The Luxembourg government published on August 4 draft legislation that would create a new tax regime offering incentives for intellectual property rights, replacing a previous scheme that fell afoul of the Organisation for Economic Co-operation and Development’s Base Erosion and Profit Shifting (BEPS) initiative to curb corporate tax avoidance. The bill was submitted to the Finance and Budget Committee of the Luxembourg parliament for consideration on October 5.

Compliance with the BEPS rules

The new regime, based on the modified nexus approach endorsed by the BEPS guidelines, aims to ensure Luxembourg’s compliance with international standards and especially the recommendations of the BEPS Action 5 report, entitled Countering Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance, released by the OECD in 2015, while maintaining the country’s attractiveness as a centre for intellectual property and research and development activities.

The OECD Action Plan, endorsed by the G20 group of countries, stipulates that IP box regimes should only offer preferential tax treatment if substance requirements are in place. The plan’s proponents reached a consensus to adopt the nexus approach, requiring R&D activities and associated expenditures for taxpayers to benefit from an IP-based low tax regime.

Previous IP box scheme

Until June 30, 2016, Luxembourg’s IP box scheme offered taxpayers an exemption for 80% of income from certain intellectual property rights, leading to an effective tax rate of around 5.5%. However, the regime did not impose appropriate substance requirements as a condition to qualify for preferential tax treatment in order to align the taxation of profits with the location of economic activities.

The provisions of the bill would be applicable from the 2018 tax year through the addition of a new article 50ter to the Luxembourg Income Tax Law. The now-abolished IP box regime under article 50bis of the income tax law continues to apply on a grandfathering basis until June 30, 2021, but the provisions of the two regimes may not be combined.

Ongoing 80% deduction for eligible income and gains

The draft law would continue to offer an 80% corporate income tax and municipal business tax exemption on adjusted and compensated net eligible income and capital gains derived from eligible IP assets, multiplied by a specific ratio calculated as eligible expenses (plus an uplift of up to 30%) as a proportion of total expenses. Eligible income and gains would also enjoy a full exemption from net worth tax.

The definition of eligible IP assets has been extended to a wider range of inventions protected nationally or internationally by patents, utility models or equivalent, and copyright on computer software, but they must be of a commercial nature. This excludes assets of a marketing nature such as trademarks or designs, which were previously eligible.

The assets must have been created, developed or improved on or after January 1, 2008, according the filing date of the registration request, as part of research and development activities carried out directly by the taxpayer itself or by a foreign permanent establishment within the European Economic Area; the permanent establishment must be operational at the time income is received and not benefit from a similar IP tax regime in the jurisdiction where it is located.

Revenues from eligible IP assets

Revenue that qualify for preferential tax treatment must be linked to an eligible IP asset: royalty income, income related to an IP asset embedded in the sale price of a product or service, capital gains, and in certain circumstances indemnities.

The adjusted and compensated net eligible income should be determined on an asset-per-asset basis, by demonstrating the link between the costs incurred and the income received or the capital gain realised. However, in cases where the taxpayer can demonstrate numerous eligible IP assets and complex R&D activities, calculation of the adjusted and compensated net eligible income may be carried on the basis of a family of products or services.

Calculating the ‘nexus ratio’

The proportion of net income that qualifies for preferential treatment is determined according to the nexus ratio, the proportion of eligible expenditure to total expenditure. The eligible income is reduced by all expenses incurred during the current or previous financial years and that are essential to the R&D activities and directly linked to the creation, development or improvement of the IP asset, by the taxpayer, an EEA permanent establishment, or outsourced to a third party.

In line with the BEPS guidelines, the new regime allows the eligible expenditure to be uplifted by up to 30%, capped by the total amount of expenditure incurred during the current or previous financial years. Total expenditure includes eligible but also non-eligible costs including real estate, interest and other financing and acquisition costs of IP assets, as well expenditure on research outsourced to related parties.

Choice of regime until 2021

Taxpayers with existing IP assets must determine which IP regime they wish to apply up to June 30, 2021 – the choice becoming irrevocable from the financial year in which it is made.

The revised regime means that Luxembourg can continue to offer an attractive option for taxpayers looking to hold intellectual property onshore in the post-BEPS environment, even if it closes off some of the advantages of the previous IP box scheme.

The draft bill submitted by the government can be viewed at: