France: Self-financing through intangible assets or how to generate significant tax savings

After half a century of status quo, the Finance Act dated 28 December 2018, for 2019, has completely changed the previous tax regime. This new approach called “Nexus” was driven by Action 5 of the OECD’s BEPS programme. It is therefore essential for groups owning, managing or developing intellectual property to integrate the new rules both to secure the existing business model and the related transfer pricing policy and to seize new opportunities that may prove very attractive.

From now on, the effective tax rate on the proceeds from the sale, licence or sub-licence of certain eligible assets (patents, copyrighted software, plant utility certificates, patent-backed manufacturing processes, etc.) will be 10% in principle, but the full application of this preferential tax rate can only be obtained if certain conditions are met relating to the research and development expenses and, specifically, to the place where they were incurred (France or abroad) and to the quality of the company that incurred them (third party or related company). Thus, the base of income that can benefit from this preferential tax rate will be potentially degraded by a tax liability ratio (known as the Nexus ratio) depending on R&D expenses.

Nexus, Research Tax Credit, management of royalty flows, transfer pricing policy: IP can be a serious ally in generating cash, which has become a priority for some groups or companies in the context of the pandemic. Some will choose to monetise their assets directly through licensing agreements, for example, or more radically through divestitures; others will prefer to manage their tax rate by taking advantage of the new Nexus approach or even applying for tax credits when possible. However, these opportunities may be counterproductive if the options chosen are the result of silo approaches.

Besides, the well-established royalty flow pattern will have to be challenged to take into account the 2019 Finance Law that has also seriously curtailed the deductibility of royalties paid to a related entity located outside of France and the EU in a state deemed “fiscally harmful by the OECD” (i.e. not “Nexus compliant”) if the royalties paid are taxed at an effective rate of less than 25%.

As the OECD has set a deadline of 30 June 2021 for compliance with the Nexus regime, the new rule limiting the deductibility of royalties paid from France to a country that has not transposed the Nexus approach could therefore quickly give rise to significant issues of challenging the full deductibility of royalties. For example, the United States currently has a regime that is considered fiscally harmful. The bill could be very high, since the deductibility questioned corresponds to a percentage of the royalties paid (product of the difference between the reference rate of 25% and the local effective tax rate and the reference rate of 25%).

Lastly, in an exsanguinated economic context that can lead to receivership procedures, the stakes in terms of intellectual property will prove to be crucial: whether it is a question of the valuation of assets, the “post mortem” survival of registered patents, their continuity, their protection, etc.

Thanks to the multidisciplinary nature of our teams, it is possible to address the issues through a 360° approach crossing several areas of expertise simultaneously in every business field and sector.

Read the WTS Global Transfer Pricing Newsletter here.