The Patent Box Decree introduced in Italy an elective tax regime that will allow companies to benefit (starting from fiscal year 2017) from a 50% exemption from corporate income tax, IRES, and local tax, IRAP, on income derived from the direct/indirect exploitation of qualifying IP. In detail, on 6 February 2018, the Ministerial Decree of 28 November 2017 was published in Official Gazette No. 30.
The Ministerial Decree, issued by the Ministry of Economic Development and the Ministry of Economy and Finance, enacts implementing rules for the patent box regime introduced by Law No. 190 of 23 December 2014 (i.e. the Stability Law 2015) and recently amended by Law Decree No. 50 of 24 April 2017, converted, with amendments, by Law No. 96 of 21 June 2017. The Ministerial Decree replaces the Ministerial Decree of 30 July 2015.
Under the patent box regime, 50% of income derived from the exploitation or direct use of qualifying IPs is exempt from corporate income tax (imposta sul reddito delle societá, IRES) and regional tax on productive activities (imposta regionale sulle attività produttive, IRAP).
In addition, capital gains arising from the sale of qualifying IPs are not included in taxable income if at least 90% of the proceeds is reinvested, within the following 2 tax years, in R&D activities for the development, maintenance and improvement of other qualifying IPs.
Under article 2 of the Ministerial Decree, the following persons earning business income and carrying on qualifying R&D activities may opt for the regime:
- individuals carrying on business activities;
- resident companies, cooperatives and other public and private entities carrying on business activities;
- Italian commercial partnerships, with the exception of simple partnerships (società semplice, S.s.); and
- non-resident entities having a permanent establishment in Italy to which the qualifying IP may be attributed, where they are resident in a country that has a tax treaty in force with Italy and that allows an effective exchange of information.
The option can be exercised by the person holding the right to economically exploit the qualifying IP. The option applies for a period of 5 years and is irrevocable and renewable.
The exercise of the option must be communicated to the Italian tax authorities at the moment of submission of the tax return. The Patent Box regime can be elected by taxpayers carrying out business activities including, among the others, Italian branches of non-resident entities provided that these entities are resident in a country with which Italy has a bilateral tax treaty ensuring an effective exchange of information and that the qualifying IP is attributable to them (according to the OECD approach).
The Decree underlines that subjects which may elect for the regime are the holders of the economic right to use the IP (this makes the regime available not only to owners of the IP but also to licensees) provided they carry out R&D activities.
Those who cannot elect for the regime are the companies subject to bankruptcy procedures, or being compulsory wound up or the extraordinary administration of large firms in crisis.
The decree also defines the scope of the regime. In particular, income derived from the following IP is considered eligible:
- software protected by copyright;
- industrial patents, granted or in the process of being granted, including patents on inventions, including biotech inventions and related certificates, utility models, plant varieties and semiconductors' topographies;
- designs and models, which can be legally protected;
- processes, formulas and information related to business, commercial or scientific knowledge, which can be legally protected; and
- two or more listed IPs, where complementary and jointly exploited for the realization of a product or process.
The option of the elective tax regime (which is characterized by a 5 lock-in period, is irrevocable and renewable) has been communicated to the Italian Revenue Agency by the tax payer following the instructions stated by the Agency Revenue during the first three year period; starting from fiscal year 2017, the option will be communicated in the tax return.
If the qualified income is determined through the ruling procedure (that is, through direct use of the IP, compulsorily or, as for “intercompany” operations, optionally) the option is effective starting from the fiscal year in which the ruling was filed.
It means that (with the aim of giving the opportunity to benefit of the regime starting from the moment of the filing) in the period between the filing of the ruling and the conclusion of the agreement with the Tax Authorities the income is determined by eligible taxpayers according to the ordinary rules and the income accrued is recognized in the tax return of this last fiscal year, notwithstanding the possibility of filing an income tax refund application or a supplementary tax return.
It also has been clarified that in the case of extraordinary transactions (mergers, demergers, contribution in kind) the transferee takes over the rights connected to the election made by the transferor, also with reference to the costs undertaken by the transferor.
In addition, among R&D activities performed for the development, maintenance and improvement of the value of IP (the condition for application of the so-called “Modified Nexus Approach”) are: fundamental research, applied research, design, creation and realization of a software protected by copyright, and preventive researches, tests, surveys and studies also aimed at obtaining protection rights and adopting systems against counterfeiting.
In case of licensing for the use of the IP, income benefitting from the regime is equal to the royalties earned in the year net of direct and indirect expenditures related to IP assets being relevant for tax purposes. In case of direct use of the IP, income benefitting from the regime is the embedded IP income from the sale of products and the use of processes net of direct and indirect expenditures related to IP assets being relevant for tax purposes directly.
The need for a direct link between the R&D activities and the qualifying IP and between the IP and the qualifying income is underlined.
Moreover, the qualifying income must derive from an adequate accounting or cost accounting system. The nexus approach requires an IP-asset-by-IP-asset tracking. The “nexus ratio” is the ratio between qualifying expenditures and overall expenditures of the IP. The qualifying expenditures represent R&D expenditures carried out by the taxpayer itself and R&D expenditures for unrelated party outsourcing, increased by those costs carried out with related parties and acquisition costs of the IP within 30% of the qualifying expenditures.
The overall expenditures represent all the above-defined costs, without the 30% cap concerning the costs carried out with related parties and the acquisition cost of the IP. It all means that numerator and denominator of the ratio are not different for cost nature purposes. In compliance with the OECD report on Action 5, where a payment is made through a related party to an unrelated party without any margin the payment will be included in qualifying expenditures.
In accordance with such principle, R&D activities-related expenditures referred to development, maintenance and improvement of the IP carried out by the tax payer in a cost sharing agreement within the limit of incomes arising from the same cost sharing agreement will be included in qualifying expenditures.
It should be noted that for the nexus ratio computation purposes interest expenses, expenses regarding immovable properties and any costs which can’t be directly linked to any IP can’t be taken into account.
With the aim to allow taxpayers to adopt proper cost accounting systems it is stated that relevant costs shall be allocated to the ratio as follows: for the first year in which the regime is in force (2015) and for the following two, relevant costs are those carried out in the year to which the relevant tax return refers to and the previous three.
The nexus ratio is not calculated on an IP basis but on an overall basis, this possibility is given to taxpayers on the assumption of them not having on their disposal an adequate accounting system allowing them to prove the link existence between R&D activities, IP and income (i.e. Modified Nexus Approach).
Starting from fiscal year 2018, however, costs to be considered are those carried out from 2015 and the ratio has to be calculated separately for each IP.
However, with the aim to make the regime adoption easier, if a product is strictly linked to the joint use of more than one IP, these IP assets incorporated into one product are considered as an only one.
The regime also foresees that capital gains arising from the sale of eligible IP are exempt provided that at least 90% of the amount received is reinvested within the end of the second fiscal year following the sale in R&D activities aimed at developing, maintaining and improving other IP.
Finally, in case of direct use of the IP, and with reference to embedded IP income from the sale of products and the use of processes, it should be noted that the Decree, apart from what stated in Legislative Decree n. 600/1973, art. 31-ter, concerning the “preventive ruling” (also known as International Standard Ruling) which states that the ruling procedure is compulsory in case of direct use of the IP or optional as for “intercompany” operations, doesn’t provide further indications.
The Decree only makes a general reference to the international Transfer Pricing standard released by the OECD in art. 12 (3) with regard to Small and Medium Enterprises.
By experience we can confirm that the reference to the OECD Transfer Pricing standard is generally followed by the Tax Agency and that in most cases a Transactional Net Margin Method is applied.
The recent developments and the "Decreto Crescita"
The first reference related to recent developments concerning Patetn Box regime is to the law n. 96-2017 which has excluded the trade marks from the objective scope of the facilitated taxation of the Patent box starting from 2017, confirming all the options exercised in 2015 and 2016 and provided that once the five years period have passed, within the maximum limit of June 30, 2012, the benefit is no longer renewable.
To determine the amount of the subsidy, the law provided for a ruling procedure – mandatory or optional depending on the case – which sees the taxpayer concerned send a specific application to the Revenue Agency, followed by a comparison for the definition of prior agreements.
However, to overcome the criticalities of the ruling procedure, on April 23, 2019 it was eventually approved the "Decreto Crescita" which includes a few important provisions about tax reliefs for companies.
Among them, it has to be mentioned the new rules for the "Patent box" which simplifies the steps to determine the eligible income for the purposes of the Patent box.
Starting from the tax period in progress on the date of entry into force of the decree-law, business income holders will in fact be able to choose, as an alternative to the ruling procedure, to determine and indicate directly the taxable income in the income tax return.
Taxpayers will have to provide all the necessary information by preparing appropriate documentation, respecting the operational that will be provided by the Revenue Agency.
The subjects who opt for this new procedure must divide the decrease in three annual quotas of the same amount to be indicated in the tax return and the regional tax on productive activities, relating to the tax period in which this option is exercised and in those relating the two subsequent tax periods.
In the event of adjustment of the income excluded from the competition of the formation of the business income, the administrative penalty from 90% to 180% envisaged for the unfaithful declaration does not apply if, during accesses, inspections, verifications of other preliminary activity, the tax payer issues to the Financial Administrations the documentation necessary to allow verification of the correct determination of the income excluded from taxation.
The taxpayer who holds the documentation in question must notify the Revenue Agency in the declaration relating to the tax period for which the benefit is being granted. The new rules are also applicable in the event that a ruling procedure has already been activated, provided that the related agreement has not been concluded.
Taxpayers must divide the sum of the decreasing variations, relative to the tax periods of application of the subsidy, into three annual installments of the same amount to be indicated in the tax return and Irap relating to the two subsequent tax periods.
The options remains open for all taxpayers who wish to benefit from the Patent box regime to access the reward penalty system by submitting a supplementary declaration, in which the possession of the appropriate documentation must be indicated for each tax period subject to integration, provided that the declaration is presented before the formal knowledge of the beginning of any control activity.
It will be fundamental then to have in place a proper documentation attesting the economic value of the regime benefitting intangibles in compliance with the OECD principle and local transfer pricing regulations.
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