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A Tax Efficient EU Intellectual Property (IP) Box

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The key factors contributing to the development of Cyprus as an international business base for holding companies remain:

• It’s strategic geographic location;
• A favorable tax package with one of the lowest corporate tax rates in Europe;
• A well-developed double tax treaty network;
• Legal system and legislation based on English Law; and
• The existence of an efficient, high-level professional services sector.

The Constitution of Cyprus and international treaties ratified by Cyprus safeguard basic rights of both legal entities and individuals. Cyprus has two revenue raising measures that should be considered when planning to use Cyprus as a base for a holding company, one is the income tax and the other the defense levy. 

The flat income tax rate on annual net profit is 12.5% applicable to Cyprus resident both companies and individuals, on their worldwide income, which includes:

• Business income
• Rental income
• Dividends, interest and royalties
• Goodwill
• Employment income, pensions and director’s fees

However, several important exceptions apply to this rule which very briefly are:

• Profits from the activities of a permanent establishment outside Cyprus are exempt.
• Gains from trading in shares and securities generally are exempt from income tax for corporations. 
• Dividends paid into a Cyprus holding company are exempt from income tax, and no withholding tax is payable when dividends are paid by a Cyprus holding company to its nonresident shareholders.
• A unilateral tax credit is allowed in Cyprus for taxes withheld or paid in other countries where there is no bilateral agreement or Double Tax Treaty in force.
Certain types of income are subject to favorable tax treatments and the subject of the present article is the tax treatment of income from intellectual property the main features of which are:
• Royalties granted for the use of intellectual property rights outside Cyprus are not subject to withholding tax. 
• Royalties granted for the use of intellectual property rights outside Cyprus to a Cyprus-resident company are not subject to withholding tax, and corporate income tax is applied only on the profit margin left in the Cyprus company at an effective rate of 2.5% on net income. 

This is covered by the new legislation for the taxation of income from intangible property, which was introduced in 2012, the so called “IP Box” regime, which is applicable as from 1 January 2012 and applies to the following types of income whereby a significant deemed deduction on IPs Revenues is granted to the owner of the intangible:

• profits from the use of the intangible (e.g. royalties)
• penalties for the improper use of the intangible
• profits on the disposal of the intangible.

What intangible assets are covered?

Intellectual property as defined in the Intellectual Property Law includes the following:

• “scientific work” - work of every scientific nature, irrespective of its scientific quality
• “literary work” - novels, novellas, poems, theatre plays, scenery, movie scenarios, texts for shows, manuals, dissertations, historic works, biographies, proof texts, articles, encyclopaedias, dictionaries, letters, reports and memos, speeches (excluding the church speeches, the speeches in the House of Representatives, the conferences and the Court orations), table or combination, computer software.
• “musical work” - every musical work, irrespective of its musical quality.
• “artistic work” - paintings, drawings, maps, plans, graphs, sculpture works, photographs, architectural projects and any other artistic work.
• “movie” - cinema or audio-visual work or moving images whether they have sound or not.
• “database” - collection of works, data or other independent information, arranged on a systematic and methodical way and to which an individual has access using electronic or other means
• “recording” - the initial and constant fixing of sound sequence which may be received via hearing and be reproduced
• “broadcast” -  the simultaneous or posteriori broadcast of a programme by a radio authority located in Cyprus or abroad and includes wired broadcast of such programmes
• “publication” - publication of unpublished works
• Patent rights which are governed by the Patents Law are defined as:
“patent” – discovery which results in a product consisting of or including biological material or method for the production, development or use of biological material
• Trademarks, which are governed by the Trade Marks Law are defined as:
“trademark” - a mark which consists of any graphic marks (especially of words, including the name of people, images, letters, the shape of the good or its package, or any combination of these), which may because of their nature be distinctive features of the goods or the services of a business compared to relevant goods or services of other businesses, if this mark is used or going to be used for the purpose of this distinction.

Period of amortisation of costs

The cost for the acquisition or development of an intangible asset (being of a capital nature, from an IFRS perspective) is amortized equally over a 5 year period, i.e. the tax year in which the costs have been incurred and the four subsequent years.

Cyprus withholding taxes

Cyprus does not impose any withholding taxes on payment of royalties to an overseas beneficiary if exploitation of the royalty does not take place in Cyprus. However a 10% withholding tax is imposed if the royalty is exploited in Cyprus.

The withholding is however not applicable if the overseas beneficiary is an associated company of the Cypriot payer company in accordance with the provisions of the EU Interest and Royalties Directive or under the provisions of the applicable treaty. 

Calculation of profits

In calculating the profit which would be subject to corporation tax a deemed deduction is granted, representing 80% of profits after the deduction of all direct costs including:

• interest
• research and development
• amortisation of the intangible
• salaries and other direct costs

Sale of the intangible

The gain realized upon disposal of an intangible asset (i.e. sale, contribution to share capital, gift, etc.) is subject to 12.5% income tax (not capital gains tax). 80% of such gain is deemed to be an expense and is deductible for income tax purposes.

Example


       
Annual royalty income €100,000
Direct Expenses €(30.000)
Gross profit €70.000
80% deduction €(56.000)
Indirect expenses €(4.000)
 
Taxable profit €10.000  
Corporation tax at 12.5% €1.250

International considerations

Addressing base erosion and profit shifting (BEPS) is a key priority of governments around the globe. In 2013, OECD and G20 countries, working together on an equal footing, adopted a 15-point Action Plan to address BEPS. The Action Plan aims to ensure that profits are taxed where economic activities generating the profits are performed and where value is created.

In September 2014, OECD published their progress report on “Countering Harmful Tax Practices More Efficiently, Taking into Account Transparency and Substance”, setting out the progress made under Action 5 of the OECD BEPS.

One of the approaches considered in the September report relating to IP regimes is “the nexus approach”.

Nexus approach at a glance

Modified Nexus Approach
As stated above, this approach is founded on the principle of rewarding taxpayers for expenditure undertaken by themselves for the development of patents or products within the jurisdiction in which the preferential tax regime exists. Thus the effect of the said approach is that only a proportion of royalty income, applicable only on qualifying expenses, will be taxed under the preferential tax regime. The remaining royalty income will be taxed under normal tax rates.

Qualifying IP Assets

Under the Modified Nexus Approach, the only qualifying IP assets are patents and other patent-like IP assets which are protected by registration or any other relevant procedure. The Modified Nexus Approach explicitly excludes from receiving benefits marketing-related IP assets such as trademarks.

Qualifying Expenditure

The expenditure which qualifies for preferential tax treatment under the regime is that which relates to research and development of patents or products (in house). The definition excludes acquisition costs and outsourcing expenditure subject to the conditions explained before.

Timing, Grandfathering and reporting issues

• No new entrants after 30 June 2016
• Final abolition of old regime 30 June 2021
• Appropriate mechanisms to tackle the difficulties which may result during the transitional period
• Tracking and tracing methodology for R&D is expected to be determined.

Effect on Cyprus

 
With the current BEPS proposals and the introduction of the NEXUS APPROACH it would be difficult for the international businesses which have taken the Cypriot IP Box regime to be able to qualify for the benefit beyond the expiration of the grandfathering provisions period available until the end of the year 2021.

Cyprus with its infrastructure, highly qualified personnel and lower operating costs can play a significant role in innovation and creating of qualified intangibles and benefit beyond the year 2021.

The proposed changes mean that countries need to invest in technological plants for the creation of IP and provide incentives for such plants/parks (tax wise, cost wise, facility wise). This is currently under review by the Government.

Cyprus is signatory to the following international conventions relevant to IP:

• European Community Trademarks
• Convention Establishing the World Intellectual Property Organization (‘WIPO’)
• The Madrid Agreement Concerning the International Registration of Marks (the “Madrid Agreement”) and Protocol to the Madrid Agreement
• The Patent Cooperation Treaty
• Berne Convention for the Protection of Literary and Artistic Works
• Paris Convention for the Protection of Industrial Property
• Convention for the Protection of Producers of Phonograms Against Unauthorized Duplication of Their Phonograms
• WIPO Performance and Phonograms Treaty
• Rome Convention for the Protection of Performers, Producers of Phonograms and Broadcasting Organizations
• Trademark Law Treaty
• WIPO Beijing Treaty on Audiovisual Performances