Luxembourg has recently enacted a new intellectual property (IP) regime in line with the OECD recommendations for more tax transparency, and in June an administrative circular was issued to help clarify this regime. The new IP regime aims to promote R&D activities largely performed in Luxembourg and offers, to Luxembourg taxpayers, an 80% tax exemption on eligible net income derived from qualifying IP.
The circular (available here) is very welcome, given the complexity of the new IP regime. It brings explanations and clarifications on R&D qualifying expenditures, several numerical examples, and guidance on where the former and new IP regimes intersect.
Read on for an overview of key points and remaining questions.
Key points on scope
The circular provides a clear definition of each eligible asset and the conditions under which it needs to be licensed and protected at national, European and international levels, as well as to which extent “improved” assets can be qualified as eligible. It confirms through those definitions that software does not need to be formally registered to be copyrighted and to qualify for the application of the new IP regime.
Notably, the circular also gives helpful guidance on the type of R&D activities that meet the requirements of the new IP regime, and in particular on the enhancement of existing and marketable software.
Key points on determining which R&D expenditures qualify
Important clarifications are given in this area, in particular regarding R&D expenditures incurred by a foreign permanent establishment (PE) within the EEA area of a Luxembourg head office. The circular helps specify one of the conditions, for example, about which expenditures are allocated to the head office of the foreign PE in accordance with the provisions of a double tax treaty. This condition seems to be met in cases where the Luxembourg taxpayer controls all of the development, enhancement, maintenance, protection, and exploitation (DEMPE) functions in relation to R&D carried out by its foreign PE.
Key points on burden of proof
The circular further stresses the importance of supporting transfer pricing and tracking documentation, as well as of the evidence that needs to be provided by the Luxembourg taxpayer when filing a corporate tax return and the related form 760 (available here for 2018).
This confirms that documentation is the cornerstone of the IP regime for taxpayers in order to benefit from the partial exemption.
A few outstanding questions
While reading the circular, you will notice that the concept of “fair and reasonable basis” is used several times. However, no definition or explanation is provided for this concept, which is new and which thus contains some room for interpretation.
In addition, there is still a lack of clarity with regard to the treatment of capital gains derived from the disposal of a license to use an IP right.