The breathless conundrum for IP companies is four-fold: not only should royalties be taxed at a low rate in order to maximise profits; but also research and development (R&D) or acquisition costs should be considered as allowable expenses to the maximum possible effect, whilst also the jurisdiction where the IP holding is situated should have a considerable treaty network in order to allow for global exploitation of the IP rights, not forgetting that an exit route should always be available and beneficial. Or is it fifth-fold? Developments with regards to BEPS, transparency, tests on beneficial ownership and anti-treaty shopping provisions add another factor to the puzzle.
The recent changes effected in the IP holding taxation in Cyprus solve the problem. It is interesting to examine how.
Who qualifies under the law?
In order for an IP holder to benefit from the law all the following conditions must be met:-
The IP right should be a Qualifying IP; it must be owned by a Cyprus Company and it should be used for the production of taxable income.
According to the tax legislation, any intangible asset that is protected by the IP laws of Cyprus will be considered as a Qualifying IP Right for the purposes of the favourable tax regime. It is noted that an IP right registered outside Cyprus, on a European or International level is still protected by the IP laws of Cyprus.
The ownership of the qualifying IP may come either through acquisition of an existing IP Right or through the actual development of the IP Right by the Cyprus Company. It must be noted that the acquisition of an already existing IP right can be done not only with cash but it can also be acquired as a contribution in the share capital of the Cyprus Company.
Further, the Cyprus IP Holding Company should use the Qualifying IP Right for the production of taxable income. This means that the IP Holding Company must be an operating company and that the IP Right should be licensed to other parties in exchange for royalty income.
Tax treatment of Royalty profits
The maximum effective tax rate for royalties received by the Cyprus IP Holding company is limited to 2.5%, as follows:- According to the law 80% of "Royalty Profit" generated from Qualifying IP Rights will be considered as a deemed expense for corporation tax purposes. The remaining 20% will be subject to the normal corporation tax rate of 12.5% rendering the maximum effective tax rate to 2.5%. For the purpose of determining the "Royalty Profit" the law allows the deduction from the resulting royalty income of all direct expenses incurred wholly and exclusively for the production of royalty income. Following the deduction of these direct expenses there is the application of 80% deemed expense on the resulting income. Additionally there are provisions in the law, for allowing capital expenditures to be deducted from the income as will be explained below.
R & D, Acquisition costs and Capital Allowances
The maximum effective rate of 2.5% can be further reduced by deducting capital allowances within the first five years of the company's acquisition or development of each IP right. The company will be able to use capital allowances of 20% straight line, starting from the first year of usage of the asset, as well as the subsequent four years thereof.
Ability to extract royalties from multiple jurisdictions with low or no withholding tax
Another important consideration for setting up an IP holding company is whether the jurisdiction chosen is sufficiently networked in order to give such holder the ability to extract incoming royalties from various jurisdictions with as low as possible withholding tax.
Cyprus has many tools available that will enable the investor to achieve this and in particular:-
- Extensive Network of Double Tax treaties,
- Applicability of EU Royalty Directives, as well as
- Unilateral Tax Credit Relief.
1. The Double Tax Treaties
Cyprus has over 50 Double Tax Treaties currently in effect and many more in the pipeline. This gives the ability to extract royalties from these jurisdictions at reduced or even zero withholding tax rates.
2. Relief under the EU Interest and Royalty Directive
The EU Interest and Royalty Directive eliminates withholding taxes on Interest and Royalties paid by a licensee who is resident in one EU Member State to a licensor company being resident in another EU Member State.
With careful tax planning, a Cyprus IP Holding Company can enjoy the benefits of this EU directive, which grants the ability to receive royalties from all other EU member states with no withholding tax. It therefore opens the European Market to the investor, it reduces the tax leakage and hence, gives flexibility and significant competitive advantage in relation to pricing.
3. Unilateral Tax Credit Relief
In cases were the Double Tax Treaty network or the Interest and Royalty Directive relief are not providing sufficient protection, it is possible for a Cyprus IP Holding Company, under the provisions of the Cyprus Tax Law, to claim a Unilateral Tax Credit Relief.
In effect, any tax paid abroad will be credited against any tax that might be payable for the particular income in Cyprus avoiding therefore the double taxation of the specific income. In order to obtain this tax credit, the company must prove the payment of such overseas taxation.
All of the above tools allow the investor to minimise its tax exposure on withholding taxes paid abroad on the incoming royalties and therefore enhance its overall tax exposure.
It is worth mentioning that any profits generated by the Cyprus IP Holding Company can be distributed to its shareholder in the form of dividends. According to the Cyprus Tax Law any dividends payable by a company resident in Cyprus to its foreign shareholders (natural or legal persons) are not subject to any withholding tax in Cyprus. This is very important as it allows for funds to be moved to the investor without any additional tax leakage in Cyprus.
The favourable tax treatment of a maximum effective tax rate of 2.5%, covers also potential profits from any future sale of the IP Right.
Investing through a Cyprus IP Holding Company will provide the investor with a tax efficient exit route since, 80% of the profits from the sale of the IP right will be considered as deemed expenses. The remaining 20% will be subject to corporation tax at 12.5% as in the case of Royalty profit.
BEPS/Transparency/Beneficial ownership/Anti Treaty shopping concerns addressed
In addition to the above benefits of the IP tax regime, Cyprus can further be differentiated from the traditional IP jurisdictions since it can provide an efficient and cost-effective way for companies, to create actual substance in Cyprus. This way companies can avoid concerns arising from the attacks on aggressive tax planning and most importantly the attack on the so called "conduit" or passive entities. In other words, structures that are mere vehicles for rerouting profits or are only established for the sole reason of taking into advantage a low tax jurisdiction or double tax treaty without a corresponding real physical presence in the country of its tax residence.
With its infrastructure, provision of services, supply of highly qualified personnel and low cost of living, Cyprus provides the economic ability to a wide range of companies, whether small, medium or large, to establish themselves in Cyprus and enjoy the whole spectrum of benefits to its fullest.
As a final note the trend of large IP companies relocating to Cyprus is becoming apparent, examples being renowned gaming and IT companies. Through careful structuring and tax planning there is light at the end of the tunnel and Cyprus demonstrates all the qualities of becoming the way forward in the IP world.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.