Source : www.ieepi.org
IEEPI gives the floor to its experts, today Terence Wilhelm, lawyer and founder of the law firm CARA Société d'Avocats, specializing in international taxation, transfer pricing and intellectual property taxation. He offers us an analysis of :
The new preferential regime applicable to patents and related industrial property rights
Article 37 of the 2019 Finance Act, codified in Article 238 of the General Tax Code, has profoundly modified the French preferential tax regime applicable to patents and certain other inventions. With effect from January 1, 2019, this special arrangement has been brought into line with the recommendations of the OECD, which, as part of its action plan to combat "tax base erosion and profit shifting", enjoins States to make the application of a preferential tax regime conditional on the actual performance of R&D activities and expenditure having directly contributed to the creation of the invention. But while this new system is certainly more attractive, it is also tougher and less flexible.
Why was it necessary to reform the taxation of patents and related inventions?
Our former preferential tax regime, set out in article 39 terdecies of the French General Tax Code, suffered from two major drawbacks. On the one hand, the 15% tax rate applicable to proceeds from the sale and granting of patents and certain other inventions was unattractive compared with some of our European neighbors. Even though it offered real tax savings compared with the standard rate (then 33.33%), it struggled to compete with the Dutch, Irish and Belgian regimes. On the other hand, and above all, it could enable companies to outsource R&D efforts abroad, while benefiting from a reduced tax rate in France. It was this disconnect between the benefit of the preferential regime in one jurisdiction and the deduction of R&D costs in another that was highlighted by the OECD as part of its work to combat so-called "harmful" tax practices, i.e. those that created a situation of harmful tax competition between countries. As a result, the OECD singled out the French system for criticism, on the grounds that it did not make the benefit of the preferential tax regime conditional on incurring the R&D expenditure that led to the creation of the invention. Admittedly, many of our partners were in the same situation. But they reacted before we did, by revising their preferential tax regime to focus on patents and similar inventions, and above all by integrating the "nexus" approach.
We often hear the term "nexus", so what exactly is it?
Rather than "nexus", we could refer to the "link theory". Behind this mystical formula lies the imperative need to correlate the benefit of a preferential tax regime with the fact that, in the same State and by the same taxpayer, the efforts which led to the development of the asset or operation which is the subject of this preferential tax regime must be borne. To put it more simplistically, the nexus is the weapon that the OECD has drawn against "letterbox" companies, the empty shells that have flourished in certain countries where intangible assets (mainly patents and trademarks) were housed to benefit from the preferential tax regime applicable in that country, without any or very little R&D expenditure having been incurred. The aim of many tax schemes was to house R&D activities in high-tax countries, with minimal remuneration; and once the patent or trademark had been exploited, to transfer the proceeds of sale or concession to an owner established in a lower-tax country. The operation was thus optimal: costs were incurred in high-tax countries, and profits were captured in low-tax countries. The nexus ratio aims to combat this disconnect by introducing a tax liability ratio into preferential tax regimes. Under the French system set out in Article 238 of the General Tax Code, this ratio is equal to R&D expenditure incurred directly by the company or subcontracted to unrelated companies, divided by total R&D expenditure (including any subcontracted to companies in the same group, even though these are not included in the numerator).
Apart from this nexus ratio, are there any other changes compared with the previous preferential regime?
Because it is international in nature, the nexus ratio has tended to focus attention on itself, overshadowing the other changes introduced by the Finance Act. But in reality, more than a simple tidying-up, it is a real overhaul of our preferential tax regime that has taken place. In fact, the former article containing it (Article 39 terdecies of the French General Tax Code) has not just been amended. It has been gutted and a new article has been specially drafted in the code to contain this preferential regime, namely article 238.
Firstly, the scope of application has been modified. Eligible rights still include patents, patentable inventions, plant breeders' rights and improvements to patented inventions. But there's a new addition to the list: software. From now on, the use of software will also be eligible for preferential tax treatment. The idea behind the law was clearly to make France a land of welcome for companies whose purpose is to develop and market software, a sector which is booming.
The calculation of the proceeds from the transfer or concession has also been modified. Firstly, a net result must be calculated, by subtracting all R&D, maintenance and other costs from the results (royalties received, for example); secondly, this net result must be weighted in relation to the taxable income ratio, the famous "nexus".
Lastly, the tax rate has been reduced to 10%, compared with 15% previously (excluding social security contributions for individual taxpayers), to bring France back into line with the European average and prevent it from being left behind in the race for tax competition.
So what are we to make of this new preferential tax regime?
To be perfectly frank, I'm still perplexed, and for the time being my analysis is dominated by disappointment. First of all, the scope of application: before the law was finally drafted, Bercy published a survey in which participants were asked to choose between three options. One of these was to extend the preferential tax regime to a portion of the income earned by companies that market their own products incorporating patents, patentable inventions, VOCs or any other assets falling within the scope, without these assets giving rise to a transfer or concession. The idea was to calculate a kind of "notional income", subtracted from the sale price of the products, and tax this portion at the reduced 10% rate. Instead of this option, the legislator preferred to extend the preferential tax regime to software, which until then had been treated like any other asset for tax purposes, and therefore did not benefit from any particularly favorable treatment. In my view, this is a mistake. Firstly, the current text is cruelly lacking in clarity. It makes application of the regime conditional on software being "protected by copyright", i.e. necessarily linked to a degree of inventiveness. However, as we know from research tax credit applications, this notion of inventiveness is very often undermined. Either all software is inventive, or none at all! The borderline is very blurred. Secondly, the administrative instruction published this summer casts doubt on the products linked to the use of software that could be taxed at the reduced rate. It's confusing. Finally, companies that exploit their own inventions and integrate them into their products will have to set up concession schemes in order to benefit from the preferential tax regime. Not only can such structuring prove cumbersome and costly for some modest-sized companies, but such a project is bound to be essentially fiscal in nature, and therefore bordering on abuse of rights.
Implementing the preferential tax regime also promises to be complex. It entails a twofold obligation: firstly, to file declarations, and secondly, to provide documentation. Every year, the taxpayer will have to append to his income tax return a document summarizing his calculations to determine the amount of net income taxed at the reduced rate. These calculations appear to be relatively complex when you read the instructions, and any error will necessarily be paid for in cash. In addition to this declaration, the taxpayer will also have to provide the tax authorities with a more comprehensive report, detailing the scheme, the assets exploited, the origin and nature of R&D costs, etc. These reports, if added to those already prepared for the CIR or to comply with transfer pricing obligations, will only add to the burden of formal obligations which are already excessive in France.
Finally, while the 10% tax rate is in line with the European average, it should be remembered that social security contributions are added to this, bringing the effective tax rate to 27.2% for individuals. In my opinion, there is little or no point in activating this tax regime, which is only favorable in name, for individual inventors.
So it's a failure...
No, I clearly wouldn't be so abrupt. The text will evolve in line with the final administrative instructions, which have yet to be published and which will be fuelled by the call for comments issued by the tax authorities this summer, and which will run until mid-September. It should also be remembered that France enjoys a real tradition of tax attractiveness when it comes to innovation and research and development. Look at the CIR, the CII - these are real success stories, which other countries have subsequently tried to replicate. We need to give this new preferential tax regime a chance, as it has the advantage of attempting to align with foreign regimes and thus move towards standardization, and perhaps even ultimately harmonization in Europe. It should also reinvigorate the software and digital sectors in general, offering real opportunities for optimization to players who until now have not been concerned. Just imagine, for some, the tax rate could drop from 33.33% to 10%!
What does this mean for companies with intellectual property?
This sends out a very strong message to businesses. Behind this new preferential tax regime lies an underlying trend that affects intellectual property more generally and its tax treatment. In fact, this regime, which is the result of an OECD initiative, is in line with other work by this organization, which in particular advocates a gradual shift in recognition, for tax purposes, from legal ownership to so-called "economic" ownership. The owner in the tax sense - i.e., the person legitimately entitled to receive the proceeds from the exploitation of intellectual property - would not be the person registered as such, but rather the person who performs the essential functions that have made it possible to develop, improve, maintain, protect and exploit this intellectual property. In other words, the schemes we've seen flourish in recent years, whereby intellectual property is placed in the hands of an entity based in Luxembourg, Belgium, the Netherlands, or even more exotic territories, without any activity actually being carried out there, have come to an end and are now condemned. These preferential tax regimes therefore call for a wide-ranging reflection on the legitimate location of intellectual property, and hence the applicability of these preferential tax regimes. For if no R&D activity is carried out in the countries I have just mentioned, then no preferential tax regime should be applicable by the same token. These tax structures would then no longer be of any interest, and on the contrary would expose the taxpayer to a high risk of rectification. I therefore actively advocate greater interaction between IP experts and tax specialists, to secure IP-related schemes and protect the economic and tax interests of inventors. Of course, this may involve some analytical work upstream of any transaction, but the tax savings - which can be quite substantial! - is well worth the effort.
(interview published on the IEEPI website on 18.11.2019)
