Getting the most out of tax benefits for R&D and royalty income.
In recent times many companies have been forced to focus their energies almost exclusively on their immediate concerns aroused by the economic crisis: drop in revenue, cash and credit shortages, excess capacity, etc. However, as the end of the crisis seems to be drawing closer companies need to plan realistically for their future. In this context optimising their investment in R&D and other intangibles will rank high in their agendas.
The Basque Country (an autonomous region of northern Spain) can offer many opportunities to companies developing and owning intangibles: qualified personnel, a well established entrepreneurial tradition and business infrastructure, and subsidies and interest free loans. The Basque Country also enjoys autonomy to enact its own tax legislation, and it has used this to offer a unique set of tax benefits to R&D activities and to the licensing of intangibles. Spain discusses the tax treatment of intangibles under Basque autonomous corporate income tax legislation and the tax saving opportunities it provides for businesses.
The tax benefits available with regard to intangibles include:
- The royalty box regime.
- Depreciation of intangibles.
- Tax credits for research, development and innovation (R&D&I).
- Personal income tax reduction for impatriates engaged in R&D&I activities.
- Reductions in social security contributions for personnel engaged in R&D&I.
Royalties benefit of an exemption of 60% of gross income, when the intangible asset being licensed is developed by the company or 30% when it was acquired from another person or entity.
It would not be appropriate to call this special tax regime a patent box because it is not limited to royalties on patents or technological know-how, but it also extends to royalty income accruing from any kind of industrial or intellectual property, except for those items expressly excluded by the law (mainly, copyrights and image rights). Thus, the royalty generating assets that can benefit from this special regime also include such intangibles as trademarks, commercial know-how and software.
This broad definition of the scope of items that can benefit from the tax reduction also avoids many of the complexities that may arise under other patent box regimes. These often make it necessary in complex agreements, such as franchises, to try to determine which part of the remuneration is for technological knowledge and which part is for commercial knowledge, such as trademarks or similar items of a commercial nature. Under the Basque royalty box regime this issue does not arise because the whole package can benefit from tax reduction.
A further extension of the scope of the tax reduction results is the fact that qualifying IP includes not only self-developed intangibles but also those acquired from third parties. However, in the case of assets acquired the exemption is limited to 30% of the gross income, while the exempt portion is 60% for intangibles developed by the company. In our view, if an intangible holding company is set up and intangibles previously developed by other group companies are transferred to it by means of a qualifying reorganisation, such as a demerger, a contribution of branch of activity or a qualifying contribution of assets, these assets should be considered as self-developed and therefore benefit of the 60% rate of reduction.
Since the reduction operates on gross income, all costs relating to that income (development costs, depreciation of intangibles, general management costs, financial costs, etc.) are deductible under general rules. As a result of this, the intangible holding company can operate with a very large margin without recognising taxable income.
There is no limit to the amount of income that can benefit from the reduction or to the period of time during which it can be applied: the tax reduction will apply for as long as the intangible keeps generating royalty income.
Companies subject to Basque tax regulations are Spanish residents. They can in principle benefit from a wide range of Spanish tax treaties reducing the source taxation on royalty income.
Depreciation of intangibles
For the purposes of their depreciation, intangibles are classified in two categories:
- Intangibles with a limited useful life. These include intangibles which legally or contractually are only enforceable for a limited period of time, for example with patents. These intangibles may be depreciated for tax purposes over five years, or within their useful life, if shorter.
- Other intangibles, such as trademarks last indefinitely from a legal perspective and do not represent a legal right (goodwill, clientele) and therefore do not have a predetermined legal life. Such intangibles are not systematically depreciated for book purposes, but only written off in case of impairment. However, for tax purposes, these intangible assets can also depreciate at a maximum 20% yearly rate. Moreover, depreciation can also be taken for indirect goodwill, i.e. the part of the acquisition cost of a subsidiary that represents the value of the subsidiary’s goodwill. Some limitations and anti abuse provisions apply in connection mainly with intangibles acquired in related party transactions.
Capitalised R&D expenditure can be freely depreciated for tax purposes.
Tax credits for R&D&I
Tax credits are available for expenditure not only in research and development but also in technological innovation. While research and development is aimed at an absolute technological advance, innovation may simply represent a technological improvement for the company, although equivalent technology may already be available to others. It includes the development of new products, services or processes, or substantial improvements to the existing ones, the construction or fabrication of prototypes, and pilot or demonstration projects, technical diagnosis and the cost of obtaining quality certifications.
The basic rate of the tax credit for R&D expenditure is 30%. This basic rate is further increased for the amount of R&D expenditure in excess of the average two preceding years, the cost of works subcontracted with qualifying research centres and for labour costs of qualifying researchers. The rate for technological innovation is 15% or 20%, depending on the particular type of expenditure. The applicable tax credit rates are summarised in the following box.
|Increase over average expenditure of two prior years||+||20%|
|Specially qualified expenditure:||+||20%|
|Labour costs on qualified researchers|
|Fees paid to qualified research centres|
|Total maximum rate||70%|
|Production process engineering||15%|
|Royalties: patents, licenses, technical know-how||15%|
|Fees paid to qualified research centres||20%|
The tax credits are computed on the amount of gross R&D&I expenditure, less the after-tax amount of grants received in their connection. For these purposes, the after-tax amount of a grant is deemed to be 72% of the gross grant, even though the effective tax rate for a company engaged a R&D&I activities will often be significantly lower than the 28% nominal corporate income tax rate.
These tax credits can offset the company’s tax liability in full. Unused amounts can be carried forward indefinitely.
There are uncertainties concerning the classification of technological projects relating to research, development or innovation, and which expenses should be allocated to the research, development or innovation phases rather than being classified as ordinary production costs. In order to obtain legal certainty in advance of the tax credits being available for a particular project, taxpayers may obtain an advance binding ruling on the classification of the company’s projects as R&D or technological innovation and the reasonability of the project’s budget.
Acquisition of tangible fixed assets to be used in R&D&I activities
Investments in tangible fixed assets to be used in R&D&I activities also qualify for a tax credit of 10% of their cost.
Furthermore, these assets also benefit from free depreciation for tax purposes, with the exception of buildings, which can be depreciated over 10 years for tax purposes (instead of the general minimum 30-year period for the tax depreciation of buildings).
Special personal income tax regime for impatriates
Individuals who were not previously Spanish tax residents and become tax residents in the Basque Country as a consequence of taking up a job as researchers involved in R&D activities can opt to be treated as non residents in their first six years of residency in Spain. In practice impatriates receive two benefits:
- They are only taxable on their Spanish-source income. Thus they can shelter their financial income from Spanish taxation by simply not importing their net worth into Spain. Also, if they derive part of their remuneration from activities carried out outside Spain, such remuneration will not be taxable either.
- Spanish source income will be taxed at a flat rate of 24% (compared to a top marginal personal income tax rate of 45%).
This tax regime can reduce salary costs for a company by up to one fourth when negotiating remuneration packages on an after-tax basis with highly remunerated individuals.
Social security contributions
A reduction of 40% is available for the social security contributions of personnel employed in R&D or technological innovation activities.
R&D&I and intangible holding companies set up in the Basque Country can benefit from a combination of generous tax incentives for the development and licensing of intangibles, which, together with the available non-tax incentives and the overall business climate and infrastructure, offer very favourable opportunities for R&D&I activities and the management of intangible assets.
Your Taxand contact for further queries is:
T. +34 (944) 700 699
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