The Luxembourg tax regime for Intellectual Property

Frank Kuijk

Speed read

As from 2008, Luxembourg provides for a beneficial tax regime for income and capital gains attributable to a wide variety of intellectual property. Over the last three years an increasing number of UK corporates transferred their intellectual property to Luxembourg companies in order to benefit from the intellectual property regime. This article only focuses on the situation wherein a foreign entity transfers intellectual property to a Luxembourg entity.

Frank van Kuijk looks at the Luxembourg beneficial tax regime for income and capital gains attributable to a wide variety of intellectual property

Why an IP regime?

The intellectual property regime (IP Regime) was introduced in the light of the Lisbon strategy of the European Union (EU). The Lisbon strategy was launched in March 2000 and aims to make the EU the most competitive and dynamic knowledge-based economy in the world. The IP Regime also aims to improve Luxembourg’s visibility as an intellectual property jurisdiction and as a financial centre in general.

General outline of the IP regime

The IP Regime is laid down in article 50bis of the Luxembourg income tax act. The IP Regime provides for an 80% exemption of net positive income and capital gains derived from IP acquired or created after 31 December 2007. As such, the effective tax rate in the IP Regime is reduced from the general combined rate of 28.8% to 5.76% for 2011 in Luxembourg City. Luxembourg provides for a tax credit/deduction for royalty withholding tax imposed by source countries. Qualifying IP escapes Luxembourg net wealth tax at a rate of 0.5%, levied on 1 January of each year. On 5 March 2009, the Luxembourg tax authorities issued a circular (Circular) in which they clarify their point of view on certain aspects of the IP Regime. In the following paragraphs this article will focus on the different conditions to be met to benefit from the IP Regime.

Ownership requirement

The IP Regime can only be applied by the owner of the IP. In case of a discrepancy between legal and economic ownership the latter prevails. The economic owner is the party who generally exercises the effective control over the IP and can exclude the legal owner from his economic influence during the expected lifetime of the IP. The economic ownership of IP is in practice often transferred pursuant to a so-called exclusive licence contract. This contract gives the licensee the exclusive right to exploit the IP for its expected life time in a certain territory. The fact that the economic owner can apply the IP Regime is a very welcome feature. It avoids a burdensome re-registration of the IP rights (required for a transfer of legal ownership) in the name of the Luxembourg company that wants to apply the IP Regime. Logically, a Luxembourg company that licences and sublicenses IP cannot apply the IP Regime, because it neither legally nor economically own the IP.

Qualifying IP

To benefit from the IP Regime, the net positive income and capital gains have to be attributable to the following categories of IP:

software copyrights;
patents;
trademarks;
service marks;
designs;
models; and
domain names.

The concept of a patent also covers utility models and complementary protection certificates. A utility model is an IP right similar to a patent, but it generally has a shorter term, is subject to less stringent patentability requirements and registration is less costly. A complementary protection certificate relates to pharmaceutical patents. It is a title which allows extending the duration of such a patent in order to compensate for the time which passes between the date of the patent application and the authorisation for the pharmaceutical product to be put on sale. The Circular explains that image rights do not constitute qualifying IP.

Qualifying revenues

To benefit from the IP Regime, the IP has to generate qualifying revenues, being net positive income and capital gains. Net positive income is defined as the gross income minus costs in direct economic relation to such income, including depreciation and amortisation. To qualify for the IP Regime, the income has to have the form of a royalty payment in the sense of article 12 paragraph 2 of the OECD Model Convention. The official commentary to this article is therefore a relevant source of guidance. A royalty is defined herein as the payment for the use, or the entitlement to use IP.

Capital gains on the alienation of IP are exempt for 80% in the year of alienation. The exempt amount is decreased with the sum of 80% of the net negative revenues stemming from the alienated IP in the year of alienation and previous years, but only to the extent that these net negative revenues were not capitalised pursuant to the capitalisation requirement. Losses of prior years can be carried forward for their full amount and set off against the non exempt part of the capital gain. This rule aims to avoid that the exemption over the years effectively exceeds 80% of the total revenues over the years during which the IP Regime applies. The Circular and the parliamentary documents provide fore some clarifying numerical examples to illustrate these effects.

Required creation and acquisition date

To qualify for the IP Regime, the IP has to be acquired or self-developed after 31 December 2007. Also here, the acquisition date of the economic ownership opposed to the legal ownership prevails. The Circular explains that the acquisition moment has to be determined from a Luxembourg fiscal point of view. In case of a sale of the legal or economic ownership of IP, the determination of the date on which the ownership passes should not pose a problem. With respect to cross border transfers the Circular explains that no new acquisition moment is recognised amongst other if a permanent establishment (not a legal distinct entity) is created in Luxembourg to which the IP is allocated and also not when a company is migrated to Luxembourg.

Capitalisation requirement

Before the IP Regime can be applied all costs, including depreciation and amortisation costs attributable to the IP have to be capitalised and will be integrated in the taxable result of the first year in which the IP Regime applies. This provision is typically relevant for taxable companies that have self developed IP, but can also be relevant for companies that acquired the IP, incurred costs and only apply the IP regime in a later year. The capitalised cost can be amortised for tax purposes over the useful lifetime of the IP. Logically, the profit realised as a result of the capitalisation does not benefit from the IP regime, because it is neither income in the form of a royalty nor a capital gain. The losses of prior years can be carried forward and will offset the profit originating from the capitalisation. The capitalisation requirement aims to avoid that the sum of the pre IP Regime losses and IP Regime profits benefits from an exemption that effectively exceeds 80% of this sum. The Circular and the parliamentary documents provide for some clarifying numerical examples to illustrate these effects.

Anti-abuse requirement

In order to avoid possible abuse, IP acquired from related companies as opposed to individuals does not qualify for the IP Regime. The Circular and the parliamentary documents explain that the targeted abuse is the application of the IP Regime on the same piece of IP within the same group more than once. It is hard to imagine a situation in which such abuse would occur. Considering the targeted abuse it would have been logical to limit the scope of the related party test to Luxembourg taxpayers, or the foreign head office of a Luxembourg permanent establishments owning Luxembourg IP. Only in these cases abuse may arise. The scope of the concept of related companies is however not limited to Luxembourg resident and non-resident corporate taxpayers with Luxembourg IP. Related companies are defined as entities:

that own at least directly 10% in the capital of the Luxembourg taxpayer;
of which the capital is directly owned for at least 10% by the Luxembourg taxpayer, or;
that are directly owned for at least 10% of their capital by a company that also holds directly at least 10% in the capital of the Luxembourg taxpayer.

Transactions with indirectly related parties, e.g. a Luxembourg taxpayer that acquires IP from its grandparent do not prevent the applicability of the IP Regime. Entities which are for Luxembourg tax purposes transparent are “looked through” for this test. The related party test has to be applied directly prior to the moment of the transfer of the IP. This would mean that a company that contributes its IP upon incorporation of its Luxembourg subsidiary is not considered to be related to its Luxembourg subsidiary, because directly prior to the contribution the Luxembourg recipient company did not exist yet. The related party test does not prevent the taxpayer from applying the IP Regime to royalty income received from related parties. Since the anti abuse requirement will only have effect in case of direct relationships it should in practice not substantially hinder intra group transfers of IP.

Summary

The IP Regime provides for an 80% exemption of the net positive income and capital gains attributable to a wide range of IP acquired or self developed after 31 December 2007 and results in an effective rate of 5.76%. Opposed to most other tax beneficial IP regimes in Europe the Luxembourg IP Regime also applies if IP is acquired from other (foreign) parties. This feature makes the IP Regime very attractive for groups that hold their existing IP outside Luxembourg. Since the introduction of the IP Regime a lot of IP owned in foreign jurisdictions, for example by UK corporates, was transferred to Luxembourg and licensed out to foreign third parties or group companies. One has to take a number of requirements into consideration to safeguard the applicability of the IP Regime when transferring IP to Luxembourg.

Frank van Kuijk, Corporate Tax Associate, Loyens & Loeff

Issue: 1057
Categories: Analysis