The amendment of the existing rules will have no retroactive effect on existing IP structures: Luxembourg taxpayers with an IP structure in Luxembourg which benefit from the existing regime will be granted a transitory period ending on June 30 2021 during which they will still be able to benefit from the current regime (grandfathering rule). A draft law is expected to be released in the course of this year.
Back in September 2014, a report on Action 5 of the OECD's BEPS action plan was released: 'Countering harmful tax practices more effectively, taking into account transparency and substance'. The report refers to the work of the Forum on Harmful Tax Practices (FHTP). Action 5 requires the FHTP to revamp the work on harmful tax practices, with a priority and renewed focus on requiring substantial activity for any preferential regime. The report focuses on the preferential tax treatment given to certain income arising from qualifying IP and offers three possible approaches.
Nexus approach for IP regimes under the September 2014 BEPS report on Action 5
One of the three approaches is the so-called nexus approach. This approach aims to ensure that IP regimes, since they are intended to encourage R&D activity, only provide benefits to taxpayers that do in fact engage in such R&D activities. As a consequence, according to the nexus approach, a taxpayer will be able to benefit from an IP regime only to the extent that it can demonstrate that it did incur expenditures, such as R&D, which gave rise to the IP income.
Modified nexus approach endorsed in February 2015
To reach a consensus on a single approach, a proposal was put forward by Germany and the UK, which has now been endorsed by all OECD and G20 countries. The agreed approach (so-called 'modified nexus' approach) is based on the principle of the nexus approach proposed in the September 2014 paper, with the following amendments:
- A 30% increase in qualifying expenditures – the expenditures that a taxpayer incurs on IP and which can be taken into account in the nexus approach calculation can, in limited circumstances, be increased by 30%;
- Closing old regimes to new entrants – countries that have IP regimes in place which are not consistent with the nexus approach have to amend their regimes. The amendment process should start in 2015. No new entrants to such IP regimes after June 30 2016; and
- Grandfathering and transition – taxpayers benefitting from existing regimes that do not comply with the nexus approach will not be able to receive any additional tax benefits from those regimes after June 30 2021.
OECD work on the practical implementation of the nexus approach is still underway and will focus, among other things, on determining in further detail which IP assets could qualify for benefits under an IP regime. In this respect, the modified nexus approach currently provides that only patents and functionally equivalent IP assets that are legally protected and subject to approval and registration processes can qualify. It excludes marketing-related IP assets such as trademarks. OECD work on implementation is expected to be finalised by June 30 2015 and the agreed approach and additional guidance will be included in the 2015 Action 5 progress report.
At the Luxembourg level, one should keep in mind that at this stage, the Luxembourg Government has only made an announcement. Nothing concrete has been determined yet, as far as the future Luxembourg IP regime is concerned. No draft legislation has been elaborated yet. As long as the OECD work has not been finalised, the scope and details of the new regime to be introduced in Luxembourg to replace the existing IP regime remains unsure. As a consequence, it is too soon to take any action. However, taxpayers now wishing to set up an IP structure to benefit from the existing Luxembourg IP regime as well as taxpayers in the process of implementing an IP structure in Luxembourg should seek the advice of their Luxembourg tax adviser before taking any investment decision given the upcoming changes.
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