Also called “IP Box”. This deduction aims to incentivize research & development (RD) and the earnings that such activity generates. This incentive will apply to a Cyprus company that owns “qualifying IP assets” and receives income from such assets.
In order for such income to benefit from the applicable IP Box incentives, the revenue-generating intellectual property must be categorised as a Qualifying Intangible Asset. Qualifying Intangible Asset is defined as one that is “acquired, developed or exploited by a person as a going concern with an aim to further a business and which is the result of research and development activity”.
In order to qualify for the almost complete tax exemption afforded to IP companies, their Qualifying Intangible Assets can be patents (as defined in the Patents Law), computer software, utility models, protection to plants and genetic material, orphan drug designations and other intangible assets which are “non-obvious, useful and novel”, that are certified as such by a designated authority. The taxpayer must also satisfy size criteria: its annual IP related revenue must not exceed €7,5m for the taxpayer, or €50m for a group, using a 5 year average for both calculations.
Not all intangible property qualifies! Non-qualifying assets are copyrights, trademarks, image rights, brands and other IP assets related to marketing – in other words, those assets where a distinct scientific and technological value is not present.
The Cyprus company must be the actual owner of the qualifying IP assets. The IP must also be developed after 1st July 2016. (Specific rules apply to assets developed prior to that date.) The company must also demonstrate that it has carried the actual true burden of expense of developing the IP asset, either in-house, or by outsourcing the work to non-related parties.
The Cyprus “IP Box” incentive regulations are designed to to comply with the OECD’s “modified nexus” standards, as set out in the final reports of the OECD’s Base Erosion and Profit Shifting (“BEPS”) Project. The “modified nexus” approach allows a company to benefit from the Intellectual Property tax relief only to the extent that the company itself incurred qualifying research and development expenses that gave rise to the Intellectual Property income.
Typically, income from Intellectual Property assets can take one of the following forms:
- royalties or other amounts in relation to the use of qualifying intangible asset;
- any amount for licensing of the operation of a qualifying intangible asset;
- any amount received from insurance or as compensation in relation to the qualifying intangible asset;
- capital gains and other income arising from the sale of a qualifying intangible asset;
- embedded income of the qualifying intangible asset arising from the sale of products or services or through use of procedures that are directly related to this.
“Qualifying profits” relate to the share of Company income that corresponds to the part of the qualifying expenditure as well as the uplift expenditure (initial acquisition costs) across the total expenditure incurred for the qualifying intangible asset. The formula used to derive the Qualifying Profit amount can be reduced to the following:
QE is the qualifying expenditure on the qualifying assets. This is the expenditure incurred wholly and exclusively by a company in the research and development activities of the qualifying asset. Outsourcing to unrelated parties in any jurisdiction can be included. Certain items are excluded from the definition of qualifying expenditure including acquisition costs, interest and intra group expenditure. However, some excluded expenses can be “saved” to some degree by means of the uplift expenditure. Typically, qualifying expenditure will include wages and salaries, direct costs, general expenses relevant to installations used for Research and Development; commission expenses relating to R&D; outsourced costs to non-related persons for the purpose of R&D.
UE is the uplift expenditure. Uplift expenditure is the lower of (i) 30% of the Qualifying expenditure and (ii) the total cost of acquiring the qualifying asset plus the cost of subcontracting to related parties of any research and development regarding the said qualifying asset.
OE is the overall expenditure on the qualifying asset being the total of qualifying expenditure, acquisition costs and group outsourcing costs.
QA is the profit of the specified trade relevant to the qualifying asset (before taking account of any IP Box allowance)
As an illustration, we can use a the straightforward example of a Cyprus company which has spent €100,000 to acquire a qualifying patent from an unrelated party and has subsequently spent €900,000 on further research and development. The company has subsequently generated a net profit of €2,000,000.
Thus, the company’s qualifying profits for IP Box relief purposes are the entire 2’000’000.
Once these requirements are met, an 80% deduction on the taxable income can be claimed.
Only the remainder of 400’000 will be taxed at the standard rate of 12.5%, resulting in the net tax payable of 50’000 – or an effective tax rate of 2.5%.
Obviously, this can only achieved when the development of the qualifying IP asset is the only source of revenue for the Company.