New Belgian innovation income deduction regime adopted, qualifying IP rights include copyrighted software

by Daniel Garabedian and Steven Peeters

The Belgian parliament last week approved the new Belgian innovation income deduction regime, which modifies tax incentives for multinational enterprises that derive income from intellectual property rights.

The new law replaces Belgium’s patent income deduction, considered inconsistent with the modified nexus approach as provided for in the final report under Action 5 of the OECD/G20 base erosion profit shifting (BEPS) plan.

The new regime will become effective retroactively from 1 July 2016. The previous patent income deduction rules are extinguished on the same date, with a grandfathering for existing situations until 30 June 2021.

While, undeniably, the new Belgian innovation income deduction is more restrictive than the previous patent income deduction, as it is tied to the requirements of the modified nexus approach prescribed by the BEPS project, it also significantly expands the incentives for research and development (R&D) in Belgium where that is possible within the boundaries of the modified nexus approach.  This succinct note sets out the main characteristics of the new regime.

Substantial extension of qualifying IP rights

The scope of the innovation income deduction is substantially enlarged and now also includes copyrighted software, breeder’s rights, orphan drugs, data exclusivity and market exclusivity, while the previous regime was limited to patents and supplementary protection certificates. All intangibles related to marketing remain excluded.

The extended scope of application justifies the name change from “patent income deduction” to “innovation income deduction.”

Calculation in line with the modified nexus approach

The deductible amount equals 85% of the net R&D income arising from the qualifying IP assets, restricted in line with the modified nexus approach as set out in Action 5 of the BEPS project.

In a nutshell, the modified nexus approach aims at linking the R&D tax benefit with the substance of the entity enjoying that benefit. It uses the R&D expenses incurred by the relevant entity as a yardstick to measure the substance of that entity.

Consequently, the Belgian innovation income deduction is calculated according to the following formula:

The “overall net income from an IP asset” refers to the net income generated by the relevant entity, and not the gross income, as is the case in the patent income deduction. The income includes royalties, IP income embedded in the sale price for products, process innovation income, and certain damages and capital gains.

The “qualifying expenditure” includes all expenses directly related to the IP asset that are made by the relevant group entity itself or that are outsourced to non-related parties.

The “overall expenditure” is the “qualifying expenditure” increased by the acquisition costs of the IP asset and any costs related to outsourcing to related parties.  To avoid excessive penalization of entities that acquire R&D assets or outsource R&D activities to related parties, an uplift of 30% of the qualifying expenditure is allowed, it being understood that the uplifted qualifying expenditure may never exceed the overall expenditure.

In principle, this formula must be applied on an IP-asset-by-IP-asset basis. When this approach turns out to be impossible from a practical perspective, it may be applied to each product or service or for each group of products or services.

In any event, significant tracking and tracing of the income and expenses relating to IP assets will be required. In this respect, the deduction is conditional upon the satisfaction of stringent documentary requirements.

The formula set out above thus links the tax advantage with the R&D activity of an entity. Under the patent income deduction regime, no such formula was applied; rather, it was required that the qualifying IP assets was either partly or fully developed in a R&D center of the company, or acquired from a third party and improved in a R&D center of the company (except for small and medium-sized companies).

Startup phase

Contrary to the previous regime, the innovation income deduction also applies to income generated prior to obtaining the IP protection. During the preparatory phase, the tax benefit would be structured as a temporary and conditional tax exemption which becomes final once the IP protection has been obtained.

Excess deductions

The Belgian innovation income deduction allows the transfer of excess deductions to subsequent taxable years. This is remarkable, as the patent income deduction was restricted to the taxable year itself, and any carry-over was prohibited.

Advance decisions

Legal certainty regarding the application of the Belgian innovation income deduction regime – in strict compliance with its legal framework – may be obtained by requesting an advance decision from the Belgian tax authorities.

Additionally, as provided for in the final report in BEPS Action 5, the calculation method for the innovation income deduction is considered as a rebuttable presumption.  In certain exceptional circumstances, an advance decision may be obtained allowing a deviation from the fraction set out above to accurately reflect the proportion of the added value of the R&D activities exercised by the relevant company compared to the overall activities. Such exceptions are subject to strict monitoring and international exchange of information.

Belgian innovation income deduction in context

The Belgian federal government is currently preparing a fundamental reform of the corporate income tax regime, which aims at reducing the nominal corporate income tax rate to 20% combined with simplification of the calculation of the corporate income tax base.

Based on the information currently available, the government is not envisaged to amend the new Belgium innovation income deduction in the framework of this reform.

However, the European Commission proposal of 25 October 2016 for a Council Directive on a Common Corporate Tax Base included no similar innovation income deduction. On the contrary, the proposal provides for a so-called “super-deduction” of R&D expenses in addition to the ordinary deduction thereof, for an amount of 25%, 50%, or 100% of the incurred expenses under certain conditions (cf. article 9.3 of the proposed directive).

Although the EU Commission approach also links the tax advantage to R&D activity, it is remarkable that the tax advantage is structured as a “super-deduction” of expenses and not as a deduction based on the (net) R&D income.