Luxembourg.Tax Regime for Intellectual Property Income December 2009
Table of contents 1. Introduction... 2 2. Qualifying IP rights... 3 3. Tax benefits under the IP regime... 3 4. Conditions to benefit from the IP regime... 4 5. Foreign withholding taxes... 5 6. Valuation of IP rights... 5 7. Conclusion... 5 8. Example... 6 Contact...7 2
1. Introduction On December 21, 2007 the Luxembourg legislator introduced Article 50bis into the Luxembourg income tax act (the "IP regime") to encourage investments in technological innovation by simulating R&D as well as managing and holding intellectual property assets ("IP"). Pursuant to the IP regime, individuals as well as corporate entities can benefit from an exemption of 80% for income derived from qualifying IP rights as well as on capital gains realized on the sale of such IP. In addition, the IP regime includes a benefit for taxpayers who develop a patent and use it for their own activities. Subsequently, the IP regime has been amended by the law of 19 December 2008 to exclude from net wealth tax qualifying IP assets. Finally, a circular issued by the Luxembourg tax authorities on March 5, 2009 laid down some guidelines with respect to the interpretation of the IP regime. 2. Qualifying IP rights Eligible IP are copyrights on software, patents, trademarks, designs, models and domain names. The common element of IP rights that fall within the scope of Article 50bis, is that they confer to their owner an exclusive exploitation right in the territory for which a protection is granted. The IP regime applies to income that qualifies as royalties within the meaning of Article 12 2 of the OECD Model Tax Convention. Consequently, the commentary to article 12 2 of the OECD Model Tax Convention is a valid source to determine whether an item of income is eligible for the IP regime or not. However, the scope of Article 12 2 is more extensive than Article 50bis, the latter excludes from its scope copyrights (other than copyrights on software), plans, formulas or secret processes and information concerning industrial, commercial or scientific experience. 3. Tax benefits under the IP regime 3.1. Remuneration for the use or the right to exploit IP rights Pursuant to the IP regime, 80% of all net income derived by a Luxembourg taxpayer as a consideration for the use of or the right to exploit qualifying IP rights is exempt from tax. The term net income is defined in the law as the difference between the gross revenue and all expenses incurred in direct economic connection with such revenue, including interest deriving from the financing of IP rights, amortization, and potential write-offs recorded in respect of each particular IP right. 3.2. Capital gains on the disposal of IP rights According to the IP regime, 80% of net capital gains arising from the disposal of qualifying IP rights are exempt from tax. However, the gain will remain taxable up to the extent of the expenses in direct connection with the income as well as depreciations and write downs that have reduced the tax base of the taxpayer in the tax year of the disposal or in any previous tax year. 3
3.3. Use of self-developed patents by taxpayers for their own businesses A taxpayer who develops a patent and uses it for its own activities is entitled to a notional deduction amounting to 80% of the net remuneration that a third party would have paid on an arms length basis for the use of such patent. This deduction can be claimed in addition to the expenses incurred during the relevant year in connection with the patent. The taxpayer may apply this deduction as from the moment the patent application is field. If the patent application is later denied, the deductions previously applied are added back in the taxable basis of the taxpayer. 4. Conditions to benefit from the IP regime 4.1. Transactions with affiliated companies In order to avoid possible abuse, the exemption rules do not apply to IP rights acquired from affiliated companies. The term "affiliated company" is defined in the law as: a parent company holding a direct participation of at least 10% in the share capital of the acquiring company (i.e. a subsidiary acquiring IP rights from its parent company); a subsidiary in which the acquiring company directly holds at least 10% of the share capital (i.e. a parent company acquiring IP rights from its subsidiary); a sister company held by a common parent company directly holding at least 10% of the share capital in both the sister company and the acquiring company (i.e. transaction between sister companies by virtue of which one acquires IP rights from the other). The determination of whether two parties are related must be made at the time the acquisition takes place. For instance, in the case of contribution of the IP to a company in exchange for shares, the analysis of whether the contributor and the acquirer are related must be made considering the participation relationship that existed between them before the moment of the exchange. In addition, the anti abuse measure does not apply neither to transactions between indirectly affiliated companies nor in the case of qualifying IP assets acquired from individuals, regardless of their participation threshold in the acquirer. 4.2. Acquisition or constitution of IP rights after December 31, 2007 In order to benefit from the IP regime, the IP rights must have been created or acquired after December 31, 2007. In case of acquisition of IP rights, the determination of the acquisition date shouldnt normally be a problem. However, only the acquisitions which from a tax perspective are considered to be a disposal at fair market value of the IP rights are aimed by the IP regime. If the IP rights are acquired via tax-neutral transactions (e.g. roll-over relief upon the transfer of IP assets in a branch of activity or pursuant to a merger), the initial acquisition date of the IP assets by the transferring entity will be considered the acquirer's acquisition date as well. 4
Furthermore, in the event of the migration of a non-resident entity to Luxembourg, the conversion of a tax-exempt entity into an ordinary fully taxable entity or the transfer of assets from a non-resident entity to a Luxembourg permanent establishment, the initial acquisition date of the IP assets shall continue to be used to determine when the assets were acquired. Even if, in these cases, a revaluation of the assets is required from a tax perspective, any such revaluation would not be relevant to determine the acquisition date of the assets. 4.3. Activation of expenses According to the IP regime, expenses in direct economic connection with IP rights must be activated, i.e., recorded as an asset in the taxpayer's balance sheet for the first book year for which the benefit of this tax regime is claimed. Expenses that must be recorder as assets in the taxpayer's balance sheet include notably, the acquisition price or the cost price of the materials used to create the intellectual right, salaries paid to people who have developed the IP right. 5. Foreign withholding taxes The credit method applies in case of withholding taxes made on royalties payment by a foreign licensee. According to this method, a Luxembourg company can credit the foreign tax against its corporate income tax up to an amount equivalent to the Luxembourg corporate income tax computed on the foreign net income. The part of the foreign tax that is not creditable can be deducted as an expense. 6. Valuation of IP rights Under the IP regime, the valuation of IP rights between related parties should comply with the arm'slength principle. In this respect, taxpayers are allowed to use all generally accepted valuation methods to value their IP rights. The burden of proof that the method applied is an adequate one, lies with the taxpayers. To avoid the burden of expensive appraisals of IP rights, micro, small and medium-sized companies are allowed to apply a safe-harbour rule. Under this rule, all the expenses that have reduced the income tax base in the year of alienation or in previous years are multiplied by 110%. Small and medium-sized enterprises are defined as enterprises that employ less then 250 employees, the turnover of which does not exceed EUR 50 million or a total balance sheet not exceeding EUR 43 million. 7. Conclusion The IP regime, will definitely increase the attractiveness of Luxembourg. This regime combined with the Luxembourg participation exemption regime contributes to making Luxembourg an integrated platform for the holding and management of IP rights and participations. 5
8. Example A Luxembourg limited liability company (an S.à r.l.) is incorporated ("LuxCo"). LuxCo acquires for cash the IP rights from a non affiliated company or from an indirectly affiliated company (e.g. from its grandparent company) or from an individual. Foreign parent company LuxCo IP Royalty payment Operating companies The main benefits of the structure described above are as follows: 80% of all net income earned in consideration for the use or the right to use IP rights is exempt from tax; Foreign withholding tax on royalty payments are creditable; Capital gains arising from the disposal of IP rights are 80% exempt from tax; 0% withholding tax on dividend distributions to treaty countries; No net wealth tax on IP assets. 6
Contact We hope you found this publication useful and welcome the opportunity to answer any questions you may have with respect to its contents. For any matters in relation with this memorandum, please contact: Jean-Marc Groelly Christophe Joosen Tax Partner Tax Partner T. + 352 / 26 12 29 95 T. + 352 / 26 12 29 45 E. jean-marc.groelly@nautadutilh.com E. christophe.joosen@nautadutilh.com www.nautadutilh.com This publication contains general information on current and upcoming legal issues and is not intended to be comprehensive or to constitute legal advice. It does not create a lawyer-client relationship. No rights whatsoever can be derived from this publication. NautaDutillh Avocats Luxembourg is not liable for any damage which may arise as a result of any incorrectness or incompleteness of the information included in this publication. This publication does not suggest that NautaDutilh Avocats Luxembourg or any of its lawyers are practising law of any jurisdiction other than Luxembourg. Should you require any legal assistance regarding any of the topics addressed herein, please contact NautaDutilh Avocats Luxembourg. 7
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