What you need to know about the innovation income deduction

The ultimate support measure for companies and software developers with innovative ideas

Since 1 July 2016, companies with innovative ideas have been able to make use of the innovation income deduction when developing their services, goods or software, in addition to many other support measures to significantly reduce their average tax rate. Unlike its predecessor, the patent income deduction, the innovation income deduction has a broader scope. Let’s discuss the measure in more detail.

Delphine Vanassche, Senior Manager BDO Tax & Legal

For the deduction of patent income, which was abolished for not meeting the OECD’s minimum standards for preferential regimes for intellectual property income, a phase-out scenario was introduced. Patents filed before 1 July 2016 and improved patents and licences acquired before 1 July 2016 can still make use of the ‘old’ tax exemption for patent income until 30 June 2021. For companies that don’t close their financial year on or before that date, the end of this transitional period falls in a current taxable period, in which both the patent and innovation income deduction can be applied to the same patent.

For what purposes can the innovation income deduction be applied?

The scope of the innovation income deduction is broader than that of its predecessor. We will discuss some important enhancements.

“Thanks to the innovation income deduction, which replaces the former patent income deduction, Belgium is the place to be for companies and software developers with innovative ideas.”

1. Eligible intellectual property rights

First, the number of eligible intellectual property rights has been extended. Only patents and supplementary protection certificates were eligible for the patent income deduction. For the innovation income deduction, this is supplemented by plant variety rights granted by the government, market exclusivity, orphan drugs and copyright-protected computer programs. However, you must be able to demonstrate that the latter category falls within the scope of a qualifying R&D project or programme and obtain a binding opinion from BELSPO. Since Belgian law itself doesn’t define the concept of ‘innovation’, we are obliged to refer to the OECD’s Frascati Manual.

2. Net income approach

The old patent income deduction was applied to the gross patent income, whereas the new innovation income deduction is calculated on the net innovation income. This is the gross income minus all costs associated with the development of intellectual property rights. Not only the development costs of the financial year itself, but also the historical development costs (from financial years ending as from 1 July 2016) must be taken into account.

Determining the gross innovation income is crucial for both the patent income deduction and the innovation income deduction. Since the use of the intellectual property right is often not licensed to third parties, we often don’t have an internal point of comparison to determine the (included) licence fee. To determine the gross innovation income, we can base ourselves on the development cost (the cost approach), on comparable transactions with comparable intellectual property rights (the market approach) or on the possibility of the intellectual property right to generate income (the income approach).

3. Nexus fraction

In addition, before starting an innovative project, it’s extremely important to determine in advance where the research and development activities will be located within the group. In order to optimally apply the innovation income deduction, it’s very important that these activities take place as much as possible in the company that is the legal owner of the intellectual property rights. Third parties may be called upon in the context of the research and development activity. However, when group companies charge for services in the context of the research and/or development activities, this might have a negative impact on the deduction.

4. Percentage of the innovation income deduction

Finally, a deduction of 85% can be claimed on the net innovation income (after application of the Nexus factor), which is 5% higher than the earlier percentage of the patent income deduction (80%).

What is the significance of the innovation deduction?

The application of the innovation income deduction has become more prevalent in recent years and that hasn’t escaped the notice of the tax authorities. Checks on the correct application of the innovation income deduction – a technically complex process – have increased exponentially in recent years.

Given the technical nature of the measure, it’s advisable to draw up a justification memo that substantiates all aspects of the deduction. Many companies also submit a ruling request to obtain certainty regarding the valuation of the gross innovation income. In 2019 and 2020, the innovation and patent income deduction ranked fourth on the list of main topics on which a ruling was requested.