General
The innovation deduction is the successor to the former patent deduction and is now, due to its success, an integral part of the Belgian fiscal landscape. Figures from the recent annual report of the Advance Rulings Service show that the number of rulings in 2019 doubled compared to the previous year. In addition to this, the innovation deduction has recently come back into the spotlight following the amendment of certain positions in the so-called FAQs about the innovation deduction and the publication of the Royal Decree of 2 October 2019 regulating – at last – the rules concerning documentary evidence.
Finally, the Advance Rulings Service announced in a news flash on September 2019 that all applications (NB no complete ruling needs to be delivered yet) relating to the financial year 2019 must be submitted before 31 January 2020 in order for a ruling to be made in time. This again points to the current success of the innovation deduction.
Given the widespread use of this measure in practice and the usually accessible qualification requirements, we briefly explain the general outlines of this measure (again) below. As no less than half of the published rulings so far include income from software, that will be our main focus.
What is the innovation deduction?
Since 1 July 2016, thanks to the innovation deduction, 85% of net income from a number of intellectual property rights can be exempted from corporate income tax (instead of 80% under the former patent deduction).
Which property rights?
The intellectual property rights that are specifically eligible for this are:
- patents;
- supplementary protection certificates;
- breeders’ rights;
- copyrighted software;
- orphan drugs; and
- data and/or market exclusivity for plant protection products, and medicinal products for human or animal use.
Which income?
Specifically, the innovation deduction is applicable if the entity concerned earns income from licenses or if the company exploits patents, software or other intellectual property rights itself. Internal use of software, patents or other rights may also fall within the scope of the measure (e.g. damages for the infringement of intellectual property rights and compensation obtained from the disposal of intellectual property rights that have the nature of a fixed asset).
However, in order to be able to benefit from the aforementioned measure it is crucial that the entity is the owner, co-owner, licensee (exclusive or not) or usufructuary of the intellectual property right in question.
Net revenue approach
Next, note that the innovation deduction is calculated on the basis of net innovation income, i.e. the gross income minus all the costs related to the intellectual property right in question.
Should the result of this calculation be negative, the result will be deducted from the net innovation income of each of the subsequent taxable periods.
Application of the nexus fraction
Finally, this tax advantage is limited based on the so-called nexus fraction. The idea behind this is that a company’s own costs for the development of specific qualifying intangible fixed assets are used as a guideline for the availability of sufficient material (substantial) activities by the taxpayers who wish to make use of the measure. In particular, the innovation deduction is not applicable if the development is outsourced to related parties or if the intellectual property rights have been acquired externally.
The nexus fraction is calculated as follows:
Qualifying
expenditure x 130%
Global expenditure
The remaining amount after calculating the net income and applying the “nexus fraction” is eligible for an 85% deduction in corporate income tax.
In what follows, we briefly discuss the specific conditions required for qualification as innovative software.
Qualification requirements for software
As mentioned above, the measure applies, amongst other things, to income from copyright-protected software. In Belgium, however, there is no specific copyright for software, therefore no special registration requirements apply.
According to the administration, in order to be able to qualify for the innovation deduction the following three conditions must be met cumulatively.
- Firstly, computer programmes must be protected by copyright.
- Secondly, computer programmes may not have generated income before 1 July 2016 (difficult to check). In practice, it is always important to demonstrate that the original software – should there be any – was completely economically dated after 1 July 2016 or a period to be determined, during which the software could be used without updates. This allows software that was already generating income before that date to be taken into account.
- Thirdly, the copyright-protected computer programme must be innovative (cf. result from R&D activities).Either the taxpayer or the tax authorities may ask BELSO for binding advice.
However, in practice this binding advice from BELSO is de facto a mandatory requirement for obtaining a decision from the Advance Ruling Service concerning the innovation deduction.
Finally, it should be noted that the assessment of innovative income from software is not self-evident and the Advance Rulings Service is very cautious in both its views and its assessments. Revenues are most commonly derived from license fees received from third parties in relation to the software. But, even when software is integrated in a production process or included in the sale price of goods and/or services, an innovation income may be available (e.g. for implementation, maintenance, helpdesk, subscription formula, etc.).
In this context, reference can be made to the annual report of 2018 in which the Advance Rulings Service explains the assessment model for software in concrete terms. https://www.ruling.be/fr/telechargements/rapport-annuel-2018 https://www.ruling.be/nl/downloads/jaarverslag-2018
Conclusion
On the basis of the explanation above and the current success of this measure, it is recommended that the specific conditions for the innovation deduction should in practice always be verified in order to see whether the company can or cannot be said to be innovating. Innovations are mapped out by screening the current and future activities of the company. After that it is necessary to examine which innovations can be protected by patents, breeders’ rights or as innovative software.
Depending on the actual situation, it will have to be determined whether filing an application for a ruling by the Advance Rulings Service is desirable. After all, obtaining a positive decision provides the prior assurance and confirmation that the tax administration agrees with the way in which the innovation deduction will be applied and substantiated within the specific company. This prior certainty is thereby granted for a period of 5 years (and easily renewable) in the case of patents and 3 years for innovative software.
Should you have additional questions about this ruling, please do not hesitate to contact us.