Influenced by the OECD, Member States have had to amend their legislation on 'IP Box' deductions for Innovation income. Indeed, during 2015, the OECD published several documents as part of the BEPS Action Plan 5. One of these documents is the report 'Countering Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance', which, among other things, analyses the different innovation incentive regimes or 'IP Boxes' applied in certain OECD member countries.
The innovation income deduction provides for significant changes compared to the patent income deduction. Among other things, the scope of the deduction has been extended beyond patents and supplementary protection certificates. Other intellectual property rights, including copyright-protected computer software, are now taken into account. In addition, in accordance with Article 205/4, § 5 ITC 92, the amounts obtained on the definitive transfer of intellectual property rights are also eligible, under certain conditions, for the application of the Innovation income deduction. For more details on this scheme, we refer you to our detailed article on this subject 'The innovation income deduction - what's new?'
The innovation income deduction scheme is part of an extensive package of tax incentives which are part of a comprehensive plan to attract new businesses to Belgium and to encourage Innovation in our country.
Patent income deduction limitations and OECD recommendations
Since the assessment year 2008, companies have been able to exempt 80% of their gross patent income from tax. This means that the effective tax rate on such patent income is significantly reduced. The aim of this measure is to stimulate Innovation through research and development and to encourage the protection of this Innovation by patents.
However, the OECD concluded that the patent income deduction introduced at the time was a ‘harmful tax regime’ that needed to be changed. Belgium therefore repealed its old patent regime and replaced it with the new Innovation income deduction scheme.
The new innovation deduction is calculated based on the net income generated by the intellectual property right in question. The innovation income deduction was introduced by the Act of 9 February 2017 and came into force retroactively on 1 July 2016.
The condition of having an R&D department in Belgium or abroad in order to qualify for the deduction is no longer relevant, as it has been replaced by the so-called 'Nexus Ratio' condition.
The Nexus Ratio (a ratio set by the OECD) ensures that only companies that have developed the intellectual property themselves or whose (part of) the development was outsourced to third parties can make optimal use of the deduction.
For companies of which the intellectual property rights were acquired or of which (part of) the development activities were developed (and charged) by a company affiliated with the company, the deduction is limited to the own efforts in development. In other words, if I acquire an intellectual property, but do not develop it further within my own company, then I have no Innovation deduction due to the operation of the nexus ratio.
It is true that in the calculation the own R&D activities are increased by 30% so that a partial development of the IP by an affiliated company does not immediately have an impact on the deduction.
Gross income vs. net income
The patent income deduction provided for a deduction based on the gross income, while the innovation income deduction is based on the net income. The innovation income deduction will therefore only result in an actual tax deduction when the innovation income exceeds the (historically) incurred expenses for R&D. It is true that the legislator foresees that the historical costs for research and development can be spread over 7 years.
Whereas under the old regime only patents and supplementary protection certificates were eligible for the deduction, the scope of the innovation deduction is much broader. For example, copyright-protected computer software, orphan drugs, government-granted market exclusivity and plant breeders' rights now also qualify for the deduction.
Amounts obtained from the final transfer of the intellectual property are also eligible under certain conditions.
Furthermore, the deduction percentage for the Innovation income deduction is 85%. For the patent income deduction this is 80%.
In line with the flexibility granted by the OECD, the Belgian government has provided for a transitional period between 1 July 2016 and 30 June 2021, so that, under certain conditions, companies can continue to benefit from the patent income deduction for five years.
Under this transitional rule, companies could still apply the deduction of patent income to patents applied for or acquired before July 1, 2016. However, for patents filed on or after July 1, 2016, the deduction of patent income could no longer be applied and the income would only qualify for the Innovation income deduction.
For patents applied for or acquired before July 1, 2016, it was an irrevocable choice to apply one of the two regimes during this transition period.
The Innovation income deduction and the effect of the transitional regime on the historical costs of R&D
As mentioned above, the innovation income deduction, contrary to the patent income deduction, is applied to the net income according to the following formula:
(Gross revenue - intellectual property related R&D costs for the year - historical R&D costs)
x nexus ratio x 85% = innovation income deduction
The approaching end of the transitional period has raised questions about the treatment of R&D expenses incurred in the years before the application of the innovation income deduction, when the patent income deduction was applied. Indeed, the law provides that historical R&D expenditures need not be reversed when the patent income deduction was applied.
In brief, the former Deputy Prime Minister and Minister of Finance, Alexander De Croo, confirmed that article 205/2, §2 ITC 92 should be interpreted as meaning that, in case of application of the patent income deduction during the transitional period, the R&D expenses incurred during the transitional period should not be deducted from the gross Innovation income for the determination of the innovation income deduction as from 1 July 2021.
In practice, this means that it is sufficient to have used the patent income deduction at least once during the transitional regime (1 July 2016 to 30 June 2021) in order to exclude all R&D expenses incurred before 1 July 2021 from the calculation of the net Innovation income.
Therefore, in order to benefit from the exclusion of R&D expenses incurred before 1 July 2021, if this scheme has not yet been applied during the transitional regime, the patent income deduction must be applied, if possible, during the 2021 tax year for the period from 1 January 2021 to 30 June 2021. In practice, companies wishing to apply this scheme will have to foresee its application in their tax return (income 2021, assessment year 2022).
For the sake of legal certainty and to avoid any risk of adjustment or rejection of the applied deduction, companies can also submit a request for a ruling to the ruling commission. In this context, requests relating to the assessment year 2022 must be the subject of a "pre-filing" that must be submitted by the end of January 2022 at the latest.
Because of this approaching deadline, it is advisable to review the options as soon as possible. After all, time is needed to calculate and document the deduction and to apply for a ruling.
Beware of tax consequences
The patent income deduction will thus be definitively consigned to the past as from 1 July 2021.
For some firms, the end of the transitional period may have significant tax implications, as this scheme may, depending on the case, be more or less advantageous than its predecessor.
It may therefore be advisable to already examine what the impact will be on the company and whether it is still possible to optimise things in view of the disappearance of the patent income deduction.
With the necessary experience and a team specialized in Innovation and patent income deductions, BDO is at your disposal to advise on this subject and to assist your company in its procedures.
If you have any questions or would like to be assisted by one of our experts, do not hesitate to contact the BDO team:
Our other articles on the same topic:
What you need to know about the Innovation income deduction
Ruling Commission sets new deadline for prefilings on transfer pricing and innovation income deduction
The innovation income deduction - what's new?