The Netherlands has several attractive tax incentives to lower R&D costs and investments for an entrepreneur and/or company. This includes the R&D tax credit, which reduces wage tax and social security contributions of employees directly involved in R & D for the employer; the R&D allowance (RDA), which allows for a 154% super deduction of qualifying costs; the one-time full amortization for R&D intangible assets; and a R&D deduction which allows for a fixed additional deduction for entrepreneurs.
R & D tax credit
R & D in this respect means technical scientific research; the development of technically new physical products or physical production processes and the development of technologically new software or components thereof. In case of a Dutch software development company the software is innovative when it is a new software development for the company it self; decisive is the level of software development of the company not the software development level of the total market with all the competitors. Otherwise it would be (very) difficult being innovative.
Qualifying R & D is also technical-scientific research seeking to explain phenomena in fields such as physics, chemistry, biotechnology, production technology and information and communication technology. Also technical research aimed at enhancing the physical production process or software qualifies for the R & D tax credit.
The R&D tax credit lowers the wage withholding tax payable by the employer for the employees who do the R & D activities. A tax credit of 35% is applicable for the first amount of €250,000 (2015) of R & D wage costs, and 14% is applicable to the remaining eligible R&D wage costs. For the first five years in which the taxpayer functions as an (‘start-up’) employer the percentage for the first €250,000 of R & D wage costs is increased to 50%. The total annual benefit of lowering the wage withholding tax is limited to €14 million per employer. Repayment is required in cases where realized R&D hours by the R & D employees are less than forecast.
The R&D tax credit is applicable for future activities. In order to claim the R&D tax credit, an application form should be filed at the department within the Dutch Ministry of Economics (so called Rijksdienst voor ondernemend Nederland) The application should be filed in advance, no later than one month prior to the start of the period covered by the application. Three applications may be filed per calendar year. These applications may cover at a maximum a six-month period. A calendar month can only be used in filing one application therefore no overlap of months is allowed. If a R&D declaration was issued in the previous year, it is possible to submit a single application for the entire calendar year.
The R&D credit for future activities may be claimed as long as qualifying activities are performed. In principle the proposed R & D activities must take place in the company who has obtained the R & D declaration from the Ministry of Economics by its own employees. However it is allowed for example via contract research to cooperate with another party in the development of the new product. A part of the R & D activities may be done by the employees who are on the pay roll of the Dutch company in another EU member state.
For software development companies the R & D declaration which has resulted into a successful new product (a so-called intangible) is the entrance to the Dutch innovation box due to the fact that in Europe it is not possible to get a grant for a patent for a software development innovation (contrary to the United States where a patent can be obtained fro a software development) The company (employer with the R & D declaration) must be the full owner of the intangible.
If ‘knowledge workers’ are recruited from abroad to come to work in The Netherlands the employer may grant them an untaxed reimbursement for the extraterritorial costs that they incur. There must be an employment relationship and the employee must have some specific expertise that is not or is only barely available on the Dutch labor market. At last the employee must have a valid decision concerning the work permit. If there is complied with these conditions the employer and employee may request the Dutch tax authorities to provide a so-called 30% tax ruling (i.e. 30% of the wage, including reimbursement can be paid tax-free to the employee) The employee does not have to prove that expenses have been incurred.
R & D allowance (RDA)
The RDA is a general R & D tax incentive which seeks to reduce companies’ R&D operating costs and investments in R&D assets. It does not apply to R&D wage costs or to costs related to outsourced or contracted R&D. An extra deduction of 60% (2015) is available for eligible R&D costs and investments. The RDA is to be deducted from the annual corporate income tax base (profit). The net benefit of the RDA for corporate income tax purposes will depend on the applicable tax rate (maximum 25%). There applies no limit as to the maximum amount that can be claimed in any given year.
The RDA concerns investments in, amongst other things, the rent of equipment, purchase of materials and investments in a laboratory which is used for R & D activities for which the company received the R & D declaration earlier (see R & D tax credit) With respect to costs which qualify you can think on the purchase of materials and parts for the personal production of a prototype or the purchase of goods, materials or parts for performing test batches. All costs and expenditure for which obligations have already been assumed prior to January 1, 2012 are excluded from the RDA.
RDA is applicable for future costs and investments and must be claimed simultaneously with the R&D tax credit. Accordingly, similar conditions apply and reference is made to the R&D tax credit applicability in this respect. In addition, the taxpayer must clarify the factual R&D costs and investments of a year within three months of end of the calendar year. If actual R&D costs and investments are lower than the already claimed R&D costs and investments, a correction should be made. RDA for future costs and investments may be claimed so long as an R&D declaration is in place to which cost and investments can be linked. Companies are required to seek preapproval in order to obtain the R&D credit.
The benefits of the Dutch innovation box
Under the Dutch innovation box R & D tax incentive, eligible R&D income (no marketing intangibles or brand names) is effectively be taxed at 5% instead of the statutory Dutch corporate income tax rate of (maximum) 25%. In order to effectuate the innovation box first the total development costs of the intangible asset must have been exceeded by the income which is derived from the new intangible assets.
The R & D corporate tax incentive of the Innovation box is granted for intangibles which are developed (for the account and risk) after December 31, 2006 of the company itself. As such intangibles like a patent or plant breeder right or an intangible that originates from R&D activities which are covered by a R&D declaration qualify for the innovation box. These intangibles must contribute to the extent of at least 30% to the expected income derived from the use of the intangible asset. It is relevant that the company who intends to apply for the innovation box is the registrated and beneficial owner of the intangible assets.
Under certain conditions it is possible to develop new intangibles with other parties (related group companies or for example Universities) via contract research or cost contribution arrangements as long as the Dutch R & D company directs and coordinates (and bears the risk and expense of) the R & D activities in order to apply for the innovation box.
Attractive aspect of the innovation box is that income qualifying for the 5% tax rate comprises all economic benefits derived from the intangible assets, royalty income and capital gains. There does not apply any limit with respect to the benefits of the innovation box. The innovation box is not granted for income out of marketing intangibles, trademarks or brand names.
The R & D tax incentive applies retroactively as long as the corporate income tax return has not yet been finalized (with cooperation of Dutch tax authorities) or the finalized tax return is still open for appeal. The innovation box is ultimately claimed in the corporate income tax return. However, it is advisable to conclude an Advance Tax Ruling with the Dutch tax authorities on the application for use of the innovation box in advance. Out of my current experience for example for software development companies in between 20% and 50% of the EBIT of these kind of R & D companies will be liable to the effective tax rate of 5%. The higher the earning capacity of the new developed innovative software the higher the percentage of the EBIT will be liable to the effective tax rate of 5%. In order to determine this percentage an analysis of the various value drivers of the R & D company included with an allocation of the income generated by these value drivers is necessary.
For companies which are involved in life science R & D activities the tax advantages of the Dutch innovation box may be even higher when the level of R & D activities which result in new intangible assets is high. The innovation box may be claimed with retrospective effect to a certain tax year as long as the final corporate income tax assessment of that year has not been finalized.
The Dutch innovation box is also attractive for foreign companies who are operating internationally. In that respect it is necessary that for example a German company incorporates a Dutch (R & D) company in which the R & D of the total company is effectively be coordinated and managed. In case of software development it means that the (Dutch) R & D declaration will be the future entrance into the innovation box for the profit which arises out of the new developed software. This means that the Dutch R & D company/subsidiary must have sufficient substance in The Netherlands in order to guarantee that the R & D company is a corporate income tax resident of The Netherlands. The board of directors of the Dutch R & D subsidiary must amongst others take strategic decisions in The Netherlands and software development employees must (mainly) do their job in The Netherlands in order to comply with the conditions related to the R & D tax credit.
When there has been developed outside The Netherlands, for the account and risk of the Dutch R & D subsidiary a new patent of which the Dutch R & D subsidiary is the registrated and beneficial owner there may arise possibilities to apply the innovation box for the profits which are a result of this intangible asset.
When the Dutch and German group companies are cooperating with the development of new software (intangible assets) reasonable transfer pricing is necessary in order to prevent from discussions with tax authorities. This also applies in case the Dutch group company obtains software which was developed earlier in Germany in order to develop that software further benefiting from the Dutch R & D tax incentives.
Conclusion as to the Dutch R & D tax
The Netherlands consist of attractive R & D tax incentives for (international) operating R & D companies. If structured well, with a long term perspective in mind foreign companies can benefit either. Necessary is that there is enough substance in The Netherlands and that the R & D for the multi national entity is coordinated and managed in and from the Dutch R & D company.
When there is complied with the conditions of the innovation box the Dutch tax authorities are cooperative in obtaining an advance tax ruling that provides certainty for several years on applying the innovation box. Such a ruling can provide very interesting corporate tax advantages.
Proposal for new rules for preferential IP regimes as of 1 July 2016
The Organisation for Economic Co-operation and Development (OECD) recently announced that consensus has been reached around a modified nexus approach for intellectual property (IP) regimes as presented in its September 2014 report under Action 5 (Countering harmful tax practices more effectively, taking into account transparency and substance) of the base erosion and profit shifting (BEPS) action plan.
The general idea is that preferential tax regimes such as IP regimes can become (part of) harmful tax practices when the taxation is not in line with the substantial activities. As part of the approach a so-called substantial activity requirement is introduced. If this requirement is not met, corporate tax payers should not have access to a preferential IP regime.
The modified nexus approach links substantial activity to R&D expenses. In other words, substantial activity is deemed to take place there where the R & D expenses are incurred.
Out of the OECD action plan, without going into detail, the following modified nexus approach formula is likely to become the new standard shortly (perhaps as of 2016)
The formula determines and limits the taxable profit which allocable to the favourable IP tax regime, as follows:
QE / OE x OII = TBI
QE = Qualifying Expenses
OE = Overall Expenses
OII = Overall IP Income
TBI = Tax Benefit Income
According to the Action 5 report, the objective of the modified nexus approach is to limit the allocation to qualifying income out of R&D activities and/or expenses that are outsourced to a group company. In that case, the outsourced R & D expenses are not included in the QE unless the key R & D performing entity in the group performs all key R & D functions and the outsourced activities performing entity only performs routine functions, the outsourced expenses should in line with the functional analysis on the at arm’s length principle, also qualify as qualifying expenses (QE)
Example IP tax regime under modified nexus approach:
R&D expenses in Dutch innovation box qualifying company 100
R&D expenses in German (contract R&D) group company 100
Total R&D Income 400
The allocation according to the modified nexus approach-formula will be as follows
QE (100) / OE (200) X OII (400) = TBI (200)
The Dutch R & D company is allowed to allocate a limited amount of 200, instead of 400, to the innovation box regime. If there is agreed with a German-UK approach to the modified nexus approach, there would be an additional allocation of 30% (“Uplift”), as a result of which the qualifying income will be 260 instead of 200, and the adjustment will be 140 instead of 200.
After publishing the Action 5 deliverable, the modified nexus approach was adopted by Germany and the UK in their bilateral agreement on the UK patent box regime. The German – UK bilateral agreement includes an allocation uplift of 30%, a grandfathering period until 2021 for existing patent box systems which are not in line with the modified nexus approach, and closing old regimes to new entrants by 30 June 2016.
The European Union Code of Conduct Group adopted this “adjusted” modified nexus approach at their meeting of 5 December 2014. The OECD and the G20 have adopted this adjusted modified nexus approach in their Action 5 agreement on MNA, published February 2015.
The OECD also requires that the qualifying IP for IP tax regimes must be linked with patents, and other IP assets that are functionally equivalent to patents if those (IP) assets are both legally protected and subject to similar approval and registration processes where such processes are relevant.
It is clear that if the modified nexus approach as described above will be introduced across the board and the Netherlands adopts it, the current Dutch innovation box regime would have to be amended as currently Dutch taxpayers are not obliged to make the adjustment pursuant to the above-mentioned formula.
It is currently not expected that the WBSO certificate will be waived as an entry ticket, as it seems to be in line with the nexus condition. This was also stated by the Dutch State Secretary of Finance in his letter to the Code of Conduct Group (Ecofin) of 9 December 2014.
Currently the precise consequences of the proposed modified nexus approach for the Dutch innovation box are not certain. It is to be expected that there will be more transparency on this issue in summer of 2015.
We look forward to work together with you.
Nijmegen, 4 May 2015