New Innovation Deduction: be aware for the tax audit pitfalls

For the last couple of months tax specialists have extensively been talking about the new innovation deduction, which was introduced by the law of 9 February 2017. This new innovation deduction replaces the previous patent income deduction (PID) and sends a powerful signal with regard to Belgium’s attractiveness for R&D activities.

The attractiveness of the new regime lies predominantly in the following aspects:

  • the substantial extension of the scope. Where the old PID regime concerned only patents, 1 the new regime also includes orphan medicinal products, 2 software, plant variety rights, 3 and data or market exclusivity rights;
  • the possibility to apply for the innovation deduction as of the request for IP protection;
  • an increased rate of 85%; and
  • the possibility to use the remaining innovation deduction for future tax years.5 Our intention is, however, not to provide an extensive overview of the new legislative initiative, but rather to highlight some of the compliance matters which taxpaying-companies can face before, during and after the implementation of the innovation deduction and solutions thereto.

Indeed practice learns that newly introduced tax incentives are subject to coordinated tax audits in the 3 years after implementation.

The documentation duty and nexus approach

First, there is the comprehensive documentation duty imposed on the company who has applied the new innovation deduction. The concerned company has to prove that the innovation revenue and the nexus calculation are laid down in a correct manner.

Nexus calculation

In accordance with BEPS-action plan (Base Erosion and Profit Shifting) of the OECD, the calculation of the new innovation deduction uses a modified nexus approach. This calculation is of a rather technical nature. Nevertheless, it has as a consequence that companies who invest directly in their own R&D will benefit, in principle, more from the new innovation deduction than if they would invest in the acquisition of qualifying IP rights or if the investments for R&D are made by related entities.

Documentation duty

The company will have to prove the correctness of the nexus calculation in order to benefit from the new innovation deduction. Consequently, it is recommended for the concerned company to engage in contractual relationships with the different stakeholders (related and/or unrelated companies) in order to fulfil the comprehensive documentation duty.

Take for instance the example of related companies:

– Company X acquires an intellectual property right from Company Y (which is a related company); and

– Company Z pays royalties for the use of the intellectual property right to Company Y (which is again a related company).

The price that X and Y pay for the acquisition resp. royalties of the qualifying IP right should be in accordance with what independent companies would have agreed on. Therefore, the acquiring resp. royalty-paying company will have to prove towards the tax administration that the price it has agreed on was at arms’ length. In order to do so, parties could make a formal contractual agreement in which both parties stipulate (read: argument) the fairness of their arrangements. Those agreements could play a convincing role in the documentation duty imposed by the new law. Our firm has the experience to assist in the drafting of such tailored agreements.

Protection of the IP as of the moment of the request

It has already been said that taxpaying-companies can apply for the new innovation deduction from the moment they make the request for IP protection. However, the exemption granted is temporary and will only become final once IP protection has effectively been granted. Consequently, it is (very much) in the interest of the tax-payingcompany to ‘secure’ their qualifying intellectual property right. In order to do so, different conditions should be met and different registration procedures apply. This, however, depends on which type of IP protection the company is applying for. A matter in which we can assist you.