1. OVERVIEW OF THE FORMER TAX REGIME IN FORCE UNTIL 12/31/2018
Up until December 31, 2018, capital gains derived from the sales of patents and similar assets, and consideration received for the use or the right of use of patents (or similar assets) were subject to a reduced 15% Corporate Income Tax (CIT) rate (art.39 terdecies 1. of the French Tax Code).
2. BACKGROUND & PURPOSES OF THE NEW IP BOX REGIME EFFECTIVE AS OF 01/01/2019
The former tax scheme was applicable irrespective of the R&D expenditures incurred by the taxpayer. R&D expenses had, therefore, no impact on the calculation of IP revenues or IP capital gains. Basically, because of this, the French IP Box regime was not compliant with OECD’s and EU’s approach and has been abolished.
Under OECD recommended « nexus approach » (BEPS Plan, Action 5), in order for a significant proportion of IP income to qualify for tax benefits, a significant proportion of the actual R&D activities must have been undertaken by the qualifying taxpayer itself. Hence, this approach limits the application of the IP box regime if R&D is being outsourced to related parties.
Additionally, this approach links the benefits of the tax regime with the materiality of R&D expenditures incurred by the taxpayer in the jurisdiction which grants the tax incentives. French provisions (new article 238 of the French Tax Code) are now compliant with these recommendations.
3. MAIN FEATURES OF THE NEW IP BOX
Under the new IP Box regime, IP capital gains and IP incomes are now subject to a 10% CIT rate.
Revenues covered by the scheme are basically:
- Incomes received as a consideration for the of use (licences and sub-licences) of patents and similar assets
- Capital gains derived from the sale of patents and similar assets.
Eligible intangible assets are mostly patents, softwares protected by copyrights, inventions for which patentability has been certified by the competent authority (INPI) and industrial manufacturing processes. Companies willing to benefit from this scheme must opt for it. The new regime goes hand in hand with additional reporting obligations and documentation obligations. A specific appendix must be filed along with the CIT return in order to provide details -for each qualifying asset- about the calculations of the net profits eligible for the reduced rated. Additionally, companies must hold a complete set of documents in order to justify the calculation of the net profits eligible for the reduced rate and will face penalties in case they are not compliant. For tax consolidated groups, specific rules apply.
4. OVERVIEW OF THE CALCULATION METHOD TO DETERMINE THE IP INCOME SUBJECT TO THE 10% CIT RATE
Following the « nexus approach », eligible profits must be determined in 3 steps.
a. Calculation of the net profit
As a first step, companies must determine the net profit derived from the intangible asset (patent or similar). This is gross incomes derived from the considered asset for the considered fiscal year minus R&D expenditures directly linked to this particular asset, incurred directly or indirectly by the taxpayer. during the same period. Example: a company receives 300k€ as consideration for use of a patent and incurs 120k€ of R&D expenses from both in-house activities and related parties. Net profit, in this case, amounts to 180k€.
b. Calculation of the nexus ratio
The nexus ratio is basically a prorata mechanism which aims to link the benefit of the tax regime to the materiality of the of R&D expenses incurred directly by the company or outsourced to independent parties. It must be calculated as follows:
- Numerator: 130% of the R&D expenses directly linked to the creation or development of the considered intangible asset (patent or similar), directly incurred by the company or outsourced to non-related entities
- Denominator: all R&D expenses directly linked to the creation or development of the considered intangible asset, including R&D activities outsourced to related parties and IP assets acquisition costs.
Example: a company incurs the following R&D expenses: (A) in-house: 120k€, (B) non-related parties.: 20k€, (C) related parties: (40k€), (D) acquisition costs: 10k€.
Numerator: 130% (A+B) =182k€
Denominator: A+B+C+D = 190k€
Nexus ratio: 182k€ / 190k€ = 95,8%
Under specific requirements and subject to tax authorities’ authorization, a « replacement ratio » can be used instead of the nexus ratio.
c. Applying the nexus ratio to the net profit
As a final step, net profits calculated as explained under section a) must be multiplied by the nexus ratio. In our example, the taxpayer derives a net profit of 180k€. Because of the nexus approach, the net profit eligible for the reduced 10% rate will be 180k€ x 95,8% = 172k€.
5. RESTRICTIONS IN THE TAX DEDUCTION OF ROYALTIES PAID TO RELATED PARTIES
For the entity which pays the royalties, such payment is ordinarily a deductible cost for CIT purposes. This said, rescritions (subject to specific rules) apply where the beneficiary of the payment, which is a related party, is subject to a CIT rate lower than 25%. This applies where the beneficiary is not established in the EU or in the EEE and benefits from a tax regime considered as harmful by the OECD.
Laurent Dommergues Alain Boudot
Tax Director Partner