The new Italian Patent Box

A preferential tax regime has been introduced in the Italian legislation to encourage the development of Intellectual Property. This regime, well-known as patent box, designs an optional taxation regime for income produced by certain kinds of intangible assets. Under the implemented scheme, taxpayers are allowed to exempt a percentage of such income from their tax base.

The patent box regime, as patterned by article 1 (clauses 37 to 45) of the 2015 Stability Law and modified by Article 5 of the Law Decree No. 3 of 24 January 2015 (turned into Law No. 33 of 24 March 2015), has been published in the Official Gazette No. 244 on 20 October 2015 following the issuance of a Ministerial Decree on 30 July 2015. On 1 December 2015 the Italian Tax Authorities drafted the Circular No. 36/E to provide the taxpayers with the (first) practical explanations about the functioning of the new regime and the consequent activities to be carried out in the immediate next future (since the first deadline to benefit of this procedure for the taxable year 2015 is on 31 December 2015).

This article highlights the main aspects of this new patent box regime and introduces the impact for small and medium-sized companies.

Qualifying taxpayers for the scheme are both Italians resident entities and Italian branches of non-resident entities with which Italy has an enforceable agreement for the effective exchange of information and concluded a Bilateral Tax Treaty for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income. The election for the regime can be exercised only by the holder of the IP rights carrying out R&D activities, which means either the owner of the IP rights or the licensees.

Qualifying IPs for the regime at hand are: software covered by copyright; industrial patents; trademarks, including collective brands registered or in the process of registration; models and designs that are capable of legal protection; know-how and other industrial information. For the purposes of the patent box regime, the R&D activities carried out for the development, maintenance and improvement of the IPs value includes: fundamental research with the main scope of knowledge acquisition; applied research aimed at the creation of competences for the development of new products, processes or existing services; design; creation and realization of software protected by copyrights; testing, surveys and market researches aimed at protecting existing IPs and the renewal of IP rights.

The patent box regime grants beneficial exemption for qualifying income derived from a direct or indirect use of qualifying IP. Direct use is understood as using the qualifying IP itself and without licensing it to other entities, meaning that the qualifying income derives from the sale of products and the use of processes, net of all direct and indirect costs related to the IPs. On the other hand, indirect use of qualifying IPs means that the qualifying income derives from the royalties earned in the year, deducted of all IP related costs and expenditure to acquire those IPs.

The main features of this regime, in brief, are:

• the patent box regime is optional,
• the option has a duration of 5 years and it is irrevocable for the same period,
• the option can be renewed,
• for 2015 and 2016 the election must be exercised through a specific form provided by the Revenue Agency,
• from 2017 on the election will be made in the annual tax return,
• if the patent box regime involves the direct use of IPs, obtaining a specific ruling from the Revenue Agency is mandatory in order to determine the eligible income,
• if the patent box regime involves an indirect use of IPs, the ruling is optional since the eligible income should be determined by the amount in the agreement subscribed between the licensor and the licensee.

The scheme grants a 50% exemption (for both corporate income tax and local tax purposes) on income derived from the exploitation of direct use of qualifying IPs. However, for 2015 and 2016 the beneficial exemption will be, respectively, limited to 30% and 40% of the qualifying income (fundamentally due to a computation of qualifying R&D expenditure on an overall basis instead of a specific basis).

The provisions in this regime are in line with the OECD nexus approach, defined by Action 5 of the Beps Project as an approach that “allows a taxpayer to benefit from an IP regime only to the extent that the taxpayer itself incurred qualifying research and development (R&D) expenditures that gave rise to the IP income. The nexus approach uses expenditure as a proxy for activity and builds on the principle that, because IP regimes are designed to encourage R&D activities and to foster growth and employment, a substantial activity requirement should ensure that taxpayers benefiting from these regimes did in fact engage in such activities and did incur actual expenditures on such activities”. In other words, there must be a direct nexus between the R&D activities and the qualifying IP income.

The nexus ratio will be calculated on an asset-by-asset basis, through the tracking and tracing approach, as a ratio between:

• qualifying expenditure (directly carried out by the taxpayer, or from universities, public research institutes or equivalent bodies, or from innovative start-ups) and increased by related and acquisition costs (limited to 30% of the qualifying costs, and defined by the OECD as the 30% up-lift),

and

• total expenditure of the above-mentioned activities.

However, for the first three years of the scheme (2015-2017), the ratio will be calculated on an overall basis, given the difficulty to split the qualifying R&D activities for the period 2012-2014 (for 2015), 2013-2015 (for 2016) and 2014-2016 (for 2017). Starting from 2018 (i.e. the R&D expenditure incurred from 2015 on) the ratio must be determined on a specific asset-by-asset basis.

Furthermore, potential capital gains realized from the sale of qualifying IP assets are entirely exempt from taxation, provided that at least 90% of the gain is reinvested in R&D activities.

All things considered, this regime reflects the Italian Government’s concern to make the Italian tax environment more attractive for inbound investments and to encourage the local ownership of intangible assets, in line with the last OECD recommendations under BEPS Action 5.

Written by Dott. Palmitessa – RSM