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:
QP = OI ×(QE+UE)/OE
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
- 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.