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Transfer Pricing Forum: July 2018

Transfer Pricing Forum: July 2018

Transfer Pricing Forum: July 2018

1. Does your country have a Patent Box regime (or a functionally equivalent preferential IP regime) or is a proposal for one under consideration?
  • What benefits does it offer (e.g., partial exemption or reduced tax rate)?
  • What are the terms of the regime (e.g., definition of intangible property, definition of intangible income, definition of qualifying expenditures, treatment of R&D outsourcing, treatment of acquired IP or acquisition costs, grandfathering provisions for expiring regimes, administrative/compliance requirements, etc.)?

 

Belgian taxpayers can benefit from two types of Patent Box regimes:

  1. the so-called Patent Income Deduction (PID), which was introduced in 2007 but will be terminated on July 1, 2021, and
  2. the Innovation Income Deduction (IID), which has been in effect since July 1, 2016 and can be seen as the BEPS Action Point 5-compliant successor to the PID.

Patent Income Deduction

The Law of April 27, 20071 introduced the Belgian PID. This regime covers patent income from patents commercialized on or after January 1, 2007. The regime applies to Belgian companies, as well as Belgian permanent establishments (PEs) of foreign companies that invest in research and development (R&D) of patents and obtain ownership of patents or improve licensed IP.

The PID regime grants a deduction of 80% of the Belgian taxpayer’s patent income from the taxpayer’s Belgian tax base. The PID regime applies not only to income derived from patents licensed to a Belgian or foreign company (royalties) but also the resulting income from patents used by the Belgian taxpayer in producing patented products (so-called ‘‘embedded royalties’’).

The PID regime applies to patents and extended patent certificates. Other rights such as trademarks, trade names, and designs, do not qualify for the PID. The PID regime applies to income generated from:

  • Patents or extended patent certificates developed by the company in the company’s R&D center in Belgium or abroad;
  • Patents or extended patent certificates acquired by the Belgian company, if the patents are further developed by the Belgian company in the company’s R&D center in Belgium or abroad, regardless of whether or not this further development results in additional patents; and
  • Patents that are licensed by a Belgian company, provided that these patents are further developed in the company’s research center in Belgium or abroad, regardless of whether or not this further development results in additional patents.

Innovation Income Deduction

A. Evolution from PID to IID

Beginning on July 1, 2016, the existing PID regime was replaced to be in line with the OECD BEPS Action Plan, in particular, the dispositions under Action 5 relating to the modification of the Nexus approach to Intellectual Property (IP) special regimes (the so-called ‘‘IP boxes’’). Subject to certain conditions, the existing regime is grandfathered for five years.

Taxpayers can still benefit from the PID regime for any related patent income earned until June 30, 2021. The scope of this regime includes:

  • Self-developed patents requested before July 1, 2016 and
  • Improved patents and patent licenses acquired prior to July 1, 2016.2

 

According to the Modified Nexus Approach, there should be sufficient substance and an essential link between the R&D expenses, the qualifying Intellectual Property Rights (IPR), and the related income for a taxpayer to benefit from a beneficial income tax regime.

To meet these requirements, the Belgian government has created a new tax regime called the Innovation Income Deduction, which replaces the PID.

In this context, on February 2, 2017, the Belgian legislature published the new IID Law as the successor to the PID Law of August 3, 2016.

 

The new IID Law outlines the following dispositions:

  • The deduction is no longer granted solely for income from patents and supplementary protection certificates but instead extends to plant breeders’ rights, orphan medicinal products, data exclusivity, trade exclusivity, and last but not least, copy-righted software. Given this extension to other intellectual properties, Belgium uses the term ‘‘revenues from innovation’’ instead of ‘‘revenues from patents.’’
  • Now it will also be possible to apply the IID from the moment a qualifying IP right is requested (instead of being granted under the PID). Since it is not possible to guarantee that this request will ultimately be approved at the time of the application, a temporary exemption is granted only during the time the application is in progress. As soon as the requested IP right is actually granted, the temporary exemption becomes permanent.
  • The percentage of the deduction is increased to 85%, but it only applies to the Net revenue instead of the application to Gross revenue under the PID.
  • In addition, indemnities due to the company for the violation of IPRs and sums obtained for the alienation of an IPR can now be taken into consideration for the deduction.
  • The deduction will not be lost in the context of mergers, demergers, or similar transactions.
  • The unused deduction during a taxable period may be carried over to subsequent taxable periods.

 

The differences between the previous PID regime and the new IID regime are summarized in the following diagram:

Diagram Patent vs Innovation

B. Scope of the IID 3

The IID applies to income derived from:

  • Patents that are licensed by a Belgian company or a Belgian permanent establishment and
  • Patents that are used in the manufacturing/installation process of patented products and services that are carried out by the company or in its name (embedded royalties).

 

Furthermore, the IID applies to fixed (e.g., annual or monthly fee, irrespective of volumes produced) or variable (e.g., percentage of sales) patent income, as well as to other patent income (e.g., milestone payments).

The deduction no longer applies to gross income but rather qualifying net income, which is determined after a deduction of R&D costs.

Only R&D costs directly linked to the qualifying IP should be deducted. Interest payments and costs related to land and buildings that do not represent real R&D activities should not be deducted.

Qualifying Income 4 

The IID applies to income derived from:

The types of income streams that may qualify for the application of the IID include the following:

  • Revenues from licensing fees;
  • Embedded royalties;
  • Income derived from process innovation based on qualifying IP;
  • Damages on the basis of a court decision, amicable settlement, or insurance settlement;
  • Capital gains, if they are reinvested.

 

A specific requirement of the Modified Nexus Approach is that the beneficial tax regime is applied to the net IPR income and is subject to a specific formula to weigh the taxpayer’s own contribution to the creation of the IPR.

The following formula has been introduced to determine the amount of income that can benefit from the preferential regime: [qualifying R&D costs/total R&D costs] x net income from IPR.

The costs of outsourcing R&D work to related parties or acquiring IPR are excluded from qualifying costs. However, the costs for outsourcing R&D to unrelated parties or costs occur-ring within the framework of a cost contribution arrangement are considered qualifying costs. In addition, a lift-up of 30% of the total qualifying expenses for R&D is foreseen (without the fraction exceeding 1).

As mentioned above, unused IID can be carried forward to future taxable periods, without limitation in time. The taxpayer can also claim the benefits of the regime while a patent is still pending. Under the old PID regime, it was not possible to carry forward unused PID.

Tracking and Tracing 5

The IID requires certain documentation in the context of tracking and tracing the qualifying IP, income, and costs. This means that the taxpayer needs to document and prove the qualifying and global expenses for each IP. Upon certain conditions, the taxpayer can report and document a group or type of products or services.

In order to meet these special documentation requirements, a specific form must be added to the corporate tax return by both small- and medium-sized enterprises (SMEs), as well as large companies.

 

2. Assume that a Country A parent company owns an IP affiliate eligible for the patent box regime in Country B. What Country A issues arise from this situation (e.g., CFC legislation, taxation of dividends from the patent box, etc.)

In the event Belgium can be regarded as the parent company, i.e. country A, the normal rules on dividend income will apply, independently of whether a subsidiary (situated in country B) would apply a patent box or not.

However, Belgium, as an EU member state, is subject to the Anti-Tax Avoidance Directive (ATAD), which must be implemented into its domestic law by December 31, 2018. The ATAD includes an interest limitation provision to discourage artificial debt arrangements designed to lower the taxable base, as well as CFC legislation in case of artificial constructions.

 

3. Assume that a parent company owns an operating subsidiary in Country A and an IP affiliate eligible for the patent box regime in Country B. What are the Country A issues if royalties (or other payments) are paid from Country A to the IP affiliate in Country B? What is the impact if the IP affiliate does not meet the OECD modified nexus approach?

Royalty payments will need to be made according to the arm’s length principle. Intercompany transactions are under great scrutiny pursuant to new BEPS regulations.

Current Belgian regulations also oblige taxpayers exceeding certain thresholds to complete and submit transfer pricing forms. These forms disclose detailed transactional data; there-fore, transfer pricing compliance is highly recommended.

We also refer to the ATAD, as described above, and the future application of CFC legislation in case of artificial structures.

Apart from the ATAD implementation, Belgium did not implement specific legislation through which the deductibility of royalty payments would be linked to the IP box regime at the recipient level.

 

4. What other R&D tax incentives or benefits does your country offer to attract investment in R&D, e.g., credits, super-deductions, grants, tax holidays, etc.?

  • What are the requirements to be eligible for this tax relief (e.g., revenue thresholds, definition of intangible property, definition of qualifying expenditures, treatment of R&D outsourcing, treatment of acquired IP or acquisition costs, carry-overs, administrative/compliance requirements, etc.)?
  • Can these incentives be combined with benefits received from a patent box regime (if available) or other incentives?

 

Pursuant to current Belgian Tax Law, the additional R&D incentives include the following:

Wage Withholding Tax Exemption

Companies that employ researchers with a scientific master or doctoral degree benefit from a partial exemption from payment of withholding tax on their wages. Only 20% of the with-holding tax due on the wages of these researchers need to be transferred to the tax authorities, while 100% of the withholding tax due in principle can still be credited.

As a result of the Belgian corporate income tax reform, this withholding tax payment exemption now also applies to scientific bachelor degrees. As of January 1, 2018, employers can exempt payment of up to 40% of the wage withholding tax for their bachelors engaged in R&D programs. As of January 1, 2020, the exemption will further increase to 80%. The total ex-emption for bachelors is capped at 25% of the total exemption applied for masters and doctors.

Increased Investment Deduction or Tax Credit for Re-search and Development

A percentage of the acquisition or investment value of certain assets that have been acquired or established during the taxable period and that relate to R&D is tax deductible. 

This deduction comes in addition to the normal tax deductible depreciation of these assets, leading to an overall tax deduction that is higher than the assets’ value.

Qualifying fixed assets:

  • Patents,
  • Fixed assets that promote the R&D of new products and advanced technologies that have no effect on the environment or that aim to minimize the negative effect on the environment.

 

Applicable Rules and Rates

The increased investment deduction can be applied as a one-off deduction. In that case, the deduction equals 13.5% of the acquisition or investment value (assessment year 2019).

The deduction can also be spread over the depreciation period of the fixed asset (this option is not available for patents). In that case, the investment deduction each year equals 20.5% of the depreciation amount (for fixed assets acquired or established during assessment year 2019).

Carry-Forward to Later Assessment Years

When the deduction cannot be (fully) set off against the profits of the taxable period, the (proportion of the) investment deduction that has not been used can be carried forward without any time limit and can be set off against the profits of the sub-sequent taxable periods.

Option for a Refundable Tax Credit

Companies have the option to apply for a tax credit instead of the increased investment deduction. This tax credit allows the taxpayer to show how the tax advantage directly reduces the operational R&D costs.

In case there is insufficient tax against which to set off the tax credit, the credit can be carried forward to the following four assessment years. At the end of these four assessment years, the balance of the unused tax credit is cash refundable.

Tax Exemption of Regional Subsidies

Premiums and capital or interest subsidies on tangible and intangible assets granted by regional institutions within the framework of support to R&D are fully exempt from corporate tax.

Ruling Requests

Belgium has an efficient, transparent, business-oriented, and advanced ruling practice, which provides investors the necessary legal certainty on how the tax law will be applied to their specific situations or to specific transactions. Furthermore, when deploying IP-intensive R&D activities in Belgium, the appropriate business model and related tax and transfer pricing issues may be discussed in detail with the Belgian ruling authorities up front.

 

Dirk Van Stappen, Yves de Groote, and Andrea Ramirez KPMG Belgium

Original source: Bloomberg Tax

Footnotes:

1 Belgian Official Gazette, May 8, 2007, 3rd ed.

2 Subject to an anti-abuse clause in case of intercompany acquisi-tions after December 31, 2015.

3 Article 205/2 Belgian Income Tax Code.

4 Article 205/1, § 2, 2° Belgian Income Tax Code.

5 Article 205/4 Belgian Income Tax Code.

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