The Cypriot Intellectual Property (IP) Box regime has been a popular tax incentive program for companies since its introduction in 2012. The program provides a significant reduction in corporate tax for qualifying companies that generate income from qualifying intellectual property rights. In 2016, the Cypriot IP Box regime underwent significant changes, affecting the eligibility criteria, calculation of benefits, and compliance requirements. This article aims to provide a complete overview of the Cypriot IP Box in 2022, including the changes, benefits, and challenges that companies may face when participating in the program.
Main Characteristics of Cypriot IP Box
A company (a tax resident of Cyprus, a permanent establishment of a foreign company paying taxes in Cyprus), that profits from the use of intangible assets, objects of intellectual property (hereinafter referred to as the ‘IP objects’) that have been developed, bought and directly used in the activities of such a company for profit.
Benefits of Cypriot IP Box :
1. 80% of all income and deductions received from the use of the IP objects (the so-called “qualified profit”) are not subject to a general income tax of 12.5%. There is no withdrawal limit. So only 20% of IP income is taken into account, minus the cost of generating income. Thus, the application in Cyprus of the corporate tax rate of 12.5%, which is one of the lowest in the EU, even can provide an effective tax rate of 2.5% under the IP Box regime.
2. 0% income tax on the sale of IP assets as capital transactions. On 17.07.2020, the House of Representatives of Cyprus approved a bill to amend article 9(1)(l) of the Income Tax Law, which introduced a number of changes in relation to the taxation of intangible assets. In particular, if the disposal of intangible assets is a capital transaction, then the resulting capital gain should not be taxed. The changes came into force on 01.01.2020. It also eliminates the obligation to draw up a balance sheet when transferring or selling an intangible asset (the IP objects).
3. Depreciation period for the IP objects – up to 20 years. Capital expenditures related to the acquisition or development of an IP may be deducted in the first tax year in which the expenditure is incurred and in subsequent years. That is, development or acquisition costs are amortized over a period of up to 20 years. In practice, this can reduce the effective tax rate to less than 2% at a cost.
Cyprus also provides maximum protection and confidence to IP holders by ratifying all major IP treaties and protocols. In particular, the Republic of Cyprus has signed the following international conventions governing intellectual property rights:
Convention Establishing the World Intellectual Property Organization (hereinafter referred to as WIPO);
EU Community Trade Mark Regulation (CTMR);
Beijing Treaty on Audiovisual Performances of the WIPO;
WIPO Performances and Phonograms Treaty (WPPT);
Berne Convention for the Protection of Literary and Artistic Works;
Madrid Agreement Concerning the International Registration of Marks (Madrid Agreement, MMA) and the Protocol to the Madrid Agreement;
Patent Cooperation Treaty (PCT);
the Paris Convention for the Protection of Industrial Property;
Geneva Convention for the Protection of Phonograms Producers from Unauthorized Reproduction of their Phonograms;
Rome Convention for the Protection of Performers, Producers of Phonograms, and Broadcasting Organizations;
WIPO Trademark Law Treaty.
Requirements for IP Objects
According to the amended legislation, a “qualifying intangible asset” is defined as an asset that was acquired, developed or operated by a company in the course of its business activities (excluding intellectual property related to marketing), which is the result of research and development activities (hereinafter – R&D) and includes intangible assets for which there is a right of ownership.
Qualifying intangible assets include
– patents as defined in the Cypriot Patent Law;
– computer software;
– other intellectual property assets protected by law and falling into one of the following categories:
– utility models, intellectual property for the protection of plants and genetic material, orphan medicinal products and the extension of patent protection;
– non-obvious, useful and other IP objects, if the person using them to conduct business does not receive an annual gross income in excess of 7,500,000 euros from all intangible assets (50,000,000 euros for a group of companies) certified as such by the relevant authority, in Cyprus or abroad.
Important: The definition of qualifying intangible assets excludes trade names, brands, trademarks, image rights, and other intellectual property rights used to market products and services.
Qualifying Profit
In addition to obtaining approval for the use of the regime, the company must constantly monitor the receipt of the so-called. “qualifying profit”.
Qualifying Profit= QE+(UE x OI)/OE
Where:
QE – the Qualifying Expenditure on the qualifying intangible asset
UE – Up-lift Expenditure
OE – the Overall Expenditure on the qualifying intangible asset
OI – the Overall Income which derives from the qualifying intangible
Asset
General Criteria
In order for a company to qualify under the Cypriot IP Box regime, it is essential that the following conditions are met:
1. A Cypriot company is the economic owner of certain software, either acquiring it from an existing owner or developing the software from scratch;
2. The development/modernization of the software was carried out either by the company’s employees or under an agreement with third-party developers;
3. The software is licensed to a third party and the company receives royalties (royalties).
In general, it is possible to meet such criteria (and even go in different ways).
In the opinion of the Cypriot consultants, the most obvious option is to acquire assets at a low cost and significantly develop them in Cyprus, as evidenced by the associated costs.
However, there are a number of nuances, the main ones are listed below.
Strengthened Requirements for Companies as Part of the Implementation of the BEPS Plan
Since 2016, enhanced rules have been in force in Cyprus regarding the list of the IP objects, the profit from which falls under this preferential regime, and the criteria that determine the requirements for companies:
– preferential taxation of income received from the IP objects, should be due to the “significant economic activity” of the company on such objects (qualifying expenses: development, investments, etc.);
– reduction of the list of qualified assets – the IP objects, the profit from which may be taxed on preferential terms, the company is obliged to prove that the IP object complies with the definition of a qualified asset in accordance with Cypriot law;
– the “link approach”, according to which, in order for an intangible asset to be eligible for treatment benefits, there must be a direct relationship between qualifying income and own qualifying expenses that contribute to obtaining this income.
This is an appraisal concept and companies should prepare a justification for compliance with such a regime. As a rule, such a process can take about six months, in some cases even more.
In addition, taxpayers should be familiar with the process of calculating qualifying profits and ensure that they have the proper records to isolate relevant revenue streams and collect information on R&D expenditures to make the linkages. Taxpayers should carefully consider the potential impact of new tax regulations on their IP structures and transactions. This causes an additional need to attract local consultants and a greater scope of their work.
The Process of Obtaining Approval from the Tax Authority to Use the Regime
The preparation process can take about (often at least) half a year, since in addition to the formal requirements, it is important to demonstrate the process of creating or significantly modifying an asset in Cyprus.
Provided that the company and the client believe that the company may be eligible for an IP box, the following roadmap will apply:
– Assessment of the tax status by Cypriot tax consultants, that is, whether the Company is entitled to the IP Box or not on the basis of the current legislation (this stage involves several rounds of consultations, the study of documentation, and questionnaires);
– Obtaining recommendations on taking measures to best meet the criteria of the IP Box regime (as a rule, these are recommendations on minimizing outsourcing related to R&D and maximizing in-house R&D by hiring more employees, licensing the right to use by granting licenses to 3rd parties, etc.);
– Implementation of recommendations (carrying out transactions, accruals, etc.) and starting from the appropriate company accounting procedures to comply with IP Regime rules Box and IFRS;
– Preparation of a report to the tax authority, as well as verification and preparation of supporting documentation, strengthening positions (agreements with suppliers/clients/employees);
– Obtaining confirmation from the tax authority on the possibility of using the IP Box mode for qualified profits.
All of the above steps depend on the scope and complexity of the business and operations of the company.
Conclusion
Thus, to company may be able to pay an effective income tax rate of up to 2.5% on the IP Box and become an asset-holding company that accumulates profits in the form of royalties for granting the right to use such objects.
However, the process of obtaining positive approval from the tax authority may require significant preparation:
– substantiation of the value of the IP objects;
– evidence of “significant economic activity” of the company, i.e. significant internal refinement of the IP object directly by the Cypriot company;
– evidence of a direct link between qualifying income and these own qualifying expenses (corresponding to the so-called ” link approach “).
At the same time, it will be important for the Company to understand the nature of the planned activity, including in terms of the scope and nature of the income received, so that the process of obtaining approval for the use of the IP Box does not become a waste of money and time, which, moreover, limits the company in choosing counterparties, parameters of transactions.
Contact us for a personalized consultation to determine your IP box business opportunities in Cyprus.
