Losses incurred during the development phase do not have to be put “on hold” and can be offset immediately, even by sole proprietors
Example: Physician claims losses from development activities for tax purposes
A physician has developed a completely new type of electrocardiograph that is protected under a patent. Trial runs of a prototype of the device as well as of six other demonstration devices were performed in hospitals and medical centres. After the development of the prototype, the know-how was transferred to a GmbH, with the physician receiving a current license fee from the GmbH.
Obviously, during the development phase, the physician incurred losses due to this research and invention activity. For income tax purposes, he wanted to offset these losses (resulting from business operations) against the profits from his surgery, in order to save taxes.
Tax office assesses development activity to be “administrative activity” and refuses loss set-off
The tax office argued that the main focus of the research activity had consisted in “managing intangible assets”. For this kind of administrative activity, the law provides for a ban on offsetting any losses against profits from other sources of income. Consequently, the losses incurred through the development, patenting and manufacture of the electrocardiograph cannot be offset against the profits from practising medicine (income from self-employed work), but only against any later profits from exploitation of the development (in Austria, such losses are called Wartetastenverluste (‘on-hold losses’).
The Federal Finance Court (BFG) recognises the developer’s active operations, the Supreme Administrative Court (VwGH) confirms the legal view of the BFG – full loss set-off is possible
The Federal Finance Court (BFG) did not concur with the view of the tax office and sustained the physician’s appeal. The tax office lodged an appeal on points of law, arguing that the physician had left the marketing of his invention to a limited liability company (GmbH) controlled by him, so that only income from the granting of licenses was generated, which constitutes the management of intangible assets.
The Supreme Administrative Court (VwGH) dismissed the appeal by the tax office as unfounded (Ra 2018/15/0085 dated 3 September 2019).
Important practical results for start-up losses
In practice, some favourable conclusions can be drawn from the decision:
- Even if the invention concerned is subsequently licensed, the development activity will not be considered as the mere management of an intangible asset:
The management of intangible assets comprises the profit-oriented usufruct of (existing) intangible assets, e.g. the management of participating interests or copyrights. The activity of inventors or product developers is not limited to the “management” of assets. The activity of any inventor is primarily aimed at developing a new product that is meant to replace or complement existing products. Any originally creative inventor is not only managing knowledge, but creating new knowledge. Losses incurred through any such inventive activity can be offset against any profits from other sources of income without restrictions.
- Losses incurred through development activities will also be deductible in the event of subsequent exploitation by a GmbH:
In the opinion of the supreme court, the transfer of the development results to a GmbH against payment of a current license fee does not mean that the relief for losses incurred through the development activities cannot be exploited. The only purpose of the prohibition of loss compensation is to prevent the creation of a business structure for the fiscal exploitation of any relief for losses that would be irrelevant in the private sphere.
- Prohibition of loss compensation and loss deduction also applies to sole proprietors:
While the restrictions on the exploitation of tax relief for losses are aimed at companies created for the sole purpose of loss allocation, the only aspect that the VwGH considers decisive is whether a business operation within the meaning of the Austrian income tax act (EStG) exists; the legal form chosen for the management of the business operation is irrelevant.
Conclusion on ‘on-hold losses’
Austrian inventors within a company structure may offset the losses incurred in the development phase against other income without restrictions. The so-called “on-hold losses” provision does not apply, even though the development may subsequently be transferred to a GmbH (for instance) and exploited by the same.