The Intellectual Property (IP) Tax Regime in Cyprus
THE INTELLECTUAL PROPERTY (IP) TAX REGIME IN CYPRUS
On 14 October 2016, the House of Representatives passed amendments to the Income Tax Law in order to align the current Cyprus IP tax legislation with the provisions of Action 5 of the OECD’s Base Erosion and Profit Shifting (BEPS) project.
The amendments apply retroactively, as from 1 July 2016. The revised legislation includes certain transitional provisions for IP assets that have already qualified under the existing IP box regime.
In such cases, taxpayers will continue to benefit from the existing IP regime for a maximum of five years, after which date the new IP tax regime shall apply. Cyprus IP box regime tax benefit:
In essence, both the transitional and the new Cyprus IP box regime offer a tax benefit of up to 80% on qualifying IP profit, by way of notional expense deduction.
The benefits of the IP Regime apply only to certain categories of ‘qualifying intangible assets. The categories of qualifying intangible assets include:
What is a qualifying intangible asset?
Previously, qualifying assets were widely defined and included copyrights (literary works, dramatic works, musical works, scientific works, artistic works, sound recordings, films, broadcasts, published editions, databases, publications and software programs); patented inventions; trademarks and service marks; and designs or models applicable to products.
The new regime narrows the range of assets that qualify. Broadly speaking, a ‘qualifying intangible asset’ now means an asset which is acquired, developed or exploited by a person to further a business (excluding intellectual property associated with marketing) and which is the result of research and development activities.
These assets include patents (as defined in the Patents Law); computer software; and other IP assets that are non-obvious, useful and novel.
The person exploiting the asset must not generate annual gross revenue over €7.5 million, and if the person is a group company, the group’s revenue must not exceed €50 million.
Qualifying Profit (QP)
Qualifying profit (QP) is defined as the proportion of the overall income (OI) derived from the qualifying asset, corresponding to the fraction of the qualifying expenditure (QE) plus the uplift expenditure (UE) over the overall expenditure (OE) incurred for the qualifying intangible asset.
Overall Income (OI)
Overall income is defined as the gross income earned from qualifying intangible assets during the tax year, minus any direct costs incurred for generating the income.
Overall Income (OI) includes, but is not limited to:
- royalties or other amounts resulting from the use of qualifying intangible assets
- license income from the exploitation of qualifying intangible assets
- any amount received from insurance or as compensation in relation to qualifying intangible assets
- proceeds from the disposal of qualifying intangible assets, excluding profits of a capital nature
- embedded income of qualifying intangible assets arising from the sale of products or services, or from the use of procedures that are directly related to the assets
For the purpose of calculating OI direct costs include:
- all direct and indirect costs incurred wholly and exclusively for the purpose of earning the income from qualifying intangible assets
- notional interest on equity contributed to finance the development of the assets
- the amortization on the cost of acquisition or development of the assets
Qualifying Expenditure (QE)
Qualifying expenditure for qualifying intangible assets is defined as the sum of all research and development costs incurred during any given tax year wholly and exclusively for the development, improvement or creation of Qualifying Intangible Assets. These costs must be directly related to such assets. Qualifying expenditure includes, but is not limited to:
- costs associated with R&D that has been outsourced to non-related persons
- general expenses relating to installations used for R&D
- commission expenses associated with R&D activities
- wages and salaries
- direct costs
Qualifying Expenditure does not include:
- costs for acquisition of intangible assets
- interest paid or payable
- costs for acquisition or construction of immovable property
- amounts paid or payable directly or indirectly to a related person to conduct R&D activities, regardless of whether such amounts relate to cost sharing agreements
- costs which cannot be proved directly connected to a specific qualifying intangible asset
It is noted that any expenditure for R&D that has been outsourced to non-related parties, as well as any expenses of a general nature for R&D, which cannot be allocated to the qualifying expenditure of a specific qualifying intangible asset, can be apportioned pro rata to the qualifying intangible assets.
Uplift Expenditure (UE)
An up-lift expenditure will be added to the Qualifying Expenditure, equal to the lower of:
- 30% of the qualifying expenditure, and
- the total cost of acquisition of the qualifying intangible assets, plus the cost of outsourcing to related parties of any research and development activities in relation to such assets.
How the IP Box regime works:
For the calculation of the taxable profit, 80% of the qualifying profit derived from the qualifying intangible assets is treated as a deductible expense. For each tax year the tax payer may choose to waive the allowance, either in part or in whole.
How it works using nexus ratio
The overall qualifying income generated from qualifying intangibles is multiplied by the Nexus Ratio and the resulting sum is eligible to an 80% exemption in tax. However a taxpayer that acquires the IP asset or outsources its development to a related party would have a much smaller ratio, thus a much lower tax benefit.
Below we set out an example of how the 80% notional reduction in tax would be applied.
Overall Income from Qualifying IP –€1.000,000.00
Overall Expenditure (OE) in the form of research and development of the IP product-€500,000.00
Qualifying Expenditure (QE) which is the internal research and development of the company not outsourced is €500,000.00
Uplift Expenditure (UE) being the lower of:
30% of the Qualifying Expenditure: €150,000.00 and total cost of acquisition plus costs of outsourcing research and development to related parties which in this scenario is zero.
The QR for 80% tax benefit is €1.000.000 and the tax benefit would be €800,000.00.
Taxable profit will be decreased by €800,000 notional expense
FSMO team will be glad to assist you with the applications and further guidance.
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