Cyprus proposed new legislation for its intellectual property (IP) tax regime, known as the IP box regime. This is an amendment of the regime introduced by Cyprus in 2012, bringing it in line with new EU requirements and OECD (Organisation for Economic Co-operation and Development) rules against base erosion and profit shifting.
While the amended IP box regime may not benefit businesses quite as extensively as before, it still gives Cyprus a competitive edge and safeguards Cyprus’ future as a center for IP structuring.
Key provisions of the new IP box regime
The new regime applies to intangible assets developed after 1 July 2016, owned by a Cyprus entity, registered in its name either in Cyprus or abroad, and that satisfies the following criteria:
1. Qualifying intangible assets
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.
2. Qualifying profits
Not all of a business’s profits will qualify for a favourable tax treatment. ‘Qualifying profits’ are defined as the proportion of a business’s overall income equivalent to the portion of the qualifying expenditure incurred for the qualifying intangible asset.
3. Overall income
80% of the overall income derived from the qualifying intangible asset is treated as a deductible expense.
Overall income includes royalties from the use of a qualifying intangible asset; license fees from the operation of a qualifying intangible asset; and capital gains from the sale of a qualifying intangible asset.
4. Qualifying expenditure
One of the main reasons for introducing the new regime is to ensure an entity only benefits from favourable tax treatment on IP profits if that same entity has incurred expenditure developing the IP.
‘Qualifying expenditure’ is defined as the total research and development costs incurred in any tax year, wholly and exclusively for the development, improvement or creation of a qualifying intangible asset, providing such costs directly relate to the qualifying intangible asset.
This includes wages and salaries; direct costs; general expenses relating to installations used for research and development; expenses for supplies relating to research and development; and costs associated with research and development that have been outsourced to non-related persons.
Excluded from the definition are costs for the acquisition of intangible assets; interest paid or payable; costs relating to the acquisition or construction of immovable property; amounts paid or payable directly or indirectly to a related person to conduct research and development, regardless of whether these amounts relate to a cost sharing agreement; and costs which are not directly connected to a qualifying intangible asset.
Under Cyprus’s previous IP box regime, businesses could reduce their tax on gross income derived from an intangible asset by 80% (after deduction of direct costs and amortisation over five years). This could result in an effective tax rate of 2.5% or lower.
For businesses within the regime before the proposed changes on 1 July 2016, transitional provisions allow them to continue benefiting on the same basis until 30 June 2021 for intangible assets which were:
- acquired before 2 January 2016;
- acquired from a related person between 2 January 2016 and 30 June 2016 and at the time of acquisition were benefiting under the IP box regime or a similar scheme in another state;
- acquired from an unrelated person between 2 January 2016 and 30 June 2016; or
- developed between 2 January 2016 and 30 June 2016.
The transitional rules only apply to assets which were already generating income or had completed development as at 30 June 2016.
Conclusion: an international context for the IP box regime
In today’s digital age, countries battle to attract leading technology, design and media businesses. Alongside robust protection for intellectual property (IP), monetary incentives are a key tactic. The most notable of these is favourable tax treatment on profits generated from IP exploitation.
In light of such IP regimes, the OECD and the EU have both introduced rules to prevent businesses exploiting loopholes in local and international tax law. In particular, they want to ensure businesses only benefit from a favourable IP income tax rate if those businesses have incurred expenses developing the IP.
Cyprus, together with many other jurisdictions, has now amended its IP box regime so it complies with the new international provisions. With these changes, Cyprus continues its compliance of OECD requirements for tax transparency and information sharing and demonstrates active support for the OECD’s global measures to tackle aggressive tax planning and avoidance.
The IP tax regime was introduced on 1 July 2016.
Director of Client Accounting – Vistra (Cyprus) Ltd
Member of the CFA Tax & VAT Committee