Only innovation deduction will be allowed as from 1 July 2021

You were able to continue to apply the PD during a transitional period. But it's all over on 30 June 2021. As of 1 July, you can opt for the broader ID. What are the differences?

Transitional period for patent deduction (PD)

Companies with qualifying intellectual property rights (IPs) can still benefit from the patent deduction (PD) for patents acquired or applied for before 1 July 2016. From then on, a transition period began, which ends on 30 June 2021. If you wanted to make use of that transitional period, you had to make an irrevocable choice between the PD or the ID for the entire transitional period per patent. So if you opted for the PD for patent A in the past, you will only be able to apply the ID for the first time for that patent in the financial year that ends on or after 1 July 2021.

Importance of own Research & Development for innovation deduction (ID)

The aim of the innovation deduction (ID) is to offer a maximum incentive in terms of corporate tax to companies that carry out their own Research and Development (R&D) activities, and thereby also bear their own R&D costs. Or to undertakings that outsource their R&D activities to unrelated undertakings.

The PD only applied to income from patents and supplementary protection certificates. The ID applies to innovation income from the following intellectual property rights:

• Patents and supplementary protection certificates (SPCs);
• Copyrighted computer programs, including a derivative work or an adaptation of an existing computer program;
• Government-granted data and market exclusivity;
• Plant breeders' rights and orphan drugs;
• Process innovation.

Calculation of the innovation deduction

The calculation of the ID is carried out as follows: net innovation revenue x 85% x nexus break

• As was the case with the PD, the notion of revenue includes both licence fees (derived from the grant of a separate licence) and inclusive licence fees (included in the general selling price of a good or service if the company uses the IP for its own commercialisation).
• As is the case with the PD, only market-based income is eligible for the ID.
• Unlike the PD that is applicable to gross innovation income, R&D costs directly related to the IP, such as depreciation costs and personnel wage costs, must be deducted from the ID. It therefore only applies to net innovation income.
• Under the ID, innovation income is 85% exempt from corporate tax, compared to an 80% exemption under the PD.
• Finally, the nexus break ensures that the ID can only be applied to innovation income arising from IPs where the actual R&D activities are carried out by the company itself. Companies that mainly perform in-house Research & Development, and who therefore do not outsource these activities to affiliated companies or acquire IP rights (whether or not from an affiliated company), enjoy a higher nexus break in principle, and thereby a higher ID!

Other relevant differences from PD

• Unlike the PD, the unused portion of the ID can be carried forward to a subsequent financial year. You will therefore not lose the ID if the taxable profit is insufficient.
• Unlike the PD, payments obtained on the disposal of qualifying IPs also benefit from the ID. This is, however, subject to the condition that the acquired sums are reinvested within 5 years.
• While the ID has a relatively limited geographical scope, it applies to all innovation income included in the taxable result in Belgium. And that regardless of the country of origin of the income. Except when the income is attributable to a permanent foreign establishment.
• Whereas the PD could only be enjoyed from the financial year in which the patent was formally granted, the ID can already be applied from the financial year in which the IP is applied for.

Practicalities of the transition period

You can no longer apply the PD after 30 June 2021. Switching to ID is, of course, possible, but you should take the following into account:

• Make a choice
  If you close the fiscal year after 30 June 2021, you have the choice of either applying the ID for the entire fiscal year or claiming both the PD and the ID. In concrete terms, this means that the ACA can be applied until 30 June 2021. While the ID will cover the remaining part of the financial year. The application of both the ID and the AC in the same financial year is, of course, only possible if the AC has been irrevocably chosen during the transitional period.
• Maintain an overview
  The R&D expenditures for the period in which the PD was applied should only be included in the nexus break of the ID. These costs will therefore not be deducted from the gross innovation income if the PD has already been claimed for the same patent. If you wish to apply both regimes in the same financial year, it’s best to use separate analytical accounts, an interim closure on 30 June 2021 and/or timesheets.
• Calculate
  The calculation method you used for the PD can, in principle, continue to be used for the ID. You will need additional analysis of the underlying R&D-costs to determine net innovation income, however. The entire calculation method must, of course, be underpinned by a transfer pricing methodology.

More rulings and more controls

The popularity of the ID is evident from the ruling practice. Many companies want certainty regarding the calculation of the ID, and therefore enter into a prior agreement with the Ruling Committee. The committee uses specific guidelines. The amount of ID will depend on various aspects, such as the nature of the qualifying IP, the importance of the R&D function within the company, the transfer pricing method to be used, etc. At the moment, the first rulings on the transition from PD to ID have been published.

This popularity also translates into the number of tax audits. They often do not limit themselves to a review of the ID, but also focus on the underlying transfer pricing methodology. You should therefore be prepared for questions from the tax authorities, and proactively provide a substantiated file and/or start a ruling application.

With a correct application of the ID, you can further optimise your cash flow for R&D. Also take a look at other tax incentives for your R&D activities in Belgium: Optimize the cash flow of your research & development in Belgium.

If you have any questions about the application of the innovation deduction, please do not hesitate to contact our experts.