What’s in an Italian Patent (Innovation) Box? Patents, software and design (but no more know-how, ouch!)

IP practitioners are not always interested in taxation profiles of intellectual property, but sometimes it’s necessary to get acquainted with them. As many of our readers know one of the most recurrent tax-related topics that come into discussion in the IP field is the so-called Patent Box (sometimes also - more properly - defined as the Innovation Box since it is not all about patents ).

A Patent Box is a fiscal tool introduced at a national level that intends to incentivize investments in research and development (R&D), avoid the relocation of intangible assets to foreign countries or encourage returns, through tax incentives. In particular, in accordance with the OECD "nexus approach" principle, such facilitated IP regimes may be applied when the taxpayer can demonstrate the existence of a clear link between the income deriving from a certain IP asset and the underlying R&D that generated the IP asset at stake. Any company that wishes to profit from a patent box incentive should then (i) have the right to the economic exploitation of an intangible assets which is legally protected and (ii) have carried out R&D in relation to the asset being facilitated. Most of the discussion over the year has been on what kind of IP assets could be protected.

The Patent Box was introduced in Italy in 2015. Aside from the purely fiscal considerations, it is important to note that the very first version of the Italian Patent Box initially included the following definition of  “intangible assets” as being:

(i) Software;

(ii) Patents;

(iii) Trademarks;

(iv) Designs and models;

(v) legally protectable business information and industrial and technical experience, including commercial or scientific information protected as secret information.

This definition of "intangible assets" in the initial Italian provision, however, appeared immediately to be in contrast with the OECD guidelines and, in particular, with the recommendations contained in the document "Countering Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance" (which constitutes Action 5 of the OECD's Base Erosion and Profit Shifting (Beps) Action Plan 2015). The nexus approach in the OECD guidelines in fact provides that trademarks, in particular, should not benefit from a preferential regime, given that the policy rationale of an IP regime is to encourage and reward scientific innovation rather than marketing activity, with the consequence that a taxpayer engaged in exploiting marketing intangibles must be required to pay tax at the ordinary rate. Given this inconsistency, in 2017, the scope of the Italian patent box was narrowed by excluding the income generated by the use of trademarks (Article 56 of Decree-Law no. 50 of 24.4.2017).

After that modification, and also according to this Kat’s experience, the Patent Box served rather well its purpose, especially as far as trade secrets were concerned. Many companies in fact made an effort to prepare extensive and detailed records of their R&D activities, with an in-depth examination of their production processes and value chain, sometimes also revealing the weak points of their business structure, which otherwise would have probably remained ignored. This, therefore, became (a) a very useful moment of self-analysis for Italian entrepreneurs, who are often accustomed to simply answering, when asked where the added value of their activities lays: “We have always done it this way”; (b) an important tool for litigation when a company wanted to claim in Court infringement or misappropriation of its trade secrets (especially ex parte). The argument used by the party that wanted to enforce its rights in fact sounded like: I have been able to convince the Revenues Authority to allow my company a tax advantage on my trade secrets, so it meant that I had a valid underlying right.

Unfortunately, though, the Italian legislator is sometimes keen on modifying those laws and provisions that are working decently fine. And as such at the end of 2021 the Italian Government decided to modify the Italian Patent Box legislation in an attempt to simplify the regime, inserting some amendments into the annual Finance Act for 2022.

The first modification that was proposed concerned the system of the tax incentive. In a nutshell, the previous system provided for an increased exemption of 50% of the income deriving from the economic exploitation of intangible assets (in 2015 the percentage of exemption was 30%, in 2016 40%). With the new system, it is envisaged that companies operating in Italy - including companies not resident in Italy, provided they are resident in countries with which an agreement to avoid double taxation is in force and with which there is an effective exchange of information - may increase the R&D spending in relation to these intangible assets by 110% (by means of a decrease in the income declaration).

But what’s more interesting for the readers, from a substantive point of view, is that the new amended Italian Patent Box legislation will no longer apply to know-how and trade secrets.

What happened is that in the initial version of the Finance Act 2022 the legislature had proposed to reintroduce trademarks among the intangibles that could give rise to a tax deduction. This obviously was criticized by many sides, because it would have implied a further violation of OECD rules as discussed above. So, during the promulgation discussion, it was decided to, again, remove the trade marks from the draft. Fair enough, but this Kat sincerely does not understand why during the parliamentary revision another item was removed, namely the item relating to “legally protectable business information and industrial and technical experience, including commercial or scientific information protected as secret information”.

The Finance Act has now been approved with the following wording: “For income tax purposes, research and development costs incurred by the persons indicated in paragraph 1 in relation to software protected by copyright, industrial patents, designs and models, which are used by the same persons directly or indirectly in the performance of their business activities shall be increased by 110 percent”.

With the consequence that Italian taxpayers have lost the possibility to claim a tax advantage for the costs related to R&D concerning processes, formulas, and information related to the experience acquired in several industrial, commercial or scientific fields (to give an example, the old patent box with the detaxation of income produced by intangibles could also concern chemical or industrial processes used in very successful in the market). Needless to say that many industries are not happy with the removal of know-how from the list of rights and the hope is that the legislature could change its mind and reintroduce them. In the meantime, we IP lawyers can only hope that Italian companies do not lose interest in a consistent system of tracking their know-how and trade secrets because of this reduced fiscal opportunity.

 The kitten looking for the return of trade secrets is CC0 Public Domain from https://pxhere.com/en/photo/628503

The first picture is "Cat in a box", by Greg Mote from Glendora, CA, USA - CC 2.0