In today’s creative, developing and “digitalised” world, Intellectual Property (IP) can be the most important or even the sole asset of a business, even of multinational organisations.
Cyprus has proven to be an ideal jurisdiction for technology companies and other organisations which own patents, trademarks, trade secrets, copyrights in literary and artistic works, computer software, and other inventions for the establishment of their IP Structures. The 12.5% Corporation Tax rate, the special IP Regime granting 80% exemption under certain conditions, the EU Interest & Royalty Directive and the plethora of Double Tax Treaties (DTTs) with very beneficial terms, are all contributing to the increase in popularity of the country as an ideal location to hold and manage IP.
We examine in some detail below, only a few of the aspects related to choosing Cyprus for holding and managing IP.
1. IP Regime
The IP Regime of Cyprus is fully compliant with international developments in the tax treatment of IP income and OECD’s guidance and it is fully compatible with EU standards.
As the Cyprus IP regime, 80% of the qualifying profits generated from the qualifying assets is deemed to be a tax deductible expense for qualifying taxpayers. In calculating the qualifying profits, the new regime adopts the ‘Nexus’ approach. According to this approach, the level of the qualifying profits is positively correlated to the extent the claimant performs R&D activities to develop the qualifying asset within the same company.
The following are considered as Qualifying Assets (QAs):
• copyrighted software programs, and
• other intangible assets that are non-obvious, useful and novel.
Trademarks and copyrights are not considered as QAs.
Qualifying Persons (QPs) include Cyprus tax residents, Permanent Establishments (PEs) of foreign entities, which are tax residents of Cyprus, and foreign PEs which are subject to tax in Cyprus.
Qualifying Profits are calculated in accordance with the nexus fraction that follows:
OI x QE + UE
OI: overall income derived from the QA
QE: qualifying expenditure on the QA
UE: uplift expenditure on the QA
OE: overall expenditure on the QA
The Overall Income (OI) is calculated as the gross income less any direct expenditure (including capital allowances - amortisation). So, in effect it is the gross profit from use of the asset. Overall income includes, but is not limited to, royalties received for the use of a QA, trading income from the disposal of such an asset and embedded income earned from the asset.
Capital gains arising from the disposal of a QA are not included in the overall income and are fully exempt from tax.
The Qualifying Expenditure (QE) includes salary and wages, direct costs, general expenses associated with R&D activities and R&D expenditure outsourced to unrelated parties. The QE does not include any acquisition costs of the QA, interest expenses, any amounts payable to related persons carrying out R&D and costs which are not directly associated with the specific asset.
The Up-lift Expenditure (UE) is the lower of:
• 30% of QE; and
• The total acquisition cost of the QA and any R&D costs outsourced to related parties.
The overall expenditure (OE) is the sum of:
• QE; and
• The total acquisition costs of the QA and any R&D costs outsourced to related parties incurred in any tax year.
The calculation requires that 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.
2. Not qualifying for the IP Regime
But even in cases where a company cannot benefit from the tax benefits of the IP regime (for example because the IP is not a Qualifying, significant R&D work is assigned to related parties, etc.), it can still achieve low effective taxation due to the following tax incentives:
All intangible assets (excluding goodwill), irrespective of whether they are qualifying assets or not, are eligible for amortisation for tax purposes, known as capital allowance, over their useful economic life with a maximum of 20 years. The taxpayer has the option not to claim capital allowances in a specific year. In addition, capital allowances not claimed in a year are claimed over the remaining useful life of the asset.
Notional Interest Deduction
Notional Interest Deduction (NID), is a deduction for tax purposes (hence the term “notional”) available on assets introduced in a Cyprus company financed through equity which are employed in the production of taxable income. So, it is also available to companies employing IP assets in the production of taxable revenue (e.g. royalties), which have been funded out of new equity financing. The NID cannot exceed 80% of the taxable profit generated from the IP assets and can potentially reduce the effective tax rate to as low as 2.5%. For more information on NID please refer to our related newsfeeds.
Increased tax deduction for R&D expenses
Expenses for scientific research and those for research and development, as recognized on the basis of the international accounting standards, will qualify for an increased allowance of 20% for tax purposes, thus giving a 120% total deduction from taxable income. The increased deduction will also apply on expenditure of a capital nature, for which capital allowances will be claimed and will be applicable during the years 2022, 2023 and 2024. For more information you can refer to our related newsfeed.
3. Embedded Income and Other Considerations
In cases where the income earned by a company from the sale of goods, provision of services or use of any processes is directly related to QAs, such income may include an element of embedded income, connected with the right to use of the IP. In order to claim a tax exemption on that element, a Transfer Pricing (TP) study in accordance with the OECD TP guidelines must be prepared.
A company is required to keep track of the relevant income and expenditure per QA so that it can calculate the Qualifying Profits. Furthermore, it is vital for any expenditure incurred for R&D or associated activities to be explicitly identified.