Let’s consider together why the nexus ratio is so important and whether a taxpayer using the IP Box relief must incur qualified expenses included in the nexus ratio.
What is the nexus ratio?
The Innovation Box instrument, also known as the IP Box relief, is a tool adopted as part of the Base Erosion and Profit Shifting (BEPS) initiative under the Organization for Economic Co-operation and Development (OECD). Therefore, regulations developed in different countries should comply with the OECD guidelines regarding the taxation of income derived from intellectual property rights (see OECD BEPS Action Plan No. 5, paragraph 39).
According to the OECD Report mentioned earlier, the inclusion of qualified costs for the nexus ratio is independent of how they are recorded in general tax costs (this is also confirmed by tax explanations issued by the Ministry of Finance).
In line with the nexus approach, there should be a connection between the expenses incurred by the taxpayer for the creation, development, or improvement of qualified IP, the IP itself, and its commercialization. Therefore, in short, taxpayers who do not incur any costs for the creation/development/improvement of qualified intellectual property rights cannot benefit from the IP Box tax preference.
Why do we use nexus?
The nexus ratio, to some extent, filters the income obtained by a taxpayer from qualified intellectual property rights, indicating the portion that can be subject to the preferential 5% PIT tax rate. This reflects the OECD approach, which allows preferential treatment only to the extent that it results from R&D activities and expenses incurred. Hence, the nexus ratio and the cost side of the IP Box relief should not be underestimated.
Calculating the nexus ratio
Art. 30ca para. 4 of the PIT Act
The nexus ratio is calculated according to the formula:
[(a + b) ∗ 1,3] / [a + b + c + d]
where each letter denotes the costs actually incurred by the taxpayer for:
a – directly conducted by the taxpayer research and development activities related to qualified intellectual property rights;
b – acquisition of research and development results related to qualified intellectual property rights, other than those listed in lit. d, from an unrelated entity within the meaning of art. 23m para. 1 point 3;
c – acquisition of research and development results related to qualified intellectual property rights, other than those listed in lit. d, from a related entity within the meaning of art. 23m para. 1 point 4;
d – acquisition by the taxpayer of qualified intellectual property rights.”.
The nexus ratio should be calculated separately for income from each qualified IP.
Of course, the regulations in this area are also complex and unclear. Technically, if a taxpayer does not incur any costs included in the nexus ratio, both the numerator and the denominator would be “0,” making the equation impossible to solve correctly (infinitely many possibilities). However, in practice, tax authorities/administrative courts treat such a situation as if the nexus ratio were actually “0,” and then, in short, 0% of the qualified income can be subject to the preferential rate.
In practice, for many entities operating in the IT sector in the B2B scheme, the formula used to calculate the nexus ratio will boil down to the following operation:
[ a∗ 1,3] / [a ]
Where the letter “a” represents the costs actually incurred by the taxpayer for directly conducted research and development activities related to qualified intellectual property. The multiplication by 1.3 can be safely omitted here due to subsequent rounding.
Do I have to incur costs?
Therefore, if a taxpayer incurs any costs directly related to research and development activities, in any amount, the nexus ratio will effectively be 1. Consequently, 100% of the previously allocated income from qualified intellectual property rights can be taxed at the 5% IP Box rate.
This is, of course, one of the crucial points when benefiting from the IP Box relief. In case of a tax audit, if the tax authority determines that the costs incurred by the taxpayer were not actually related to “research and development activities directly related to qualified intellectual property,” then, unfortunately, the nexus ratio will be “0,” making it impossible to use the IP Box relief. The income should be taxed according to the model adopted by the taxpayer (either a linear 19% PIT or a progressive 17/32% PIT), with all the negative consequences that come with it.
This topic was discussed in more detail in our previous post:
This is the second of the posts explaining the essence of income related to the IP Box and the nexus ratio. More publications will follow shortly.
If you have questions about applying the IP Box relief, please visit www.outsourced.pl.
