Analysis of Italy’s New Patent Box Regime

I. Introduction

In light of the recognized importance for Italy of R&D investment to fight the economic crisis and boost economic growth, the Italian Government has formally confirmed and extended the input incentives on research and development¹ and has now also enacted the output incentive (“Patent Box” regime) (see “Italy’s New Patent Box Regime Could Have Limited Impact” [29 WIPR 14, 10/1/15]).

This new regime is characterized by the internal neutrality between the beneficiaries and the application of the modified nexus approach requested by the Organisation for Economic Co-operation and Development (OECD).

The benefits arising from these input and output incentives may be combined to offer an attractive form of economic assistance to entrepreneurs engaged in the development of their qualified intangible assets through the carrying out of R&D activities.

The Italian Patent Box regime was introduced by the Italian Stability Law for 2015² and the content has since been modified by the Investment Compact Law.³ The operational parameters have been included in a decree recently signed by the Italian Ministry of Finance, to be published shortly in the Official Gazette after examination by the Italian Court of Auditors.

The Patent Box becomes a permanent rule within Italian tax law from the tax period subsequent to the one in progress at December 31, 2014 and it permits that a portion of the income derived from the use of the qualifying IP assets may be exempted from the taxable income.

II. Qualifying Taxpayers

Persons that can exercise this special regime are:

• Individuals carrying out a business activity;

• All types of limited liabilities entities in the form of corporations, cooperative entities, mutual assurance entities, European entities,⁴ and the European cooperative entities⁵ resident in Italian territory;

• Private and public bodies different from legal entities, trusts included, resident in Italian territory that have the exercise of business activities as their exclusive purpose;

• Private and public bodies different from legal entities, trusts that does not have the exercise of business activities as their exclusive or main purpose, OICR included, resident in Italian territory, with reference to the business activity eventually carried out;

• All type of partnerships resident in Italian territory;

• Entities and bodies of any type, trusts included, having a limited liability or not, not resident in Italian territory but with a permanent establishment to which the qualified IP is attributed.⁶

The regime can be exercised by the qualifying taxpayers that have the right to exploit the qualified intangible assets.

On the other hand, persons subject to bankruptcy and other winding up procedures, not being maintained as a going concern, are excluded from the qualified taxpayers.

III. Privileged Income

Privileged income is that deriving from the direct or indirect use of the following intangible assets:

• Copyrighted software;

• Industrial patents;

• Registered trademarks or trademarks for which the registration is in progress;

• Designs and models which are legally protectable;

• Processes, formulae and information relating to experience acquired in the industrial, commercial or scientific fields which are legally protectable.

To identify the abovementioned categories of qualifying intangible assets it is possible to make reference to the Italian rules, the European and international rules and the rules included in the EU regulations, treaties and international conventions. This means that the qualifying intangible assets are protectable goods in Italy and in any other foreign country based on the local applicable rules.

Income received as indemnity and restitution of income for contractual and extra-contractual responsibility for failure to contract and/or violation of the rights on qualifying intangible assets are included as privileged income.

IV. Procedural Aspects

The option to benefit from the patent box regime need not necessarily be exercised with reference to all the qualifying intangible assets.

The presence of two or more intangible assets that are characterized by a strict joint business use (either in a specific process or to manufacture the same product), are considered as a unique qualifying intangible asset for the purpose of the Patent Box regime.

The qualifying taxpayer can use these qualifying intangible assets:

• Directly — the privileged income corresponds to the economic contribution⁷ given by each qualifying intangible assets to the income generation; such a value must be determined through the signature of a specific ruling⁸ with the Central Unit of International Affairs of the Italian Tax authorities;

• Indirectly — through the licensing of the qualifying intangible assets to other external or group entities. In this case, the privileged income is royalties obtained from the licensing, less all the pertaining direct and indirect expenses sustained on an accrual basis during the same tax period.

Where there is an indirect use through the licensing to one or more group companies, the ruling procedure may be used also to determine the arm’s length income and protect the qualified taxpayer from an audit.

If the privileged income is determined through the ruling procedure, the option is effective from the tax period during which the ruling has been filed. If the ruling is not concluded and signed in accordance with the terms for the filing of the annual income tax return, the qualifying taxpayer must determine the taxable income based on the ordinary rules. Nevertheless, in order to permit the qualifying taxpayer to benefit from the privileged regime since the tax period during which the ruling was filed, the privileged income related to the tax periods from the date of filing and the date of signature of the ruling can be included in the annual income tax return related to the tax period of signature. Alternatively, the qualified taxpayer can file amended income tax returns for the previous tax periods or request the benefit to be reimbursed.

V. Small and Medium-Sized Enterprises

Small and medium-sized enterprises,⁹ as defined by the European Commission Recommendation 2003/361/CE,¹⁰ will be entitled to activate the ruling procedure in a simplified mode to be established by the director of the Italian tax authorities.

VI. Sale of Intangible Assets

The capital gain deriving from the sale of qualifying intangible assets can be considered privileged income provided that 90% of the amount is then re-invested in the maintenance or in the development of other qualifying intangible assets before the closure of the second tax period subsequent to the one in which the sale occurred. Any re-investment made to purchase other intangible assets is not considered valid for the income to be considered privileged.

In the event that 90% of the capital gain is not reinvested as specified above, the taxpayer will have to increase the upper limit of the taxable income of the tax period subsequent to the one in which the sale occurred by the amount of the capital gain that was exempted from the taxable income at the time of the sale.

VII. Extraordinary Transactions

In the case of an extraordinary transaction,¹¹ the transferee will assume the option to exercise the Patent Box, the length of the Patent Box period activated by the transferor and will assume responsibility for the relevant costs sustained by the transferor.

VIII. Qualifying R&D Activity

The regime requires the qualifying entity to perform an effective R&D activity leading to the creation of qualifying intangible assets, irrespective of where such activity is carried on (in Italy or abroad).

In addition, it is not necessary that the R&D activity is exercised in the tax period in which the preferential regime is in place; it is sufficient that such activities have been carried out in the previous tax periods.

The list of qualifying R&D activities is composed as follows:

• Basic research;

• Applied research;

• Design;

• Creation of copyrighted software;

• Preventive research, market research, anti-forgery studies and procedures, activities for the renewal and protection of rights;

• Presentation, communication and promotion activities aimed at improving the knowledge of the trademarks.

The R&D activity can be carried out:

• Directly;

• Outsourced to third parties:
  • —  universities;
  • —  research centres and equivalent bodies;
  • —  external entities non belonging to the same group.

IX. Duration

The optional regime, if exercised, has a mandatory and irrevocable duration of 5 years.

X. Option Exercise

The option exercised in the two tax periods subsequent to the one in progress at December 31, 2014, shall be communicated to the Italian tax authorities accordingly, the specific measure still waits to be defined by the Italian tax authorities.

Any option exercised starting from the third tax period subsequent to the one in progress at December 31, 2014, will be done directly in the annual income tax return.

XI. Determination of the Qualified Income

Privileged income must be determined as follows:

Costs to be considered for the formula are only those deductible for tax purposes and the ratio shall make reference to the expenses incurred in the tax period valid for the computation of the income tax benefit as well as expenses incurred in the previous three tax periods.

The qualifying expenditures incurred to develop the intangible assets (numerator of the ratio) include all costs directly connected to the R&D activity carried out:

• Directly;

• Outsourced to third parties (universities, research centres and equivalent bodies and external entities unrelated to the same group);

• By a group company, but only for the portion of the costs which consists in the recharge of costs paid by the group company to third parties;

• By the beneficiary person in presence of a Cost Contribution Agreement (CCA), excluding those costs recharged to the participating companies.

Finally, the overall amount of qualifying expenditure is increased by 30% (uplift), with a limit on the amount of the “excluded expenditures” on R&D activity: costs for the purchase or license of intangible assets and costs for R&D activity carried out by group companies.

The overall expenditure incurred in the development of the intangible assets (denominator of the ratio) includes the qualifying expenditures plus excluded costs (costs for the purchase or license of intangible assets and costs for R&D activity carried out by group companies).

In any case, the following costs cannot be considered relevant when calculating the formula:

• Passive interests;

• Expenses related to buildings;

• Any other cost not directly linked to a specific intangible asset.

The exemption from the determination of the taxable income is obtained by applying the following percentages of the value of the qualifying income:

• 30% for the tax period subsequent to the one in progress at December 31, 2014;

• 40% for the tax period subsequent to the one in progress at December 31, 2015;

• 50% for the tax period subsequent to the one in progress at December 31, 2016 onwards.

XII. Tracking and Tracing of R&D Expenditure

In line with the OECD’s recommendation, the rule requires that the qualifying taxpayer will adopt an adequate accounting system which permit the tracking and tracing of the R&D expenditure for each qualifying intangible asset.

Nevertheless, as the first application of the rule also makes reference to the expenditures sustained in previous years, the patent box regime permits the qualifying taxpayer to define the aggregate value of expenditures sustained for all the qualifying intangible assets for the first 3 years of application. Starting from the fourth period of application a detailed tracking and tracing of the expenditures will be required for each qualified intangible assets. The formula will be applied to the qualifying income of each qualifying intangible asset.

XIII. Conclusion

The Patent Box regime, together with the tax credit on R&D activities, are tools that the Italian Government and the Italian tax authorities have enacted to boost the R&D activities carried out (in agreement with the EU programs) by qualified entrepreneurs resident in the Italian territory, to diminish the disadvantage with respect to the rules already enacted in other EU and non-EU countries and, finally, to reduce the past trend of sales of intangibles and transfer of R&D activity abroad.

The procedure might seem at a first sight to be complex, due also to the need to sign a ruling with the Italian tax authorities. However, in the author’s personal experience, all this activity will increase the overall value of the enterprise, reduce the risk of tax litigation and permit the taxpayer to obtain a saving.