Belgium: IP tax incentive − implementing the nexus approach and broadening the scope of application

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In 2007, Belgium introduced a patent income deduction (PID) for Belgian companies (and permanent establishments of foreign companies) that derive income from or by means of patents and supplementary protection certificates. The PID regime allowed for the deduction of 80 percent of the gross patent income from the company's corporate income tax base.

On October 5, 2015, the OECD found that the PID regime, along with 15 other IP regimes in OECD member and associate countries, was inconsistent with the n­exus approach (OECD, Countering Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance, Action 5 - 2015 Final Report). The OECD considers the nexus approach to be the most appropriate methodology to align substance and tax for IP regimes. Under this approach, tax benefits should only be available to income generated by IP rights to the extent the taxpayer ­has actually incurred the expenditures to develop those IP rights. 

Following that OECD report, Belgium abolished the PID regime per July 1, 2016 (Law of 3 August 2016). Grandfathering rules were foreseen, under which the PID may still apply for income earned until June 30, 2021 in relation to (i) patents for which the application was submitted before 1 July 2016 or to (ii) licenses on patents that have been acquired before July 1, 2016. The option for grandfathering is irreversible and has to be made per patent, individually.

To avoid abuses, no grandfathering is available for patents that were acquired (directly or indirectly) from related companies after January 1, 2016, if the seller of the patent could not benefit from the PID or from an analogous foreign tax scheme.

The abolition of the PID was only a first step in Belgium's reform of its corporate tax scheme for IP income. As a second step, Belgium has now adopted a new incentive, the innovation deduction (ID), which is aimed at replacing the PID (Law of 9 February 2017). The ID retroactively entered into force as of July 1, 2016 and is aimed at complying with the OECD's recommendations on BEPS action point 5.

INNOVATION DEDUCTION

Principle

The ID regime allows Belgian companies (and permanent establishments of foreign companies) to deduct 85 percent of the net income they derive from qualifying IP assets, which results in an effective tax rate of a maximum 5.1 percent. The 85 percent deduction is computed on the net income reduced by the application of the so-called nexus fraction. The latter fraction should result in leaving out income to the extent it is not linked to expenditures effectively incurred by the taxpayer to develop the qualifying IP assets.

ID= 85%  X  (net income from an IP asset  X  nexus fraction)

Excess ID may be transferred to subsequent tax years without limitation in time.

IP assets

The PID regime was limited to patents and supplementary protection certificates. The scope of application of the ID regime is substantially broader since it includes the following IP assets:

  • Plant variety rights (applied for or acquired at the earliest after June 30, 2016)
  • Orphan drugs (i.e., drugs for treatment of rare diseases) that were applied for or acquired at the earliest after June 30, 2016[1]
  • Data or market exclusivity granted by a public authority after June 30, 2016
  • Copyrighted computer programs (including upgraded software).[2]

These IP assets may be self-developed or acquired/licensed from related or unrelated third parties.  IP rights that need to be granted upon application, may qualify as from the date of submission of the application. The benefit of the ID will remain temporary pending the approval and will be confirmed (or clawed back) in the year when the IP right will be granted (or refused). The above doesn't apply to qualifying copyrighted software, given that such IP asset is not subject to approval.

The taxpayer must hold a right to use the IP asset, such as full ownership, a license or usufruct. The explanatory memorandum of the Law states that a broad interpretation is to be applied. Economic ownership of IP on the basis of a cost contributing arrangement should thus also suffice. 

Type of income

Aside from arm's length license fees and IP income embedded in the sales price of products and services, the ID regime also applies to the following types of income derived from the qualifying IP:

  • IP income from process innovation
  • Damages received for infringements of qualifying IP rights
  • Capital gains realized on the sale of the IP right

The capital gains only qualify provided that the IP right was a fixed asset and the company developed or acquired that asset at the latest during the previous taxable period or at least 24 months prior to the sale respectively. The proceeds of the sale must be reinvested in qualifying expenditures within five years.

The qualifying income is considered for the ID irrespective of the origin of the income or the countries where the IP rights are protected. The income must, however, be included in the taxpayer's Belgian corporate income tax base.

The said (gross) income must be reduced by (i) subtracting the overall expenditures and (ii) applying the nexus fraction; 85 percent of the remaining amount may be deducted as ID from the income tax base.

Net income

The net income is obtained by subtracting the overall expenditures from the gross income.

The overall expenditures encompass the current-year expenditures for the development of a specific IP asset, including the cost of acquiring IP rights and the costs of R&D (whether performed by the company or by (un)related companies). A recapture applies for expenditures dating from financial years ending after 30 June 2016. That recapture amount may however be spread over a period of up to seven years.

Determining the nexus fraction

The further reduction of the ID amount by means of the nexus fraction should result in limiting the tax benefit of the ID to the extent that the taxpayer incurred qualifying expenditures:

                                  qualified expenditures  x  130%                                                                                                                  overall expenditures                                 

The qualifying expenditures encompass costs incurred in relation to R&D performed for a specific IP right by the taxpayer or by an unrelated third party. This fraction should thus bar the benefit of the ID to the extent that the taxpayer acquired IP rights or outsourced the R&D to related entities.

The computation of nexus fraction is made on a cumulative basis for each IP right separately – that is, the respective expenditures are cumulatively increased each year for each IP right separately. The expenditures in the nexus fraction include the costs that were incurred in all the previous tax years. This recapture may turn out to be beneficial in the event – e.g., a large amount of qualified expenditures were incurred in the previous tax years.

The 30 percent increase of the qualified expenditures is intended to avoid creating a disproportionate disadvantage for companies that outsource their R&D to a related entity. The nexus fraction is capped at 100 percent.

In certain specific circumstances foreseen by the Law, a taxpayer may request a deviation from the nexus fraction by means of a ruling request submitted to the federal ruling commission.

TAKEAWAYS

Compared with the PID regime, the newly adopted ID regime holds many improvements, such as: 

  • The broadening of the scope of application in terms of eligible IP assets (e.g., software) and types of income (e.g., capital gains)
  • A broad interpretation of ownership of eligible IP right (e.g., economic ownership on the basis of a cost sharing arrangement should be sufficient)
  • The possibility to carry forward excess ID without limitation in time
  • The (temporary) application of the ID before the IP right has been approved 

These improvements should generate substantial tax advantages to companies that could not benefit from the PID and should also increase foreign investment into R&D activities in Belgium. 

The ID regime may become even more competitive in the near future if the Belgian government manages to fulfil its promise to lower the corporate income tax rate next year. A decrease of the said rate to for example 25 percent would result in an effective tax rate of maximum 3.75 percent for eligible ID income. 

Companies wishing to use the ID should examine the nexus fraction for each IP right and assess to what extent, if need be, it can be improved by making (or shifting) more investment in (to) Belgium. Companies owning qualifying patents should also carefully examine which regime would be more advantageous, if it is more advantageous to opt for the PID (grandfathering). 

The ID regime imposes a number of conditions that may seem to be strict (e.g., effective R&D activity, the incentive is computed on net income instead of gross income). Yet these conditions do not constitute a comparative disadvantage, given that they should also apply in other countries that are compliant with the BEPS Action 5 recommendations. 

Find out more about the ID regime in Belgium by contacting the author.


[1] Limited to the first 10 years after registration in the Register of designated Orphan Medicinal Products.

[2] These may not have generated income before July 1, 2016 and must have been developed in the framework of a R&D program which could benefit from a professional withholding tax scheme in the sense of art. 275³ of the Income Tax Code. Confirmation that the latter requirement is met can be obtained from the Federal Public Planning Service Science Policy.