Cyprus is considered as an ideal place for the establishment of an Intellectual Property (IP) holding and development company.
The Cyprus IP tax rate and the legal protection (by EU Member States) are the main reasons for choosing Cyprus as the country where the IP shall be centralized and managed.
Provisions of the new IP tax regime
The new Cyprus IP Box, which gives an 80% deduction on qualifying IP profits, is fully aligned with the OECD/G20 Base Erosion and Profit Shifting (BEPS) Action 5 report.
Under the provisions of the new IP tax regime, the ‘Nexus approach’ is followed, whereas in order for an intangible asset to qualify for the benefits of the regime, there needs to be a direct correlation with the qualifying income and the own qualifying expenses contributing to that income.
The ‘Nexus approach’ is used to determine the amount of qualifying profits that will give the relevant deduction to the taxpayer.
80% of the qualifying profits earned from qualifying intangible assets will be allowed as a tax-deductible expense, resulting in an effective tax rate as low as 2.5%.
Qualifying IP Assets
Intangible assets qualify as IP assets if they were acquired, developed or exploited by a person within the course of carrying out his business (except IPs used for marketing of the business, eg. brand, image right, etc.).
These IP assets are the result of research and development and where there is existence of economic ownership. I.e. patents, copyrighted software programs, utility models and other intangible assets that are non-obvious, useful and novel.
The qualifying IP assets need to be legally and/or economically owned.
Qualifying persons include Cyprus tax residents, tax resident permanent establishments (PEs) of non-tax resident persons, as well as foreign PEs that are subject to tax in Cyprus.
Persons claiming benefits under the new regime are obliged to maintain proper accounting records, including income and expenses records of each IP.
Cumulative Nexus fraction
The ‘Nexus approach’ is an additive approach: the calculation requires both 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. (Explanation of terms follows):
OI X QE + UE
OI: the “overall income derived from the QA”
QE: the “qualifying expenditure on the QA”
UE: the “uplift expenditure on the QA” and
OE: the “overall expenditure on the QA”
Overall Income (OI) = Gross income – direct expenses (and capital allowances of IP asset).
Overall income includes, but is not limited to, royalties received for the use of the IP, trading income from the disposal of qualifying IP, licence income earned from the operation of IP and embedded income earned from the qualifying IP.
Capital Gains arising from the disposal of an IP are not included in the overall income and are fully exempt from tax.
Qualifying Expenditure (QE) = Salary and wages, direct costs, general expenses associated with R&D activities and R&D expenditure outsourced to non-related parties.
Uplift Expenditure (UE) = The lower of:
-30% of the QE and
-the total acquisition cost of the QA and any R&D costs outsourced to related parties.
Overall Expenditure (OE) = Total of:
-the qualifying expenditure and
-the total acquisition costs of the QA and any R&D costs outsourced to related parties incurred in any tax year.
Less: Direct expenditure from IP asset – 60.000
Overall income (OI) 40.000
Assume nexus fraction of 90%
Qualifying profits: 90% (nexus fraction) of OI 36.000
Less: 80% exemption on qualifying profits -28.800
Taxable qualifying profits 7.200
Remaining OI (10% of OI) (Note 1) 4.000
Total taxable profit 11.200
Tax @ 12.5% 1.400
Effective tax rate (Note 2) 3.5%
Note 1: The remaining overall income is added to the taxable qualifying profits and the total is subject to tax at the corporate tax rate of 12.5%.
Note 2: The effective tax rate can be reduced to 2.5% with a nexus fraction of 100%.
Losses from the qualifying assets
Where the calculation of qualifying profits results in a loss, only 20% of this loss may be carried forward or group relieved.
Non-qualifying assets for the IP regime
Expenses incurred for the acquisition of an intangible asset do not qualify for the transitional provisions, while the intangible assets that are used for business purposes of the company can be amortized over its useful life for a maximum of 20 years. In case the asset is disposed, similar treatment is followed as in the case of disposal of fixed assets. Goodwill does not qualify for amortization.
The content of this article is valid as at the date of its first publication. It is intended to provide a general guide to the subject matter and does not constitute advice. We recommend that you seek professional advice on your specific matter before acting on any information provided.
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