Belgium to replace patent income deduction by broader innovation deduction
On 2 December 2016, the Belgian government formally announced the innovation deduction, as the successor of the Belgian patent income deduction. The new regime is intended to boost the competitiveness of the Belgian economy while complying with the requirements of Action 5 of the OECD’s Base Erosion and Profit Shifting (BEPS) Action Plan.
There are significant improvements compared to Belgium’s previous intellectual property (IP) regime. The scope of the new innovation deduction is not limited to patents, but will be extended to other IP rights, including copyright protected software. According to the proposal, the income qualifying for the incentive will also include capital gains. The incentive can be applied as of the year in which the IP right is requested. The deduction rate is increased to 85% of the net qualifying IP income. This results in an effective tax rate of 5,10%.
The innovation deduction will retroactively apply as of 1 July 2016. It replaces the patent income deduction which was already abolished as of 1 July 2016 with a five-year grandfathering period until 2021.
Qualifying IP assets: extension to copyright protected software and other IP rights
The new innovation deduction will apply to the following IP rights:
- Patents and supplementary protection certificates (SPCs);
- Copyright protected software, provided that the software results from an R&D project or program, as defined in the rules on the partial payroll tax exemption for researchers;
- Orphan drug designations, requested or acquired as of 1 July 2016 (for the first 10 years);
- Data and marketing exclusivity granted by the authorities, notably for medicinal products (also limited to the first 10 years);
- Plant breeders’ rights requested or acquired as of 1 July 2016.
The deduction applies to self-developed IP rights as well as IP rights acquired or licensed from related or unrelated third parties. Marketing intangibles, such as trademarks, are excluded.
Qualifying IP income
In addition to at arm’s length license fees and IP income included in the sales price of products and services (so-called embedded royalties), the new innovation deduction also applies to damages received further to IP infringements, IP income derived from process innovation, as well as capital gains.
Capital gains only qualify as IP income, provided that they relate to a fixed asset that was created in the previous taxable period or acquired 24 months in advance. The sales price received should be re-invested in qualifying expenditures, within five years (see below).
Determination of net income
The innovation deduction applies to the net IP income, i.e. the gross IP income after deduction of current-year expenditures for the development of the IP asset, including expenditures for the acquisition of IP rights, expenditures in relation to the R&D conducted by the company, as well as R&D outsourced to related or unrelated parties. Prior-year expenditures incurred in financial years ending after 30 June 2016 should also be deducted. However, taxpayers may choose to spread the recapture of prior-year expenses over a period of maximum seven years.
The requirement of development or improvement of the IP assets in a qualifying R&D center is abolished and replaced by the so-called “nexus ratio” in the following formula, to calculate the innovation deduction:
Innovation Deduction =
(Qualifying expenditures x 130%) x 85% x Net qualifying IP income
The purpose of the nexus ratio is to ensure that the innovation deduction is only available to the extent that qualifying expenditures were incurred by the taxpayer. Qualifying expenditures are defined as expenditures for R&D that are incurred in the context of R&D conducted by the taxpayer or that result from outsourcing of R&D to unrelated parties. Expenditures for outsourcing to related parties and acquisition costs are excluded from the qualifying expenditures. Consequently, a taxpayer who did not acquire the IP and did not outsource the development to a related party, will have a ratio of 100% and the net IP income will fully qualify for the 85% innovation deduction.
A 30% uplift applies to the qualifying expenditures in order not to penalize taxpayers excessively for acquiring IP or for related-party outsourcing. The nexus ratio is capped at 100%.
The nexus ratio only serves as a rebuttable presumption. Subject to conditions, taxpayers can prove that due to exceptional circumstances the nexus ratio does not correctly reflect the share of their own R&D activities in the overall R&D activities. In order to deviate from the nexus ratio, taxpayers will be required to obtain an advance tax ruling.
Carry-forward of unused deduction
The innovation deduction is deducted from the corporate tax base. Unused innovation deduction can be carried forward indefinitely.
Exemption for IP rights which were requested, but not yet granted
For IP rights which require a request procedure, taxpayers will be entitled to a conditional exemption which is equivalent to the innovation deduction pending the request. The amount of the exemption should be recorded on an unavailable reserve account. The exemption will become final, provided that the request is granted. If the request is not granted, but rejected or withdrawn, the amount will be included in the corporate tax base. In such case, late payment interest will become due.
In principle, the calculation should be performed for each IP asset separately. Taxpayers should allocate expenditures and IP income to the various IP assets. However, if such allocation is not practical, the allocation can be done by type of product or service, or by group of products or services.
Taxpayers will be required to claim the innovation deduction in a special form to be added to the corporate income tax return. Furthermore, the fair market value of the IP, the gross IP income and the qualifying and overall expenditures should be documented (“tracking and tracing”).
Interaction with patent income deduction
The patent income deduction was abolished as of 1 July 2016. A five-year grandfathering period is optionally available for patent income earned up to 30 June 2021 in respect of (i) self-developed patents requested before 1 July 2016 and (ii) improved patents and patent licenses acquired before 1 July 2016.
In case the taxpayer opts for the patent income deduction during the grandfathering period, the taxpayer will not be able to apply the innovation deduction in relation to the relevant patent for the taxable periods ending prior to 1 July 2021.
For any questions or further information, please contact the persons listed above or your regular EY contact.