The Luxembourg Government submitted a bill of law to the Parliament on 4 August 2017, to introduce a new Base Erosion and Profit Shifting Action (BEPS)-compliant regime of taxation of certain intellectual property rights (IP). This regime would provide for an 80 percent exemption on certain income derived from qualifying IP rights, as well as a full exemption of these rights from net wealth tax. The legislation is expected to be applicable with effect from the 2018 fiscal year.
The bill is inspired mainly by the modified nexus approach adopted by the Organization for Economic Cooperation and Development (OECD) in its report on BEPS Action 5 on Harmful Tax Practices. The new regime would apply in parallel with the initial Luxembourg IP regime that was terminated on 30 June 2016, but with a grandfathering period expiring on 30 June 2021. Under the nexus approach, the benefit of the new regime will be linked to the level of research and development activities carried out by the taxpayer.
Eligible IP Rights
The scope of eligible IP rights has been narrowed and would encompass the following two main groups of IP rights that are created, developed or improved after 31 December 2007:
- Patents and functionally equivalent IP rights that are legally protected by utility models, extensions of patent protection for certain drugs and phytopharmaceutical products, plant breeder’s rights, and orphan drug designations; and
- Software protected by copyright.
Marketing-related IP rights (such as trademarks, designs and domain names) are not included in the new regime.
Eligible Income and Expenses
The income qualifying for the new regime would be determined on the basis of the nexus ratio. Indeed, only a certain proportion of the net income derived from a qualifying IP right would be able to benefit from the new regime. This nexus ratio corresponds to the ratio between (i) the expenses that the taxpayer incurs for the creation, development or improvement of a qualifying IP right, and (ii) the total expenses relating to that IP right.
Eligible income would include:
- Income derived from the use or the granting of the right to use qualifying IP rights;
- IP income embedded in the sales price of products or services directly related to the eligible IP asset;
- Capital gains realized upon the disposal of an eligible IP right; and
- Indemnities obtained in the context of on an arbitral or judicial decision directly linked to a breach of a qualifying IP right.
Qualifying expenses for the new regime would include the expenses necessary to conduct research and development activities of the taxpayer, and which relate directly to the creation, development or improvement of an eligible IP right.
It should be noted that outsourced research and development costs would be eligible, provided such activities are carried out by non-related parties. All costs not directly related to an eligible IP right, as well as certain expenses (e.g., costs of real estate, interest and other financing, and acquisition of IP rights) are not qualifying.
Finally, when computing the amount of eligible expenses, taxpayers are allowed to increase such expenses by up to 30% (but they cannot exceed the amount of total expenses). Therefore, the amount of IP income benefiting from the new regime may be increased.
Taxpayers should be able to track and document their qualifying total expenses to evidence the connection between such expenses and the eligible IP income.
More generally, in light of the constraints triggered by the BEPS Action 5 on Harmful Tax Practices, it may be anticipated that a certain alignment of the IP tax regimes within the OECD countries will occur within the next months. The key criteria to assess the appropriate jurisdiction to carry out research and development activities will be closely linked to the nexus approach. Therefore, it will be important to take this into account when determining where to locate global research and development headquarters, especially where research and development activities are carried out by multiple entities located in different jurisdictions within the same group.