IP Box relief – proportional allocation of indirect business costs for calculating eligible IP income under the CIT Act

The tax credit, referred to as ‘IP BOX’, was introduced into Polish legislation 23 October 2018 under the Act amending the Personal Income Tax Act, the Corporate Income Tax Act, the Act – Tax Ordinance and some other laws and apply from 1 January 2019[1].

These provisions aimed at stimulating the market for new technologies and innovative solutions, granting tax preferences to owners, co-owners, users or holders of the right to use intellectual property rights under a licensing agreement.

This was done through preferential taxation of income from qualified intellectual property rights at the rate 5% in PIT and CIT[2].

Even though it's already over two years since when first introduced in Polish income tax laws this regulation, there are still many questions about the correct establishment of the tax base and calculation of the above mentioned relief. How should this be done in practice?

1. A preferential tax base under the Corporate Income Tax Act

one of the frequently recurring questions is whether the IP BOX beneficiary, when calculating the tax base, can take into account so-called indirect business costs, such as the cost of rented premises, the remuneration of employees not directly involved in research and development (e.g.

office administration), depreciation or leasing payments, etc.

In view of the imprecise provisions of the rules governing these matters, there are situations where taxpayers, when calculating income taxed at a preferential rate, sometimes prefer not to take into account their indirect costs of obtaining revenue in order not to expose themselves to the charge of underselling the tax base.

So what is the correct approach? Is it true that taxpayers who ignore indirect expenditure are more secure and minimize the risk of questioning their accounts? And if indirect business costs can be taken into account for IP BOX calculations, how can this be properly done in calculating this relief? The purpose of this Article is to provide answers to these questions.

Intellectual property rights (hereinafter IP rights) from which income entitles to a preferential tax rate are listed under Article 24d(2) Act on 15 February 1992 on corporate income tax 3 (Next: the Corporate Income Tax Act).

This provision provides that these rights include not only those created by taxable persons but also those acquired by taxable persons if, after acquisition, they are developed or improved by the taxpayer. Article 24d(1) the Corporate Income Tax Act points out that the income tax on such income generated by taxpayers is 5% the tax base.

It is also very important that Article 24d(3) the Corporate Income Tax Act points out that the tax base on which the income tax will be calculated 5%, is the sum of eligible income from eligible intellectual property rights achieved in the tax year.

In terms of Article 24d(4) the Corporate Income Tax Act The amount of eligible income from eligible IP shall be determined for each eligible IP as the product of the eligible IP income achieved in the tax year and the Nexus indicator[4].

In order to obtain the value of the tax base to which a rate of 5%, All eligible income from eligible IPs must be added up.

Particular attention should be paid to the fact that Article 24d(5) the Corporate Income Tax Act provides that it is not included in the costs in question under Article 24d(4) the Corporate Income Tax Act, expenditure not directly linked to qualified intellectual property rights. Therefore, it should be pointed out here that this provision refers only to the Nexus indicator and does not apply to the calculation of eligible IP income, which is multiplied by this indicator.

In view of the above, it is particularly noteworthy that the eligible income from qualified intellectual property rights is determined as the product of the income from qualified intellectual property rights achieved in the tax year and the ratio calculated according to Nexus, indicating that the income from qualified intellectual property rights is not the same as the eligible income from qualified intellectual property rights.

This means, without doubt, that the income from qualified intellectual property rights should be calculated in the same way as that from other sources of income, including those that do not meet the requirements of qualified intellectual property rights.

Only after calculating income from qualified intellectual property rights can it be possible to indicate which costs affect eligible income from qualified intellectual property rights.

2. Method of allocating indirect costs to eligible IP revenues

The above provisions therefore clearly state that it is necessary to calculate the correct value of income from qualified intellectual property rights (before multiplying them by the Nexus index) First, the allocation of indirect costs to eligible IP revenue according to that proportion.

In the author's assessment of the article, the correct way will be to allocate indirect costs to eligible IP revenues at a proportion determined as the ratio of eligible IP revenues to total business income in a given tax year. This position should be supported by the general principle that if the taxable person bears the costs of obtaining revenue from different sources and it is not possible to determine the costs of obtaining revenue from different sources, these costs shall be determined in the ratio to the revenue from those sources in the overall amount of revenue.

It should be stressed that the legislator has not defined any other method of attributing costs in the event of simultaneous receipt of revenues from different sources, i.e. from activities taxed, benefiting from a preferential rate of tax or exempt. In the absence of clear objective allocation of a particular category of costs to individual sources of revenue, the taxpayer is therefore obliged to use the so-called income key in question under Article 15(2) and 2a the Corporate Income Tax Act

This key should correspond to the proportion in which taxable income and revenue at a preferential rate remain. This is a universal and mandatory key when it is not possible to determine the cost of obtaining per source.

In order to properly calculate the tax base benefiting from preferential IP BOX taxation, it is therefore necessary to allocate to each eligible IP the cost of obtaining indirect revenues, i.e. those which are both the costs of the individual eligible IP and other sources of revenue which do not meet the requirements of qualified IP.

Once the common value has been established and the corresponding income per eligible IP, it should be allocated to the extent that the ratio of the eligible IP revenues falls to the total business activity in the tax year concerned.

The determination of the correct value of eligible IP income is a condition for the proper calculation of eligible IP income, so in order to establish the correct value of the tax base it is necessary to determine the cost of obtaining direct and indirect revenues.

Where it is not possible to directly allocate the costs of obtaining revenues generated throughout the activity and indirect operations carried out to individual sources of revenue, that cost should be allocated to it within the meaning of the rules.

Article 15(2) the Corporate Income Tax Act The exclusion of indirect costs for qualified IPs from the calculation of the key would therefore not be in line with tax rules and would consequently be set at an incorrect amount.

This is also due to the fact that it is the taxable person who is required to establish such rules of record-keeping, distribution and settlement of costs, which will allow the correct determination of tax revenues and the costs of obtaining taxable income, including those benefiting from a qualified IP credit.

3. Summary

The above considerations lead to the conclusion that First, the costs incurred should be assessed on the basis of the criteria defined under Article 15 the Corporate Income Tax Act The expenditure which may then be included in the cost of obtaining revenue should then be allocated to the activity concerned, i.e. activities that meet the requirements of qualified IP and activities that do not meet those requirements.

Failure to take into account indirect income costs in the calculation would therefore lead to a ‘falsification’ of the image, since if the taxpayer obtains income from qualified IPs and others, if not taken into account in an appropriate proportion of indirect costs in the calculation of eligible IP income, the taxpayer assigning all indirect costs to other revenues would unduly underestimate the income from that part of the activity. Therefore, in order to correctly calculate the income from intellectual property rights (which is then multiplied by Nexus), indirect costs should be allocated to eligible IP revenues at a proportion determined as the ratio of eligible IP income to total business income in a given tax year, which is Next, will allow the tax base benefiting from IP BOX preferences to be correctly established.

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(a) the R & D activities directly carried out by the taxpayer related to qualified intellectual property rights,

(b) the acquisition of research and development results related to qualified intellectual property rights, other than those mentioned in point (d), from an unrelated party within the meaning of Article 11a(1)(3),

(c) acquisition of research and development results related to qualified intellectual property rights other than those mentioned in point (d), from a related party within the meaning of Article 11a(1)(4),

(d) the taxpayer acquires a qualified intellectual property right.