenses, such as real estate costs, interest and other financing costs and acquisition costs of IP assets, are not eligible.
Total expenditure under the proposed rules includes eligible expenditure, acquisition costs and research expenditure outsourced to related parties.
In order to remain competitive, and in accordance with the BEPS guidelines, Luxembourg allows the eligible expenditure to be uplifted by 30 percent. This uplift is allowed as long as the eligible expenditure does not exceed the total amount of expenditure.
Firstly, the intellectual property rights must have been acquired or developed after December 31st, 2007. Secondly, the intellectual property rights and the development costs already spent must have achieved a favourable trade balance. Furthermore, proof is required when intellectual property rights are acquired that they were acquired for reasons unrelated to taxation. The transfer of intellectual property rights between parent and subsidiary companies with a shareholding exceeding 10% and by subsidiary companies with common shareholders is not permitted.
Accordingly, if intellectual property rights are transferred to an IP-Company formed in Luxembourg, gains made from the intellectual property rights can be preferentially taxed in accordance with Luxembourg’s tax relief. To do so, it is required that the IP-Company has a business address in Luxembourg and that at least one of its directors be resident in Luxembourg. In respect of the use of such IP-Companies in practice in Luxembourg, the structure of the IP-SOPARFI-Holding Company, which belongs to a group of companies, is chosen and which, among other advantages, can profit from dividend distributions being tax-free.
In Luxembourg, intellectual property rights are not subject to the net wealth tax. Similarly, gains made from liquidation, royalties payments or interest payments are exempt from taxation.
Also to be noted that there is a tax analysis letter system to secure upfront the corporate tax treatment of transactions with prompt answer from the Luxembourg tax authorities.
Interaction with the old IP regime
The former IP regime (under article 50bis LITL) was repealed in 2016, but with a grandfathering period until 30 June 2021. Consequently, the bill foresees that taxpayers with eligible IP assets, and which could possibly apply both IP regimes during this transition period, may choose which regime they prefer to apply. However, once done, the option is irrevocable.
Loi du 18 avril 2001 sur les droits d’auteur, les droits voisins et les bases de données; http://legilux.public.lu/eli/etat/leg/loi/2001/04/18/n2/jo
Luxembourg Budget (Art. 5. Régime fiscal de la propriété intellectuelle, pp 5388); http://www.impotsdirects.public.lu/content/dam/acd/fr/legislation/legi15/Memorial-A—N_-242-du-23-decembre-2015.pdf
OECD – BEPS Action Plan; https://www.oecd.org/ctp/BEPSActionPlan.pdf
Grant Thornton – New Luxembourg tax regime for income generated by intellectual property; http://www.grantthornton.lu/online/www/navMain/publications/908/981/982/contentContainer/5218/4735/ENG/New%20Luxembourg%20tax%20regime%20for%20income%20generated%20by%20IP.pdf
PWC – New IP tax regime in Luxembourg – bill 7163 submitted; https://www.pwc.lu/en/tax-consulting/docs/pwc-tax080817.pdf
Formation/Incorporation/Setting up of a Company for Intellectual Property Rights (IP-Box) in Luxembourg (patents, trademarks, designs); http://www.startup-luxembourg.com/verwaltung-immaterieller-wirtschaftsgueter-ip-box.html