Yesterday, Luxembourg went the extra mile in the pursuit of promoting innovation by passing the new intellectual property tax regime (the “new IP regime”) into law. The start of its period of effectiveness has been set to 1 January 2018.
The new IP regime makes Luxembourg compliant with the “modified nexus approach” as developed by the OECD in the final BEPS report of Action 5, “Countering Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance.”
This newsletter highlights the key amendments to the initial bill submitted last year. Please refer to our previous Tax Alert 2017-14 for more details.
A specific provision on the treatment of R&D expenditures incurred by a foreign permanent establishment of a Luxembourg head office has been added to the text, specifying that such expenditures are included in the R&D qualifying expenditures (if directly connected to the eligible IP assets and required for actual R&D activities) for the determination of the nexus ratio, provided that all of the following conditions are met:
In addition, those expenses can only be considered for the purpose of the determination of the nexus ratio if they are directly related to the creation, development, or improvement of a qualifying IP asset allocated to the Luxembourg head office. In other words, the Luxembourg head office should (i) perform and control all significant functions related to the R&D activities (such as development, enhancement, maintenance, protection, and exploitation) carried out by the foreign permanent establishment, which generated the expenses, and (ii) bear all the risks related to those functions.
As expected, the law takes over most of the bill provisions and aligns the new IP regime to the OECD requirements for taxation where substantial activities are effectively carried out.
This new IP regime is essentially similar to the other IP regimes across Europe with the exception of some specific differences, like the partial exemption of capital gain on disposal of qualifying IP assets or the possibility to consider R&D expenditures of foreign branches (located in the EEA) as qualifying R&D expenditures, which could be in the Luxembourg regime’s favour.
As far as timing is concerned, this new IP regime will coexist with the repealed “old” IP regime, which is still applicable during the grandfathering period (subject to certain conditions), until 30 June 2021.
It’s now time for groups to review their strategies with respect to R&D activities, implement the appropriate and efficient tracking of R&D income and expenditures, and prepare supporting documentation (according to transfer pricing guidelines) in order to determine the R&D income benefiting from the 80% exemption.
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