Intellectual property rights are the rights over intellectual
creations, also known as the creations of the human mind (the
“IP“), commonly protected via patents or
trademarks or copyrights or industrial designs.
The international legal framework protecting the intellectual
property rights has evolved through the years via international
treaties, notable examples being the Paris Convention of 1883, the Berne Convention of 1886, and the WIPO Convention of 1967.
Cyprus has ratified all international conventions protecting
intellectual property rights, and as a member of the European Union
has transposed all European legislation into national law,
maintaining a highly evolved regulatory regime protecting
intellectual property rights and promoting innovation.
The principles behind the IP Box tax regime
To promote artistic, literary, scientific and technological
innovation many European countries have introduced since the
1970’s, tax incentives which have been widely known as the
“IP Box Regime”, offering either lower tax rates or tax
deductions in respect of income earned from licences in the form of
royalties over intellectual property rights or from the disposal of
intellectual property rights.
In 2015, the member countries of the Organization for Economic Cooperation and
Development (the “OECD“), agreed to
a modified nexus approach for IP box regimes as part of the OECD’s Base Erosion and Profit Shifting Action
5 plan (the “BEPS Action Plan“).
The OECD’s ‘nexus approach’ places specific focus on
requiring substantial activity for any preferential tax regime
which offers such incentives for the commercialization of
intellectual property assets (the “IP Assets”).
Through the nexus approach, a link must be established between
the income of qualified entities benefiting from the IP box regime
and the extent to which the taxpayer has undertaken the underlying
research and development (the “R&D“)
that generated the IP asset.
Cyprus tax legislation aligns strictly with OECD’s
principles and Cyprus remains up until today one of the most
attractive jurisdictions in the world for the protection of
intellectual property rights and the setup of headquarters of
companies developing innovative IP. This is particularly evident by
the increasing number of technology companies opting to set up
headquarters in Cyprus.
The Cyprus IP Box Regime
In 2016, Cyprus passed amendments to its Income Tax Law to align
its tax legislation relating to its IP Box Regime with the BEPS
Action Plan. The revised Cyprus IP regime has been reviewed by the
EU Code of Conduct and has been assessed as fully compatible with
EU standards.
Pursuant to section 9(1)(e) of the Cyprus Income Tax Law (as
amended), 80% of the revenue earned from the use and development of
the intellectual property which qualifies under the regime is
exempt from tax, allowing such income to be treated as a deductible
expense.
Whilst Cyprus maintains a corporate tax rate of 12.5%, companies
which have profits qualifying under the Cyprus IP Box regime may,
following the application of the nexus approach, be eligible to
reduce their effective tax rate as low as 2.5%.
In the case of a resulting loss, only 20% of the loss can be
surrendered to other group companies or be carried forward to
subsequent years.
The amendments of the Cyprus Income Tax Law, included
grandfathering provisions for companies which were benefiting from
the previous IP Box regime in Cyprus for IP assets acquired or
developed prior to 2 January 2015, extending its application until
30 June 2021.
Regulation 336/2016 of the Cyprus Income Tax Law relating to
Intangible Assets was issued following the amendment of the Income
Tax Law in 2016 (the “Regulation“).
We summarise here some of the key features of the new Cyprus IP
Box Regime, which are included in the Cyprus Income Tax Law and the
Regulation, which should be considered when deciding to opt into
this regime in Cyprus.
Which intellectual property assets qualify as qualifying
intangible assets under the Cyprus IP Box Regime?
The IP assets which constitute a qualifying intangible
asset (the “QIA” or
“Qualified Intangible Asset“) under the
Cyprus IP Box regime include only intellectual property
acquired, developed or exploited by a
person/entity in furtherance of its business, (excluding
intellectual property associated with marketing) and which is the
result of research and development activities, including intangible
assets for which only economic ownership exists.
The Regulations clarifies that the Qualified Intangible Assets
include (i) patents, (ii) copyrights in software programs / source
code and (iii) are non-obvious, useful and novel (subject to
qualifications). Intellectual property used to market products and
services, for example, trademarks, business names, images rights or
other copyrighted work developed for marketing purposes are
expressly excluded from the application of this regime.
Which entities qualify under the Cyprus IP Box Regime?
The Cyprus IP Box Regime applies to qualifying entities which
own qualified intellectual property rights (the
“QP” or “Qualified
Entity“), including, Cyprus tax resident taxpayers,
tax resident permanent establishments of non-tax resident entities,
as well as foreign permanent establishments which are subject to
tax in Cyprus.
Which part of the overall profits of the Qualified Entities,
qualify under the Cyprus IP Box Regime?
As indicated above, the revised regime has introduced the Nexus
approach as per the OECD BEPS Action Plan, which effectively limits
the level of profits eligible to qualify for tax deduction. The
nexus approach must be applied to determine what profits generated
by the Qualified Entities will be subject to the relevant tax
deduction.
The nexus fraction included in the Regulation considers the
Overall Income (the “OI”), the Qualifying Expenditure
(the “QE”), the Uplift Expenditure (the “UE”)
and the Overall Expenditure (the “OE”) as follows:
The Overall Income (OI) derived from the
qualified intangible assets is the proportion of the overall
revenue of the Qualified Intangible Asset, corresponding to the
fraction of the qualifying expenditure plus the uplift expenditure
over the total expenditure incurred for the qualifying intangible
asset.
The Overall Income is calculated as the gross income less any
direct expenditure of this asset, i.e. the gross profit.
The Overall Income includes, but is not limited, to the
following:
- royalties received for the use of the qualifying intangible
asset; - any amount for a licence for the operation of qualifying
intangible asset; - any amount received from insurance or as compensation in
relation to the qualifying intangible asset; - trading income from the sale of the qualifying intangible
asset; - embedded income earned from the qualifying intangible
asset.
If a Qualified Entity will claim that the Overall Income has an
embedded income of the revenue, which is generated when using the
Qualified Intangible Asset to deliver a service or product, the
embedded income to the Overall Income will be determined by a
transfer pricing study carried out in accordance with the OECD
Transfer Pricing guidelines.
Capital gains arising from the capital disposal of the QIA are
not included in the overall income and are fully exempt from
taxation.
The Qualifying Expenditure (QE) on the
qualified intangible asset is the sum of the total research and
development (R&D) costs incurred in any tax year, wholly and
exclusively for the development, improvement or creation of
Qualifying Intangible Assets and which costs are directly related
to the Qualifying Intangible Assets.
The QE includes, but is not limited to, the following:
- wages and salaries;
- direct costs;
- general expenses relating to installations used for research
and development;
However, the QE does not include:
- cost for the acquisition of intangible assets;
- interest paid or payable;
- costs relating to the acquisition or construction of immovable
property;
The Uplift Expenditure (UE) on the qualified
intangible assets is the lower of (i) 30% of the Qualified
Expenditure and (ii) the total acquisition cost of the qualified
intangible asset and any R&D expenditure that was outsourced to
related parties.
The Overall Expenditure (OE) on the qualified
intangible assets is the sum of (i) the Qualified Expenditure and
(ii) the total acquisition cost of the qualified intangible asset
and any R&D expenditure that was outsourced to related parties
which incurred in the tax year.
The calculation requires that both the QE includes all
qualifying expenditures incurred by the taxpayer over the life of
the IP asset and that OE includes all overall expenditures incurred
over the life of the IP asset.
A Qualified Entity would apply the relevant financial data to
the nexus fraction to determine if any part or all of its overall
income is considered qualifying profit under the IP Box regime and
thereafter determine what is the overall effective tax. If the
nexus fraction is 100% then the effective tax rate over the profit
will be reduced to 2.5%.
However, companies that outsource their R&D to affiliated
group companies may find that they gain no benefit from IP Box
regime. The being that the objective of the Nexus approach is to
provide financial incentives to companies which undertake their
R&D in-house (i.e. by the company claiming the tax deduction
and depending on the circumstances by any of its foreign branches)
or use unconnected third parties in R&D projects. Therefore,
groups wishing to claim the entire benefit of the IP Box tax relief
should take into consideration that the key element of this regime
is that the R&D is carried out within the same company.
Why is Cyprus becoming a popular jurisdiction for innovative
businesses?
There are many factors that must be considered when choosing
where to set up the headquarters and R&D functions of an IP
company. We highlight here just a few of the factors which drive
many innovative businesses and in particular tech-companies, to
Cyprus:
- A robust legal system that recognises and protects valuable IP
assets - As member of the European Union, it maintains highly evolved
legal and tax systems, in compliance with international
standards - An attractive tax system, offering one of the most competitive
financial incentives in Europe to companies and individuals. - Cyprus offers tax incentives for skilled workforce relocating
to Cyprus. Tax exemptions on personal income tax of staff
relocating and residing in Cyprus are as follows: -
- Exemption from personal income tax of 20% of the remuneration
from any employment exercised in Cyprus by an individual who was
resident outside Cyprus before the commencement of his employment,
or ?8.550, whichever is the lower. This exemption applies until
2025 - Exemption from personal income tax of 50 % of the remuneration
from any employment exercised in Cyprus by an individual who was
resident outside Cyprus before the commencement of his employment
in Cyprus. This exemption applies for a ten-year (10) period,
commencing on the year of employment, provided that the said income
exceeds hundred thousand Euros (?100.000) annually
- Exemption from personal income tax of 20% of the remuneration
- Cyprus maintains double taxation avoidance treaties with over
sixty countries, making it a strategic destination for
international business operating in global markets. - Access to international investors and venture capital who
consider investing via a Cyprus-based company a competitive
advantage, as the legal and tax system provide numerous solutions
for funding and M&A activity - Cyprus has an ideal geographical location, Mediterranean
climate, rich culture and has highly-developed infrastructure,
healthcare, and education systems. - Cyprus maintains a highly-skilled workforce, but also offers
programs that allow relocation of high skilled employees to
Cyprus. - Many entrepreneurs, senior management and staff of
international companies choose to work and live in Cyprus for the
high standard of living, reasonable cost of living and
work-life-balance it offers.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.