COMPARATIVE STUDY OF THE HUNGARIAN, MALTESE AND

LUXEMBOURG IP REGIMES

PAPER

in application for the Klaus Vogel scholarship published by the Institute of International
Taxation Inc.

March 2012

Author:

dr. Erzsébet VARGA

Faludi Wolf Theiss Attorneys at Law, Budapest

PHD, Pázmány Péter Catholic University, Budapest

Topic:

The tax treatment of the development and licencing of IP in cross-border situations:

domestic and tax treaty law discussions

@ 2012 dr. Varga Erzsébet, All rights reserved.

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I. INTRODUCTION

In the course of the last 10-20 years, several companies have been relying on licensing
intellectual property (IP) rights to achieve their business goals. Intangibles are often viewed as
important strategic assets, and intellectual property assets may constitute the cornerstone of a
company’s value. While traditionally tangible assets such as real estate and equipment were
regarded as the primary assets of value for assessing the competitiveness of an enterprise,
intangible assets, including intellectual property, are now estimated to account for more than
50% of the value of many multinational companies. In certain cases, this value may be as high
as 75%. Companies, therefore, may take considerable efforts to invest in IP assets. By way of
smart structuring, IP assets can reduce costs, increase revenues and share value, and may be
used as collateral for financing.

As companies extend the access to their IP rights globally, it is increasingly important to

recognize how corporate structures and tax arrangements may benefit or disadvantage the
owner of the IP rights, particularly in the ownership and licensing arenas. Learning about the
details of the available corporate and tax opportunities could result in efficient global IP
management at the level of the company or company group, and positive results could be
achieved from the business, IP and tax perspectives.

Governments have also realized the growing importance of the role of intangible assets,
and as a consequence, more and more countries are introducing new tax incentives in
relation to IP rights. Such tax incentives may relate tot he taxation of income generated in
connection with intangible assets, and are often supported with rules aiming at enhancing
research and development (R&D). Innovation has been recognized as an important tool to
increase the competitiveness of economies also at the European level. Existing incentives
are regularly improved and changes to the IP tax regimes in Europe have become frequent
and numerous. This is clearly an area that is very much in development and requires
permanent review.

The purpose of this paper is to focus on the tax benefits that may be obtained from the use
of certain European IP regimes, i.e. Hungary, Luxembourg and Malta1 in international tax
planning structures. The study will mainly deal with the taxation of income realized from
IP rights, but not analyse in detail connected tax incentives such as deduction of R&D
costs. Within the scope of this essay there is no place for an exhaustive analysis of all
aspects of the taxation of IP rights. Therefore, we only focus on the most important issues
related to the subject matter.

The IP regimes of Hungary, Luxembourg and Malta has been chosen for the basis of this
analysis as all three countries are Member States of the European Union and due to their
small sizes they are incentivated to attract foreign investments. All three states have been
recognized as offering very attractive solutions for international royalty structures. The
comparison will thus allow an assessment on how different tax law schemes may operate
within the framework of the European Union. It is a well-known statement that the EU

1
The Author thanks to Wouter Vosse and Tim Dopmeijer from Loyens&Loeff Amsterdam, to Jonathan
Corrieri from Corrieri Cilia Legal Malta, and to Békés Balázs from Faludi Wolf Theiss Budapest for
their active contribution to the preparation of this paper in relation to the analysis of the Luxembourg,
Malta and Hungary IP regimes.
@ 2012 dr. Varga Erzsébet, All rights reserved.
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sets several requirements and restrictions to the Member States' internal tax systems,
based on the common principles flowing from the founding treaties. It can thus be
analysed to what extent may different tax rules co-exist at the level of the European
Union.

II. DEFINITION OF IP RIGHTS

Before dealing with the tax implications of IP structures, it is essential to understand what do
we mean for IP rights.

From a traditional civil law point of view, property rights are considered as a bundle of
individual rights, such as various rights to exclude others from the property and other rights to
exploit the property as the owner wishes. Licenses are the legal tools for allowing others to
enjoy at least some of those individual rights, for at least a limited period of time, or under at
least a limited set of circumstances. There are different types of individual rights that may be
subject to a license agreement, and the classification of those individual rights is not so
simple. Some common considerations apply to all licenses, while other issues arise only in
particular types of licenses.

A license is a contractual agreement between a “licensor” and a “licensee” that allows the
licensee to make some specified use of the licensor’s property in return for the payment of a
royalty. Typically, the licensor’s property would not otherwise be available for use by the
licensee, either because it is a trade secret not known to the licensee or because there is some
legal restriction, such as a copyright or patent, that prevents the licensee from using the
property.

In the case of a license, contrary to a traditional sale and purchase, the ownership of the
property is not transferred and the licensor retains certain rights to the property. However, in
some instances, a license can grant sufficiently broad rights and might be similar to a sale.
Classifying a transaction as a license or a sale may be particularly significant in the tax area,
where the treatment of the payment (i.e. whether it is capital) and the timing of its
recognition, as well as issues of deductibility and withholding taxes, may differ drastically
depending upon how the transaction is characterized. It is not always easy to tell whether a
particular transaction will be considered a sale or a license for any particular legal purpose.

The tax law definition of IP rights is closely linked to the classification of licences under that
civil law concept. When it comes to the classification of the various IP rights, the OECD
Model Tax Convention on Income and on Capital (OECD Model) can give some guidance,
since it contains a definition in connection with royalty income. Especially, Art. 12, par. 2 of
the OECD Model on 'Royalties' expressly provides that "The term "royalties" as used in this
Article means payments of any kind received as a consideration for the use of, or the right to
use, any copyright of literary, artistic or scientific work including cinematograph films, any
patent, trade mark, design or model, plan, secret formula or process, or for information
concerning industrial, commercial or scientific experience.2 "

In the followings, we shortly describe the various types of IP rights based on the classification
of the OECD Model. Also, we refer to the classification of the receipts generated in
connection with such IP rights.

2
Art. 12, par. 2 of the OECD Model
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II.1 Copyrights

A copyright is the exclusive right to reproduce and perform certain other acts in relation to
original work which is either literary, artistic, musical or dramatic. A copyright3 provides
its owner with a number of exclusive rights pertaining to a work of authorship, including
rights of reproduction and distribution. A significant limitation of copyright protection is that
it extends only to the expression present in a work of authorship, not the underlying ideas,
concepts or systems. Nonetheless, copyright is a popular tool for the protection of such
technology as computer programs. Copyright may also exist in sound recordings, films and
videos. Besides the right to copy, copyright also covers performing in public including the
spoken word and music.

Some copyright licenses permit the work to be modified, while others do not. In copyright
terms, a new work that includes a licensed work or that modifies a licensed work is known as
a “derivative work.” If a licensee wants to make changes to a work provided under a
copyright license or wants to embed that work into another creative work, the licensee should
be sure that the license extends to the creation and marketing of such derivative works.

Royalties may arise where the performer owns at some time the copyright in his product
and he has assigned or sub-licensed these rights to someone else. Royalty income which is
received by a person who created the copyright at work is treated as trading income.

II.2 Patents

Patent rights are granted for the protection of inventions related to new, useful and
unobvious processes, machines and compositions of matter (i.e. utility patents), and for new,
ornamental and unobvious designs of manufactured articles (i.e. design patents). The owner
of a patent is given the legal right to exclude the unauthorized use, manufacture, sale, offer for
sale or importation of products or services that include the patented subject matter.

One principal motivation for inventors to seek patents is the prospect of revenue that can be
generated from licensing such patents to others. Thus, the owner of a patented manufacturing
process can negotiate patent licenses with numerous manufacturers who would find it
advantageous to use such a process. It should be noted that a manufacturer might have to
obtain patent licenses from several different patent owners if the product or the process of
manufacturing it incorporates the subject matter claimed by each of several patents. Once
protected, the invention can be exploited by licence or the patentee’s own manufacture.

Patents are usually exploited by means of a royalty payment from the licensee to the
licensor. Taxation may differ depending on whether the patent royalty is made as an
annual payment or as a lump sum receipt. In certain cases, the domestic legislation of
certain states may regard such payments as of a capital rather than of an income nature. If
of an income nature, the payor may be required to deduct income tax at the basic rate from
the payment and to pay this amount over to the local tax administration within a specified
period. Should the payment be regarded as one of a capital nature, it would be important
to determine whether capital allowances are deductible under the relevant domestic rules.

3 For more details see also http://www.fenwick.com/docstore/publications/ip/patent_licensing.pdf

@ 2012 dr. Varga Erzsébet, All rights reserved.
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II.3 Trademarks

A trademark is a word, symbol or other distinctive attribute associated with a product or

service that indicates to the marketplace the origin of the product or service and distinguishes
it from those of others. Product names, company names, logos and even colors and fragrances
may be trademarks. The purpose of a trademark is to provide the marketplace with a means of
keeping track of the source or origin of various products and services. In that sense,
trademarks protect the goodwill developed by the originating companies that manufacture or
supply goods or services bearing the associated trademark.

Because of the underlying function of trademarks, trademark licenses usually are

accompanied by other restrictions on the licensee. If the only right granted by a license is the
right to use the mark, the mark will no longer bear any relation either to a particular source of
goods or services, or to any corresponding reputation. Therefore, trademark licenses generally
include provisions that require the licensee to meet certain standards, such as quality.
Trademark licenses also generally provide the licensor with a measure of control over the
licensee to ensure that not only the licensor’s trademark, but also the licensor’s goodwill
represented by the trademark are carried over by the licensee.

If the trademark is sold for a lump sum the amount might be regarded as capital by the
relevant domestic rules; however, if the lump sum was for the licence only, it would be
taxed as income.

II.4 Design or model

The right to a design involves the protection of the shape, configuration, pattern or
ornament applied to an article. The registration gives the right to prevent others from
producing articles of the same design. Novelty is required for a design to be registrable. It
is particularly useful in areas such as fabric design, but is also applicable in character
merchandising.

For income received through designs, generally, if the consideration is a fee, income
would be taxable as a trading receipt; if a royalty is paid for the use of the design (where
no services are performed by the licensor), it could be assessed as royalty income.

II.5 Secret formulae and processess

Secret formulae and processes are rights which protect creators from others
using/exploiting their formulae/processes. Secret formulae and processes include any
information that provides value to their owners by not being generally known to others and
which are the subject of reasonable efforts by the owner to maintain the confidentiality of the
information. Trade secrets can include not only technical information such as formulas,
computer program code and manufacturing processes, but also business information such as
customer lists. Trade secret rights can exist indefinitely, but are extinguished if the
information is publicly disclosed, and are diminished and no longer the exclusive property of
the original owner to the extent that the trade secret information can be re-created or laudably
obtained.

A license of a trade secret discloses the secret to another by definition. However, the law
permits licensing of a trade secret as long as the licensee is obligated to protect the
confidentiality of the secret vis-a'-vis third parties. Licenses of trade secrets are used
extensively among hightechnology companies, particularly where the companies have a

@ 2012 dr. Varga Erzsébet, All rights reserved.

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vertical relationship, e.g. where the licensee manufactures products to the confidential
specifications of the licensor.

In some instances, information that is not strictly a trade secret is licensed as “know-how.”
The legal protection afforded a licensor of such information is unclear. In some instances,
unauthorized use of know-how may be actionable as a breach of contract or unfair
competition. In other instances, if the know-how is not protected by trade secret law (or by
patent, copyright or trademark law), the licensor may not have a cognizable property right to
assert against an infringer.

II.6 Know-how

The term 'know-how' refers to information relating to a skill/ability which can be

committed to paper or some other tangible form. Under Article 12 of the OECD Model,
the definition of royalties includes know-how but excludes show-how. ‘Know-how’ must
be distinguished from the term ‘show-how’, which is used to cover information which can
only effectively be transmitted by in-house training. Show-how is generally considered as
the provision of services rather than a transfer of intellectual property, and it is therefore
of special interest if a specific double tax treaty includes know-how under the ‘royalties’
article but effectively exempts payments for show-how from local taxation in the absence
of a permanent establishment in the country where the services are being performed.
Under a know-how/show-how contract, once the information has been transferred, or the
demonstration given, the contract is effectively concluded.

Know-how is usually taxed as a trading receipt in the normal course of business. Where
know-how remains with the licensor for further exploitation it is regarded as a trading
receipt; if on the other hand a licence means that the information once imparted cannot be
utilised commercially again, the receipt may be regarded as of a capital nature.

III. TAX CONSIDERATIONS CONCERNING IP RIGHTS

As anticipated above, income from intellectual property often takes the form of a royalty
payment, representing the consideration for the relevant license. IP tax planning,
therefore, should mainly focus on minimising the taxation of incoming royalty payments
and on maximising the after-tax-profit generated in connection with the licenses.

In line with the above, any IP tax optimazation should consider on the following issues:

• Effective taxation of income from royalty and capital gains at the level of the
licensor;

• Potential withholding taxes on royalty flows;

• Deductibility of royalty payments at the level of the licencee;

• Deductibility of R&D costs;

• Transfer pricing concerns;

• Value added tax;

• Potential local and property taxes.

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When analysing the IP tax regimes of Hungary, Malta and Luxembourg, we will mainly
focus on the factors under letters a)-c), therefore, we do not describe in details these
questions at this place. In the followings, however, we refer to the other considerations
that shall be evaluated when chosing the most appropriate location for the placement of IP
structures.

III.1 Deductibility of R&D costs

Among others, the ability to deduct the R&D costs of developing intellectual property to
be licensed can be also a significant tax issue. Research and development costs are
generally deductible even if the company is not yet, but will be at some point, engaged in
a trade or business activity involving the intellectual property. Current deductions for such
costs usually makes the most sense for a company that wants to license the developed
technology, because there is no cost recovery of the capitalized amount if the technology
is considered for tax purposes to be licensed.

III.2 Transfer pricing concerns

Transfer pricing is also a relevant issue in the case of intra-group royalty payments. The
outbound taxing authorities and the inbound taxing authorities both want to ensure that the
price or royalty is set so that sufficient income is recognized in their respective countries. This
natural tension exists but there can be only one price used on the corporate books. In most of
the cases, no identical transactions are available to test the related-party license. Valuation of
IP assets and thus reasonable royalties is thus a really difficult issue which is strongly
influenced by subjective appreciations. While generally all expenditure which is necessarily
incurred to produce income is deductible for tax purposes, transactions between related
parties would be carefully controlled by the tax authorities. Looking at the deductibility to
the payer of a royalty, the OECD report on Transfer Pricing and Multinational Enterprises
(OECD TP Guidelines) stressed that the value of the benefit to the licensee is not
necessarily the measure of the appropriate rate of payment to be made for such license.
Although it may be useful to look at the costs incurred in developing the property, the
actual open market price of intangible property is not related in a consistent manner to the
costs involved in developing it. In determining royalty rates at arm’s length, some specific
factors established in the OECD TP Guidelines may be taken into account.

III.3 Value added tax

Value added tax is also an issue in IP tax planning. At the level of the European Union, a
common value added tax system applies however, in accordance with the EU directives.
Under the European VAT system, value added tax is generally charged on the importation
of goods into a country and also on any supply of goods or services within the country.
The payment of royalties may also incur VAT. The EU model calls for VAT to be levied
in the country where the goods or services are supplied. The basic rule is that a service is
regarded as supplied where the supplier has established his business or has a fixed
establishment from which the service is supplied or, in the absence of such establishment,
the place where he has his permanent address or usually resides. Cultural, artistic,
sporting, educational and other similar services involving the presentation to an audience
are supplied where performed; the supply of intellectual property is regarded as supplied
in the place where the recipient of the service is located. As a consequence, choosing the
right IP structure must also include the minimisation of VAT costs and the compliance
costs associated with VAT.

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III.4 Potential local and property taxes

Potential local taxes or certain types of property taxes may also apply to the acquisition or
disposition of intellectual property. Therefore, such taxes shall also be taken into
consideration.

Naturally, tax issues will need to be jointly considered with economic and business
considerations, including a well-established IP registration process, the efficient
protection of IP rights and appropriate infrastructure. Also, availability of a generally
attractive tax system is also a must, such as tax incentives for holding companies and
possibility to combine royalty structures with financing, and an extensive tax treaty
network.

IV. COMPARISON OF THE HUNGARIAN, MALTESE AND LUXEMBOURG IP

REGIMES

IV.1 Hungary's IP regime in international tax planning

After the accession to the EU on 1 May 2004, Hungary had to amend its previous tax laws
and harmonise all the domestic measures with the Community requirements. At the same
time, the Hungarian government was still commited to attract foreign investments and
high-added-value businesses. As a result, Hungary now operates as a very attractive IP,
holding and financing jurisdiction in international tax planning.

IV.1.1 Exemption of royalty income and scope of application

Hungary offers key benefits for licensing companies in international tax structures. As a
main rule, 50% of the royalty income is exempt from corporate income tax in Hungary.

Please find below a simplified licensing structure illustrating the key benefits of the
Hungarian tax regime:

FP
Dividend

FS HUN IPCo

License fee

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The scope of application of the 50% exemption on royalty income is very extensive.
Especially, the term ‘royalty’ would mean any consideration received by the right-holder
for the transfer of:

• a patent, industrial design and other protected intellectual works and know-how
exploitation rights,

• a trade mark, or the right of use of a trade name or trade secret,

• right of use of authentic works protected by the Hungarian Copyright Act and
rights related to copyright, and

• rights of use related to protected industrial designs and other copyrighted articles
mentioned in the first and third points above.

It follows that based on the Hungarian domestic rules, among others also know-how is
included in the qualified IP rights.

The only limitation is that the amount of the tax benefits relating to royalty income would
be capped at 50% of the pre-tax profit.

IV.1.2 Exemption of capital gains from qualifying rights

Hungary offers key benefits for companies realizing capital gains from the alienation of
qualifying valuable rights. The rules has been introduced as from 1 January 2012, and aim
at further increasing Hungary's competitiveness as an IP holding structure.

The special tax regime exempts from corporate income tax the capital gains derived by a
Hungarian company from the disposal of valuable (IP) rights, if the following conditions
fulfil:

• the rights are held for at least one year;

• the acquisition of the rights is duly reported to the Hungarian Tax Authority within
60 days from the acquisition / transfer of the place of effective management to
Hungary.

The term ‘valuable rights’ would include: (i) concessions and similar rights and (ii)
intellectual property. ‘Concessions and similar rights’ would mean any acquired right
which is not related to real estate property and in particular, lease rights, rights of use,
trusteeship, rights of use of intellectual property, licenses, concessions, gaming rights, and
other rights which are not related to real estate property. ‘Intellectual property’ would
mean inventions, patents and industrial design rights from industrial property rights,
copyrighted software products, other intellectual property, assets without legal protection
but monopolized through secrecy; know-how and production technologies, trademarks,
whether purchased or created by the company itself, and irrespective of whether or not
used.

As the definition shows, the scope of the Hungarian rules is very extensive. In addition,
what makes the Hungarian tax regime even more attractive compared to the IP regimes
applicable in other countries, is that it provides with a convincing step-up opportunity for
foreign investors transferring their place of effective management to Hungary from states
having no exit-tax rules. Specifically, exemption can be obtained on the disposal of IP
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rights if the transfer of the place of effective management to Hungary is duly reported to
the Hungarian Tax Authority. The term ‘place of effective management’ under the
relevant Hungarian corporate income tax laws would mean the place where the
management governs the operations of the company.

As a further tax incentive, as of 1 January 2012, capital gains from the disposal of
valuable rights could be exempt from corporate income tax even if the acquisition of the
rights is not reported to the Tax Authority. The condition for the application of the
exemption is that the income from capital gains is transferred to the tied-up reserve of the
recipient company, and is used for the acquisition of further IP rights within 3 years.

IV.1.3 Other benefits

Royalty payments to any corporate shareholders (either domestic or foreign, even in an

offshore jurisdiction) are exempt from withholding tax under domestic law.

Also, double deduction is available for qualifying R&D expenses.

IP depreciation can be obtained for tax purposes over the useful life of the asset.

Hungary has a dense network of double taxation treaties concluded with more than 65
countries. Under many of these double taxation treaties, the withholding tax on royalties is
reduced to 0%, while under some other treaties the rate is reduced to 5 or 10%. Beneficial
withholding tax rates and other provisions are available, in particular, in the treaties with
Australia, Brazil, Canada, Israel, Kazakhstan, Norway, Russia, Singapore, South Africa,
and South Korea. This is only of relevance for royalties received by a Hungarian (sub-)
licensor, as royalties paid abroad by a Hungarian licensee are not subject to a withholding
tax by virtue of Hungarian domestic law.

Even though the tax benefits of Hungarian licensing and holding structures are based on
generally applicable domestic law and tax treaties rather than on discretionary rulings, it is
possible to obtain ‘ordinary’ binding rulings on the interpretation of the relevant
legislation increasing certainty of the tax position. The tax position could be further
strengthened by obtaining a so-called ‘long-term’ ruling that remains in force for 3 years
even if the underlying tax laws change. Binding rulings are issued by the Ministry of
National Economic Affairs under a formal administrative procedure, and the interpretation
confirmed in the ruling resolution is binding on the Hungarian tax authority provided the
underlying fact pattern remains unchanged.

IV.1.4 Effective tax rate

The combination of the beneficial features of the Hungarian tax regime would allow for a
0% ETR in most of the cases, but 5% to 9.5% ETR is available even without R&D costs
or depreciation. As a whole, Hungary could offer very attractive benefits for IP
companies.

IV.2 Malta's IP regime in international tax planning

Malta's profile as an intellectual property holding jurisdiction has been significantly enhanced
by the introduction of a full exemption for income derived from patents. Malta now provides
the unique possibility for taxpayers to secure a tax neutral position in the EU on qualifying
royalties and the ability to effect outbound payments free of withholding taxes regardless of
the recipient's country of residence.
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When describing Malta's IP tax regime, we do not only describe the specific IP tax exemption
scheme applicable to qualifying patents. We do also describe other tax planning opportunities
using the general Malta tax system.

IV.2.1 Exemption for qualifying patents

The Maltese government published regulations on 14 September 2010 for the application of
the income tax exemption on royalties derived from patents on inventions. The exemption
was introduced into Maltese tax law in April 2010.

Under the exemption, royalties and similar income (including any amounts paid for the grant
of a licence to exercise rights) derived from qulifying patents are exempt from tax in Malta as
from 1 January 2010. The exemption applies regardless of where the underlying R&D was
carried out.

A qualifying patent must be the result of research and development activities, which can be
performed anywhere in the world, and which have led to an invention which has then been
patented anywhere in the world. For the exemption to apply, however, the Maltese competant
authority will first need to ascertain that such qualifying patent is actually in existance and is
not contrary to Maltese public policy.

A recent proposal may extend the patent box regime to include works protected by copyright,
including books, film scripts, music and art.

Foreign withholding tax on royalties paid to Malta will be mitigated through the EU Interest
and Royalties Directive and/or through Malta’s double tax treaties. In most cases this will
reduce the withholding tax on royalties to between 0% and 10%.

IV.2.2 Taxation of royalties derived from non-qualifying patents

Malta operates a refundable tax credit system whereby royaties received in Malta from third
parties are taxable at the rate of 35%. Once the royalty is disributed as dividend to its
shareholder the Malta Tax authorities refund to the shareholder of the payor company 30% of
the tax paid by such payor company thereby reducing the ultimate effective rate of taxation to
5%.

For the purposes of the legislation, one must distinguish between active and passive royalties.

Active royalties are royalties which are derived, whether directly or indirectly, from a trade or
business. Royalty income is also deemed to be active where it is not deemed to be passive
income by virtue of having suffered at least 5% foreign tax, irrespective of whether the tax
was levied directly or indirectly, or through withholding or otherwise. Where a Maltese
company receives royalties as part of its business of licensing patents, for example, the
income is deemed to be part of its business income and taxed in Malta at the rate of 35%. In
such case the aforementioned tax treatment is applicbale netting an overal tax burden of 5%.

Passive royalties are royalties which are not derived, directly or indirectly, from a trade or
business and which have suffered less than 5% foreign tax whether directly, by way of
withholding, or otherwise. Therefore, a Maltese company which owns and licenses
intellectual property, and derives royalties which have not been subject to tax, is deemed to
receive passive royalties if the income has not been subject to foreign tax. Passive royalties
taxed in Malta as part of the company’s income at the rate of 35%. However, upon the
subsequent distribution of income as dividend, the shareholder may claim a refund of 5/7ths
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of the Malta tax paid by the company, thus reducing the effective tax paid in Malta to 10%.
This may be further reduced by virtue of the Flat-Rate Foreign Tax Credit to 6.25%.

In both cases, where double tax relief is claimed, the aforementioned refunds will be reduced
to 23.33% of the tax paid by the payor company.

IV.2.3 Royalty planning using Malta applying the 30% tax refund

The diagram above illustrates royalties being paid from operating companies with reduced
withholding taxes, due to the application of Malta’s double tax treaties.

Although the royalty is taxed in Malta at 35%, the net Malta tax is between 5% and 10%
(depending if active or passive) due to the tax refunds available to the parent on payment of
dividends.

On receipt of the dividend, the parent company can claim back 30% of the tax paid by the
company on income used to pay the dividend, if the royalties are regarded as trading income,
and 25% if the royalties are regarded as passive income. Where double tax relief has been
claimed, 23.33% of the Malta tax paid can be claimed back.

IV.2.4 Other advantages

The royalty exemption for income derived from patents is complemented by certain other
aspects of Malta’s tax system, allowing for the tax efficient structuring of intellectual property
holding and licensing activities via Malta.

Among others, the Maltese Income Tax Act has a “step up” provision, which allows
companies that re-domicile to Malta to have the base cost of the intellectual property situated
outside Malta, stepped up from the historic book value to fair market value on the day of the
transfer. IP rights can then be amortised over three years, using the stepped up fair market
value.

In addition, a possible exemption from capital gains derived from a disposal of intellectual
property could be obtained in one of the following situations:

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• an intragroup transfer (with no clawback on subsequent disposals by the related

party transferee where the transferee is a non-Malta-resident);

• a disposal of the intellectual property where the Malta resident entity is not
incorporated under the laws of Malta; and

• migration out of Malta of the Maltese intellectual property company.

Also, no withholding taxes on outbound dividends, interest or royalties paid from Malta.

Even if Malta's express IP tax regime is not (yet) so extensive, the combination of other
advantages available in the country may render it to an attractive location for IP planning.

IV.3 Luxembourg's IP regime in international tax planning

When Luxembourg has introduced its favourable tax regime for income derived from
intellectual property rights in 2007, it was the last Benelux country to set up an IP tax
scheme. Due to the latest developments in this system, the Luxembourg one is now the
most attractive when compared to the Belgian and Dutch IP tax incentives4. In the future,
tax competition may further increase5.

IV.3.1 Basic rules

The Law of 21 December 2007 introduced Art. 50bis into the Luxembourg Income Tax
Law, and its related Circular issued 5 March 2009, LIR n°50bis/1 clarifies its application
(Circular)6. Summarizing in brief, the following tax benefits are laid down by Art. 50bis:

• 80% tax exemption of the positive net income derived from qualifying IP rights;

• 80% tax exemption of capital gains arising from the disposal of qualifying IP
rights; and

• 80% deduction of a deemed royalty income in relation to self-developed patents

used by the taxpayer in its own operational activity.

The 80% exemption is calculated on the net positive income after deduction of all the
related expenses. In case some expenses were incurred before claiming the benefit of this
regime, those expenses must be activated during the year the company wants to apply the
regime. The purpose is to ensure that all the related expenses incurred are actually taken
into consideration for determining the IP right's net positive income.

4
Since the introduction of the IP regime in 2008, patent applications in Luxembourg have increased
significantly. After a stable period between 2003 and 2007, averaging at about 67 patent applications a
year, numbers have steadily been increasing up to 106 applications in 2008, 127 in 2009 and 135 in
2010.
5 After the introduction of the Dutch innovation box, January 1 2010, the competition between the Benelux
countries to attract IP income is on again. Other countries are also planning to introduce patent box type
of tax regimes to attract IP income and R&D activities (for example, the UK is introducing a patent box
tax regime from April 2013). It can be expected that Belgium and/or Luxembourg will react to reinforce
the competitiveness of their regimes. However, budgetary shortfalls may render a quick reaction
difficult.
6 Luxembourg, an attractive location for intellectual property, In 2012 January, International Tax Review
@ 2012 dr. Varga Erzsébet, All rights reserved.
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Whereas determining the reference date for acquired IP right should not be a problem, this
issue could be more sensitive for developed IP right and should be analysed for each type.
(Taxpayers that develop and use patents for their own activities may benefit from a
notional deduction that amounts to 80% of the income that they would have earned if they
had licensed the right to use the patent to a third party). For copyrights on software, the
reference date is the date on which the computer software is ready for commercial use.
For patents, this is the filing date of the patent application. As far as trademarks and
brands are concerned, this is in principle their registration date. If it appears, however,
that the trademarks or brands were actually used before their registration, the prior use
will prevail. The same rule also applies for designs and models. For domain names, the
reference date is the one of the registration request with the competent office.

IV.3.2 Scope of application

The 80% exemption would apply to the following qualifying IP rights:

• Copyrights on software;

• Patents;

• Trademarks;

• Designs and models;

• Domain names.

To the contrary, the favourable tax regime cannot apply to the following rights:

• Copyrights other than copyrights on software: e.g. copyrights of literary / artistic

work (cinematograph films);

• Plans, formulas or secret processes and other analogous rights;

• Image rights of celebrities (sportsmen, artists).

The IP tax scheme is applicable for all Luxembourg taxpayers.

IV.3.3 Limitations and statutory requirements

It is a common criterion, that the qualifying IP rights must be acquired or created after
December 31 2007. Also, it is required that expenses, amortisations and write-downs
connected with the eligible IP and which created losses in prior years are recorded as an
asset for tax purposes in the first fiscal year during which IP regime applies.

The application of the favourable rules is also subject to certain limitations in terms of
related party transactions. Especially, IP rights acquired by from a directly-associated
entity would be excluded from the scope of application. A directly-associated entity
would be defined as a shareholder or subsidiary where the direct shareholding link is
greater than 10%, or where both companies, seller and acquirer, are held by a common
shareholder holding a direct participation in both entities greater than 10%.

As regards the development and creation of the IP rights, for application of the 80%
royalty exemption treatment on licensing flows, these may be developed either in
@ 2012 dr. Varga Erzsébet, All rights reserved.
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Luxembourg or in another country and the Luxembourg taxpayer can develop them
internally or externally via sub-contracting for instance. However, for the application of
the 80% deemed royalty deduction for patents used by a taxpayer in its own activity
(hence which do not form part of a licensing arrangement), the patents need to be
developed by the taxpayer internally.

IV.3.4 Effective tax rate

The effective tax rate under the above regime is around 5.76% (please note that the
currently applicable general Luxembourg Corporate Tax rate is 28.8%). In addition,
partial tax credits against the remaining tax due are also available for foreign withholding
tax borne.

A typical structure could be illustrated as follows:

IV.3.5 Further advantages

The tax benefits of the Luxembourg IP regime can belong to the economic owner rather
than to the legal owner. This situation is a logical result of one of the main concepts of
Luxembourg direct tax law, which gives priority to economic ownership over legal
ownership in case they do not coincide. In order to be considered economic owner, the
economic substance of the transactions carried out is of paramount importance. It follows
that a Luxembourg company that is fully entitled to the economic benefits and supports
the economic risks of the IP should be able to benefit from the application of the regime
@ 2012 dr. Varga Erzsébet, All rights reserved.
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even where other group companies own the legal title to the IP (for reasons such as bank
covenants, guarantees, potential adverse consequences abroad in case of a legal transfer,
potential costly registration procedures, etcetera).

Luxembourg is actively building up a strong public support framework for local R&D and
innovation. The R&D law provides scope for financial assistance to companies that
undertake R&D activities through a list of various measures and funding schemes
covering the following:

• R&D projects or programmes;

• Technical feasibility studies;

• Protection of technical industrial property;

• Aid for young innovative enterprises;

• Innovation advisory services and innovation support services;

• Temporary secondment of highly qualified personnel;

• Process and organisational innovation in services;

• Investment in innovation clusters and animation of innovation clusters; and

minimal measures.

Complementary legislation also provides for a full net wealth tax exemption for qualifying
IP rights7.

It can be seen, therefore, that the Luxembourg IP tax regime is integrated into a well-
planned supportive background that makes the tax incentives even more favourable. The
tax regime has been approved by the Code of Conduct Group in November 2008.

V. SUMMARY

The three IP tax regimes analysed in this paper shows that IP tax planning plays an
important role in current tax structures, and IP tax schemes may successfully participate in
the global tax competition.

Hungary, Malta, and Luxembourg are all Member States of the EU and have access to
both the EU Directives and an extensive double tax treaty network with more than 60
double taxation treaties in force in the case of each countries. The appropriate use of the
domestic, the EU and the international tax provisions may eliminate or minimise not only
(royalty and/or capital gains) income from IP rights, but also withholding taxes on royalty
flows.

Further tax benefits such as deduction of R&D costs, depreciation of IP or step-up

opportunities may further increase the attractiveness of the three systems. These features,

7
Section 60bis of the Bewertungsgesetz.
@ 2012 dr. Varga Erzsébet, All rights reserved.
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combined with a stable tax system and effective protection of IP rights could be very
convincing for company groups investing in IP.

The IP tax regimes of the three countries are summarised and compared in the table
below:

Comparative overview of IP income tax incentives regimes

Tax Factors Hungary Malta Luxembourg
ETR 0% to 5/9,5% 0% 5.72%
Intellectual property Any copyrights, Patents Software copyrights,
patents, trademarks, patents, trademarks,
domain names, domain names,
designs and models, designs and models
know-how
Type of income Royalty income and Patent income IP rights income and
capital gains capital gains
Can work be Yes Yes Yes
performed outside
the jurisdiction?
Legal ownership of No, economic Yes No, economic
patent/IP right ownership is ownership is
required? sufficient sufficient

As the table chart shows, there are significant differences in the three tax regimes. To
begin with, the types of IP covered are largely different and in this competition it is
Hungary that appears the most permissive. The inclusion of all kind of copyrights and
know-how is a clear advantage compared tot he other two states. In the case of
Luxembourg, the domain names' protection represents a very positive factor, especially
for technology-based companies.

In the near future, tax competition in the field of IP is going to further increase. The UK
may introduce ist own regime in 2013, and as an answer even more favourable rules might
be expected in other states. Hungary has made an important step in that direction: as of 1
January 2012 new exemptions are available for capital gains generated in connection with
IP rights. In this trend, and with special attention to the OECD's and the EU's struggling
against harmful tax competion, one could reasonably pose the question: Quo vadis
European IP regimes?

@ 2012 dr. Varga Erzsébet, All rights reserved.

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BIBLIOGRAPHY

Articles:

1. International Tax Review, March 2010; Benelux tax competition to attract IP income is
on again

2. The Netherlands have made the latest move by introducing the Innovation Box. Wim
Eynatten, Patrick Brauns and Bernard David of Deloitte compare the IP tax regimes of the
Benelux countries.

3. 2012 January, International Tax Review, Luxembourg, an attractive location for

intellectual property

4. BEGINNING OF THE END OR END OF THE BEGINNING? Hungary faces to the

EU accession – Changes to the Hungarian offshore regime; By Dr Gabor B Szabo and Dr
Tunde Darvai, Budapest, Hungary

Links:

http://www.tax-consultants-international.com/read/Dutch_Licensing_Company#1

http://www.ttn-taxation.net/pdfs/Speeches_Miami_2011/01-JeffreyRubinger.pdf

http://www.fenwick.com/docstore/publications/ip/patent_licensing.pdf

http://www.morganlewis.com/pubs/INTA_AnnualMeeting_MaximizingBrandValue.pdf

https://clients.kilpatricktownsend.com/IPDeskReference/Documents/Taxation%20of%20I
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http://www.interfis.com/articles/the-international-tax-aspects-of-intellectual-property

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articles/aee80f9393db7210VgnVCM200000bb42f00aRCRD.htm

http://www.internationaltaxreview.com/Article/2955354/Luxembourg-Luxembourg-an-
attractive-location-for-intellectual-property.html

http://www.deloitte.com/assets/Dcom-
Malta/Local%20Assets/Documents/Tax/Publications/mt_tax_alert_021110.pdf

http://www.step.org/pdf/Chris%20Curmi.pdf

http://www.ipeg.eu/blog/wp-content/uploads/Benelux-tax-competition-to-attract-IP-
income-is-on-again.pdf

http://www.itpa.org/open/archive/kuiperszabo.html

https://www.kpmg.com/US/en/IssuesAndInsights/ArticlesPublications/Documents/film-
financing-and-television-programming.pdf

@ 2012 dr. Varga Erzsébet, All rights reserved.