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Companies owning intangible assets, such as patents, copyrights etc. are often in need of an IP Holding vehicle through which they will hold these assets, license them for the generation of royalty income and conduct their business activities.
Choosing the jurisdiction of such an IP Holding vehicle requires careful consideration to ensure that there will be adequate asset protection, ideal environment for asset development, tax optimisation and flexibility in the legal framework that this vehicle will operate in.
Cyprus with the introduction of the IP Box regime in 2012 and the subsequent amendments in 2016, to comply with the guidelines of the OECD, has become a major player in the field of IP holding jurisdictions.
In this brochure we shall examine the main features of the amended IP Box tax regime and other factors in order to analyse the importance of the Cyprus IP Holding Company and highlight the benefits it can offer to the international investor.
B. THE PROVISIONS OF THE IP BOX REGIME
The Cyprus IP Box Regime applies on Qualifying IP’s which are developed after the 1st of July 2016. In order for a Cyprus IP Holding Company to benefit from the favourable tax regime it must satisfy certain conditions of the IP Box Regime. According to the Regime, 80% of “Qualifying Profit” generated from Qualifying IP Rights will be considered as a deemed expense for corporation tax purposes. The remaining 20% will be subject to the normal corporation tax rate of 12.5%. Thus, the Qualifying profits will have an effective tax rate of as low as 2.5%. The conditions of the IP Box Regime are analysed in more detail below:
I. Qualifying IP
A qualifying IP means an asset which was acquired, developed or exploited by a person in the course of his business and it is a result of research and development. It also includes assets for which only economic ownership exist.
Qualifying assets under the regime include:
- Patents as defined in the Patents Law
- Computer Software
- Other IP assets which are legally protected and they fall under one of the following:
- Utility Models.
- Nonobvious, useful and novel where the person utilizing does not generate gross revenues over EURO 7,500,000 or in the case of a group not more than EURO 50,000,000 using a weighted average method of the last 5 years for the calculation of both figures. The IP assets mentioned in this point should be certified by an Appropriate Authority in Cyprus or abroad.
The definition of Qualifying IP specifically excludes business names, brands, trademarks, image rights and other intellectual property rights used for the marketing of products and services.
II. Qualifying Profit (QP)
The term Qualifying Profit is calculated as follows:
QP = ———- X OI
QE: Qualifying Expenditure
UE: Uplift Expenditure
OE: Overall Expenditure
OI: Overall Income
The relevant terms are explained below.
Qualifying Expenditure (QE)
Qualifying Expenditure is defined as the total expenses for research and development carried out wholly and exclusively for the development, improvement or creation of Qualifying IP in any fiscal year. The above expenditure should be a direct expenditure.
Qualifying Expenditure includes but is not limited to the following:
- Wages and Salaries for research and development
- Direct Costs
- General expenses relating to the facilities used for research and development
- Expenses for supplies relating to research and development
- Expenditure relating to research and development which has been outsourced to an unrelated party
But they do not include:
- Cost of acquisition of intangible assets
- Interest paid or payable
- Costs for the acquisition or development of immovable property
- Amounts paid or payable directly or indirectly to a related party to conduct research and development irrespective of whether these amounts relate to a cost sharing agreement
- Cost which cannot be proved that related directly to the Qualifying Asset
Uplift Expenditure (UE)
Uplift Expenditure means the lower of:
- 30% of qualifying expenditure, or
- The total amount for the cost of acquisition and the research and development outsourced to related parties
Overall Expenditure (OE)
Overall Expenditure means the total capital expenditure either qualifying or not, relating to the creation of the Qualifying IP.
Overall Income (OI)
The term Overall Income refers to the gross income arising from the Qualifying IP in a tax year less the direct costs incurred for the production of this gross income. The term includes but it is not restricted to the following:
- Royalties or other amounts in relation to the use of the Qualifying IP
- Any amount received as license for the use of a Qualifying IP
- Any amount received from insurance or compensation in relation to the Qualifying IP
- Embedded income of the Qualifying IP which income derives from the sale of goods, services or procedures relating directly with the Qualifying asset
Direct costs include:
- All direct or indirect costs incurred in earning the income from the qualifying intangible asset
- The amortization of the cost of the intangible
- Notional Interest Deduction (NID) on equity contributed to finance the development of the qualifying intangible asset
Capital gain derived from the disposal of Qualifying IP are not included in the Overall Income and are fully exempt from Tax.
III. Accounting Records
Any person who claims benefit under the IP Box Regime should maintain proper books and records in accordance with the laws in Cyprus.
IV. Practical Examples
Practical examples can be found in Schedule 2 of this brochure.
C. CYPRUS – THE IDEAL IP HOLDING JURISDICTION
Taking into consideration the global tax trends and requirements as well as the specific requirements of the Cyprus IP Box, the simple set-up of a company in Cyprus will not be adequate in order to enjoy the full benefits that Cyprus has to offer.
The investors who want to create an efficient structure in order to develop the patents or copyrights (i.e. computer software) must create strong roots and real economic substance in Cyprus. Therefore, they will need to set up their regional headquarters in Cyprus, relocate specialist from abroad to form a strong board of directors and middle management and/or use the local employment market to find suitable employees. By doing this a whole new window of opportunity is opened for the investors to develop innovation in a welcomed and tax efficient environment.
The Cyprus IP Box in relation to the tax treatment of royalties received from a Qualifying IP as analysed above, is definitely beneficial. However, when taking into consideration the other features of the Cyprus tax, legal and business environment it becomes evident that Cyprus is the ideal IP Holding Jurisdiction.
In order to demonstrate this, we analyse below, in more detail, the elements of a typical IP Holding Structure and bring up the benefits of the tax, legal and business environment in Cyprus.
I. Typical IP Holding Structure
(please refer on our website for the diagram)
As shown in the diagram above, a typical IP holding structure involves an investor setting up an IP Holding Company which will develop and be the owner of a Qualifying IP. The IP Holding Company will license the Qualifying IP, for example, to CIS Region and European licensees. The investor will need to take into consideration Tax, Legal and Local Business Environment issues when deciding which jurisdiction to use for the IP Holding such as:
Local Business Environment:
- The investor should consider to hire local employees.
- Acquisition of Premises for the execution of the primary activities.
- Relocation of the Directors and other Employees from abroad.
- Tax issues:
- withholding tax deducted from the foreign jurisdiction on the incoming royalty income.
- taxation of the royalty income at the jurisdiction of the IP Holding Co.
- withholding tax deductions on payments of dividends to the Investor.
- taxation on profit from sale of the IP Right.
- Legal issues:
- The IP asset to be sufficiently protected.
- Legally permissible to develop the Qualifying IP.
II. What Cyprus has to offer
Local Business Environment – Economic Substance:
There are several elements that contribute in the strong business environment of Cyprus. These include the strategic location, standard of living, infrastructure, skilled workforce and favourable tax system. All these combined with low operating costs make Cyprus attractive to investors and entrepreneurs. Further, as mentioned above, investors must create real economic substance in Cyprus in order to be able to enjoy the full benefits that Cyprus has to offer. Some of the elements are analysed below.
1. Acquisition of Premises for the execution of the primary activities.
Cyprus is the third largest island in the Mediterranean, which links Europe, Africa and Asia. Due to the strategic location, Cyprus is considered as a very popular tourist destination and business hub. Further the cost of maintaining premises in Cyprus is relatively low compared with other business hubs in Europe.
2. Relocation of the Directors or Employees
In Cyprus you can enjoy a high standard of living. Cyprus has a good climate which allows you to visit its clean and beautiful beaches and mountains. Also, Cyprus is well known for its rich culture and the hospitality of its people. At the same time, Cyprus offers an ideal place to raise a family with good education system with many English-speaking schools. Cyprus has a good healthcare system and one of the lowest crime rates within the EU. Furthermore, there are attractive tax schemes for highly remunerated directors and employees. For more information you may refer to our publication “Relocation and Retirement in Cyprus – The Tax Aspect”.
Therefore, considering all of the above Cyprus will be an attractive destination for a person to relocate, work and live with his/her family.
3. The investor should consider to hire local employees.
In proportion to its population, the island ranks among the highest in the EU with respect to university graduates. The majority of university graduates are from English speaking universities. Further, the average annual salary of young University graduates is considered more competitive compared with other European business hubs.
1. Incoming Royalties – Withholding Tax on Foreign Jurisdiction
Whenever a licensee makes a payment of royalty to the licensor (i.e. the IP Holding Company), the country of residence of the licensee has the right to deduct withholding tax on the amount. This means that instead of the IP Holding Company receiving the full amount of royalties, it will receive only the net amount after the deduction of withholding taxes.
The investor therefore, must choose a jurisdiction that will give him the ability to extract incoming royalties from the various jurisdictions with as low as possible withholding tax deduction from their jurisdictions
Cyprus has many tools available that will enable the investor to achieve this. In particular the investor may seek the benefits obtained from:
The Double Tax Treaties
Cyprus has signed an extensive network of Double Tax Treaties with third countries. This gives the ability to extract royalties from these jurisdictions at reduced rates when compared with the normal withholding tax rates imposed by these jurisdictions in the absence of such treaties.
A summary of the Double Tax Treaties that Cyprus has signed with the applicable withholding tax rates can be found in Schedule 1 of this brochure with relevant notes.
It is important to note that in order to be able to benefit from the treaties the company should at
- least meet the following conditions:
The Double Tax Treaties apply to natural and legal persons who are tax residents in Cyprus. Therefore it is important that careful tax planning is made to ensure that the effective management and control of the IP Holding Company is performed from Cyprus.
Further, it is important that the IP Holding Company to be considered as the beneficial owner of the income in order foreign tax authorities to grant the treaty benefits. Therefore, the company should have sufficient economic substance in order to obtain the treaty benefits.
The structure was not set up with principal purpose to obtain treaty benefits.
Relief under the EU Interest and Royalty Directive
The EU Interest and Royalty Directive provides for the abolition of withholding taxes on Interest and Royalties paid by a licensee who is resident in one EU Member State to a licensor company being resident in another EU Member State provided both are within the same group.
With careful tax planning, a Cyprus IP Holding Company can enjoy the benefits of this EU directive, which grants the ability to receive royalties from all other EU member states with no withholding tax. It therefore opens the European Market to the investor, it reduces the tax leakage and hence, gives flexibility and significant competitive advantage in relation to pricing.
The same conditions as to the tax residency, beneficial owner of the income and the principal purpose test must be met in order to benefit from this directive.
Unilateral Tax Credit Relief
In cases were the Double Tax Treaty network or the Interest and Royalty Directive relief are not providing sufficient protection, it is possible for a Cyprus IP Holding Company, under the provisions of the Cyprus Tax Law, to claim a Unilateral Tax Credit Relief.
In effect, any tax paid abroad will be credited against any tax that might be payable for the particular income in Cyprus avoiding therefore the double taxation of the specific income. In order to obtain this tax credit, the company must provide sufficient evidence in original proving the payment of overseas taxation on the specific royalty income.
All of the above three tools allow the investor to minimise its tax exposure on withholding taxes paid abroad on the incoming royalties and therefore enhance its overall tax exposure.
2. Taxation of Royalty Income Received – Local Tax
As stated in Section B above, the Cyprus tax legislation provides that 80% of “Qualifying Profit” generated from such Qualifying IP Rights will be exempt from corporation tax. The remaining 20% will be subject to the normal corporation tax rate of 12.5%.
The above provisions make the maximum effective taxation on royalties to be as low as 2.5% with the ability of further reduction.
3. Outgoing Dividends
Any profits generated by the Cyprus IP Holding Company can be distributed to its shareholder in the form of dividends.
According to the Cyprus Tax Law any dividends payable by a company resident in Cyprus to its foreign shareholders (natural or legal persons) or to a Cyprus but non domicile tax resident individual is not subject to any withholding tax in Cyprus.
This is very important as it allows for funds to move to the investor without any additional tax leakage in Cyprus.
4. Taxation on possible sale of the IP Right
Every investor needs to have an exit strategy so as to be able to respond quickly whenever favourable opportunities to dispose the IP Right appear.
Investing through a Cyprus IP Holding Company will provide the investor with a tax efficient exit route since, as mentioned in Section B the favourable tax treatment of a maximum effective tax rate of 2.5%, covers also potential profits from any future sale of the IP Right.
To avoid Beneficial Ownership issues, the Cyprus IP Holding Company must have a balanced and prudent dividend policy.
1. The IP asset to be sufficiently protected.
The legislation of Cyprus based on common law and it is in line with European legislation. In this respect, Cyprus meets all the requirements and standards of The World Intellectual Property Organization (WIPO) and the European Union Intellectual Property Office (EUIPO).
Moreover, Cyprus is a signatory to the following International Conventions:
- Bern Convention on the Protection of Literary and Artistic Works.
- Madrid Agreement and Protocol on the Registration of Trademarks at International Level.
- Paris Convention on the Protection of Industrial Property.
- European Community Trademarks.
- Convention Establishing the World Intellectual Property Organisation (“WIPO”).
- The Patent Cooperation Treaty.
- Convention for the Protection of Producers of Phonograms Against Unauthorised Duplication of Their Phonograms.
- WIPO Performance and Phonograms Treaty.
- Rome Convention for the Protection of Performers, Producers of Phonograms and Broadcasting Organisations.
- Trademark Law Treaty.
- WIPO Beijing Treaty on Audiovisual Performances.
2. Legally permissible to develop the Qualifying IP.
Cyprus is generally opened to new ideas and does not have a lot of restrictions. Further, Cyprus not only does not prohibit any development in new ideas but encourages businesspeople to introduce and develop ideas and invest in innovative products. Moreover, Cyprus offers tax incentives to support businesses in developing innovative products and services which strengthen the Cypriot entrepreneurial ecosystem.
Taking into consideration the issues analysed above it is evident that Cyprus is the Ideal IP Holding jurisdiction. It allows for proper protection of the IP Rights and it provides for very competitive and efficient tax planning opportunities.
Companies that are engaged in the acquisition and development of IP Rights, must seriously consider the Cyprus IP Holding Company as the investment vehicle that will provide them with all the necessary tools to plan and structure efficiently their investment.
E. HOW KINANIS LLC CAN ASSIST YOU
- Providing Tax Optimisation Advice
- Setting up, consulting and management of IP Holding Companies
- Advising and drafting IP transactions including financing, acquisitions, sales and licences
- Registering IP Rights in Cyprus and abroad
- Introduction of real estate agents in Cyprus
- Registration with Migration department
- Accounting and Payroll Services
This publication has been prepared as a general guide and for information purposes only. It is not a substitution for professional advice. One must not rely on it without receiving independent advice based on the particular facts of his/her own case. No responsibility can be accepted by the authors or the publishers for any loss occasioned by acting or refraining from acting on the basis of this publication.
(please refer on our website for the Schedules)
Kinanis – Tax Department