Luxembourg: New BEPS-compliant IP regime to open up opportunities

Bernard David	Thierry Bovier,

Luxembourg taxpayers had until June 30 2016 to benefit from the IP box regime that provided for an 80% exemption on income derived from certain IP rights. Because the IP box regime was not in line with the requirements of the OECD final report on Action 5 of the BEPS Project, it had to be abolished (subject to some transition rules).

The long-awaited draft bill on the new IP regime was issued on August 4 2017.

The proposed rules will provide an 80% exemption on income derived from the commercialisation of certain IP rights, as well as a 100% exemption from net wealth tax.

Qualifying assets under the proposed law would include patents (broadly defined) and copyrights on software. Trademarks, designs and models are excluded, however. Qualifying income would include royalties, capital gains and embedded IP income from the sale of products or services directly related to the qualifying IP asset. The regime would apply on a net income basis, meaning that annual costs relating to the IP, as well as previous tax losses relating to the IP, would have to be deducted from the gross income.

The nexus ratio, the cornerstone of the new regime, would determine the proportion of net income entitled to the benefits under the new rules based on the ratio of qualifying expenditure and overall expenditure. Qualifying expenditure would include all research and development (R&D) expenditure incurred by the taxpayer for the creation, development or improvement of qualifying IP rights. It would not include interest and financing charges, the costs of acquisition of the IP, real estate costs or costs that cannot be linked directly to the eligible IP asset. The outsourcing of R&D would be permitted and included in qualifying expenditures provided it was carried out by unrelated parties. Overall expenditure would be the sum of qualifying expenditure, IP acquisition costs and outsourcing costs to related parties.

The nexus ratio and the net qualifying income would be cumulative and the taxpayer would be required to track income and expenditure by IP asset, group of IP assets or, alternatively, products or services arising from IP assets.

To remain competitive, Luxembourg would allow the 30% uplift on qualifying expenditure.

Finally, in an intragroup context, all transactions would have to be properly priced and documented according to the new transfer pricing guidelines deriving from BEPSActions 8-10.

Based on the draft rules, if a company incurs all of the expenditure to develop a qualifying IP asset, all income derived from the commercialisation of that IP would qualify for benefits, leading to an effective tax rate of approximately 5.2%.

This new IP regime, along with newly introduced R&D incentives, would be beneficial for Luxembourg’s economic diversification objectives. We hope that it will be further enhanced after a first assessment period to include all options offered by BEPS Action 5 (e.g. third category of IP for SMEs) and offer more flexibility with regard to the organisation of R&D activities within a group of companies. 

By Bernard David and Thierry Bovier, Deloitte Luxembourg.