The IID is gaining momentum thanks its attractive advantages: a tax deduction of 85% applied to your net income from innovation. An opportunity not to be missed, but you still need to make the most of the scheme to optimise your benefits. The process is not automatic and everything is based on your methodology and calculations. Let’s take a behind-the-scenes look at the IID…
Belgium has all the right things in place in terms of R&D-related tax incentives. But even though the money is available, it is up to companies to go and claim it. And the process is often fraught with headaches. The principle of the innovation income deduction (IID) is not rocket science, but its application calls for specialised expertise, requiring technical, financial and legal/tax knowledge. Once you have verified that your intellectual property right is indeed eligible, the next step is to get your hands dirty: delve into the equations and accurately calculate your potential benefit. Here’s how.
Understanding the IID formula
Unlike the Patent Income Deduction (PID), which it is gradually replacing, the IID is based on your net income from innovation, limited by the nexus ratio if necessary. Indeed, this correction coefficient can negatively affect your benefit if your R&D efforts are not supported internally or outsourced to a company independent of your own. In short, the challenge with the IID – equivalent to 85% of your net revenue from innovation – lies in precise identification of the unknowns in the following equation:
Your net innovation revenue = (a – b) x nexus ratio
a = the amount of your gross innovation revenue.
b = the amount of R&D expenditure incurred during the taxable period and any historical costs.
nexus ratio = (the amount of qualifying expenditure/the total amount of R&D expenditure) x 130%.
The higher your gross revenue, the greater the benefits of the IID. The lower your R&D expenditure is over the year, the greater your tax benefit will be. And let’s not forget the potential negative impact of the nexus ratio, which can easily be avoided. The challenge therefore is to make the most of your tax base by “playing” on these variables for optimal, risk-free results. But this is no easy task… How do you isolate the share of revenue related to software? What do you do when software and hardware are linked? How do you optimise your overall expenditure and minimise the effects of the nexus ratio? etc.
Step 1: Your eligible gross income
Of course, not all revenue from innovation is eligible for IID. For example, revenue generated by a support or maintenance service cannot be included. Nor can that allocated to establishments located abroad.
- The scope of the IID covers licence fees, compensation due to the company following the violation of an intellectual property right or amounts obtained from the disposal of the product. It is therefore in your best interests to scrutinise your turnover in order to distinguish revenue that qualifies from other income.
- But that’s not all: this revenue still has to have been generated after 1 July 2016. This is not easy to work out if the development of your computer program started before this date and continued beyond it. The solution may involve applying an annual coefficient, but caution is called for. Any choice will have to be duly justified to the tax authorities.
- To work out your gross revenue from innovation: You will still need to deduct direct and indirect expenditure not related to R&D from this revenue. Here again, the leeway left by the regulations requires a few precautions.
Step 2: your R&D expenditure, past and present
Since the goal is to determine your net revenue from innovation, you must then identify the R&D expenditure incurred during the taxable year in order to deduct this from the result. This includes all expenses directly related to your innovation activities, as well as any acquisition costs.
- “Spreading out” the past. That’s not all, since your historical R&D expenditure must also be taken into account (under certain conditions). This is one of the special features of the IID: you can choose to spread out sums previously incurred over a period of up to seven years (maximum). This is a way of not penalising yourself fiscally when your efforts begin to pay off… But be aware that choosing the spreading option is irrevocable.
- Finally: any negative balance (the difference between gross income and R&D expenditure) can be carried forward to the following year.
Step 3: add in the nexus ratio
As explained, the purpose of this coefficient is to value in fiscal terms the R&D activities carried out by a company or outsourced to an independent subcontractor on its behalf. In other words, if your intellectual property rights are the result of in-house innovation, the nexus ratio will not penalise the application of the IID in any way. Conversely, if your “innovation” was acquired from a third party or developed by an affiliated company, the tax incentive will be less attractive. So it needs to be quantified, based on the following formula:
the amount of qualifying expenses
nexus ratio =
——————————————————– x 130%
total R&D expenditure
The calculation of the nexus ratio is not devoid of subtleties, not least the possibility, under certain conditions, of increasing the authorised eligible expenses by 30% (up to a maximum of 100%). Note also that this ratio is a rebuttable presumption. This means that you can challenge its application when you consider the deduction to be too low. This is a view that will obviously have to be justified…
- Qualifying R&D expenditure It is not really the nature of the expenditure that will be taken into account, but rather its allocation. In this box, enter all costs related to the development of intellectual property (IP) during the taxable period, with the exception of interest, real estate costs, and general R&D costs, whether these expenses are borne by your company or invoiced to a non-group company.
- Total R&D expenditure… You must add to these qualifying costs all other expenses related to the acquisition of a patent or software, as well as work outsourced within the group (to an associated company). Obviously, the higher the numerator is, the more negative the impact of the nexus ratio will be.
No pain, no gain
Now that you have identified all the unknowns in the equation, all that remains is to apply the 85% deduction on the amount of net income from innovation to determine your tax benefit. While this sounds clear in theory, in practice the process requires a careful and consistent methodology. Among other things, this is because your approach and decisions will be scrutinised by the tax authorities. In fact, the regulations provide for the implementation of a robust process for tracing income and expenses. So this obligation implies preparation!
As easy as saying “IID”.
It would be a real shame to deprive yourself of the IID. Don’t just activate the procedure, make sure you maximise it (and without risk). Indeed, you have enough leeway to expect to optimise your related benefits by “playing” with the variables in the equation:
- increase your profit margin by making the most of your innovation-related revenue;
- reduce your R&D expenditure;
- modulate the hardware and software portions of your invoices differently;
- try switching to a licensing model or SaaS (software as a service) that retains intellectual property where the emphasis is currently on contracted R&D;
This is the real key to the IID – getting the most out of your innovation work. This optimisation process needs to be carried out now, but at the same time with preparation and planning for the future.