On 21 December 2007, the Luxembourg government introduced beneficial tax treatment for income deriving from intellectual property (IP) rights (the "IP regime"). Pursuant to the IP regime, 80% of net income and capital gains derived from software copyrights, patents, trademarks, designs, models and domain names is exempt from corporate income tax. Furthermore, under the IP regime, a taxpayer who develops a patent and uses it for its own activities is entitled to a notional deduction of 80% of the net remuneration that a third party would have paid on an arm's-length basis to use the patent. Qualifying IP assets are also exempt from the net wealth tax.
A much-awaited circular was finally issued by the Luxembourg tax authorities on 5 March 2009, laying down certain guidelines with respect to the IP regime and clarifying certain points. These points can be summarised as follows.
Nature of the IP rights
The circular provides explanations and illustrations for each category of qualifying IP rights. In general, the tax authorities have taken a broad view on the scope of the qualifying IP rights. In other words, IP rights will benefit from the regime as long as protection is granted. For instance, with respect to patents, it has been specified that supplementary protection certificates (SPCs) may also benefit from the IP regime.
Ownership of the IP rights
The circular confirms that the owner of a qualifying IP asset needn't necessarily be the creator, inventor or initial applicant in order to claim the benefit of the 80% exemption under the IP regime. This is, however, not true for the 80% notional deduction, which is only available to the creator of the patent.
Also, in accordance with the substance-over-form principle of Luxembourg tax law, the circular specifies that if the economic owner and the legal owner of qualifying IP assets are not the same person, only the economic owner can claim the benefit of the IP regime.
The IP regime only applies to income that qualifies as royalties within the meaning of Article 12 §2 of the OECD Model Tax Convention. For example, the circular mentions that qualifying income includes damages for the infringement of IP rights within the meaning of the OECD Model Tax Convention. The circular stipulates however that if an IP license agreement also includes the supply of other services or covers rights that are ineligible for the IP regime, the income should be prorated and only the qualifying portion can benefit from the favourable rules.
In order to benefit from the IP regime, the IP rights must have been created or acquired after 31 December 2007.
The circular stipulates that if the IP rights are acquired via tax-neutral transactions (e.g. roll-over relief upon the transfer of IP assets in a branch of activity or pursuant to a merger), the initial acquisition date of the IP assets by the transferring entity will be considered the acquirer's acquisition date as well.
Furthermore, the circular indicates that in the event of the migration of a non-resident entity to Luxembourg, the conversion of a tax-exempt entity into an ordinary fully taxable entity or the transfer of assets from a non-resident entity to a Luxembourg permanent establishment, the initial acquisition date of the IP assets shall continue to be used to determine when the assets were acquired. Even if, in these cases, a revaluation of the assets is required from a tax perspective, any such revaluation would not be relevant to determine the acquisition date of the assets.
In order to benefit from the IP regime, the IP rights must not have been acquired from a related party. A "related party" is defined in the law as (i) a company that holds a direct stake of at least 10% in the company acquiring the IP rights, (ii) a company in which the acquiring company has a stake of at least 10%, or (iii) a company at least 10% of whose share capital is directly held by a third company which in turn holds at least 10% of the company claiming the benefit of the IP regime.
In this respect, the circular specifies that a qualifying IP asset acquired by a company owned by an individual (or partnership) shareholder can qualify for the regime regardless of the size of that shareholder's stake in the company. In addition, according to the circular, the determination of whether two parties are related should be made at the time the intangible asset (IP right) is transferred.
Foreign withholding taxes
The circular confirms that foreign withholding taxes may be credited or deducted, subject to certain limitations.
Valuation of IP rights
Taxpayers can use all generally accepted valuation methods to value their IP rights. In transactions between related parties, valuation should be based on the arm's-length principle. In addition, the circular allows a simplified valuation method to be used for small and medium-sized companies.