As previously announced and in order to fully align the existing IP Regime in Cyprus with the relevant parameters of the OECD BEPS Action 5, on 14th of October 2016 the amendments of the current Cyprus Intellectual Property (IP) regime have been adopted and will be applicable retrospectively as from 1st of July 2016.
The current amendments do not amend the effective tax rate of 2.5% as provided, but rather focus on the application of the modified nexus approach (explained below) and the narrowing down of the definition of what “qualifies” as an IP Asset. Furthermore, the amendments also include the transitional arrangements, allowing the provisions of the current IP Regime to continue to apply up and until 30th of June 2021.
The provisions of the existing IP Regime will continue to apply in relation to the following IP Assets:
- Existing IP asset s (i.e. IP assets qualifying under the current provisions of the Cyprus IP regime as at 2nd January 2016);
- IP assets acquired (directly or indirectly) from related parties, during the period from 2nd January to 30th June 2016, provided that such IP assets would have been eligible to qualify under the provisions of the current Cyprus IP regime or a similar IP regime; and
- IP assets acquired from a non-related party or developed during the period from 2nd January to 30th June 2016.
These provisions of the Cyprus IP regime will expire on the 31st December 2016 for IP assets acquired either directly or indirectly from related parties, during the period from 2nd January to 30th June 2016 if such assets have not been eligible to claim the current provisions of the Cyprus IP regime or a similar IP regime as per note (2) above.
Qualifying IP Assets
The changes limit qualifying assets to patents, computer software, as well as IP assets which are non-obvious, useful and novel and from which the income of a taxpayer does not exceed, €7.500.000 per annum in a 5 year period (€50.000.000 for taxpayers forming part of a group.
Modified Nexus Approach
According to the modified nexus approach, there should be sufficient substance and an essential nexus between the expenses, the IP Assets and the related IP income in order to benefit out of this regime. Under the said approach, the application of an IP Regime should be dependent on the level of R&D activities carried out by the qualified taxpayer.
The following formula has been introduced to determine the qualifying profits that can benefit from an IP regime:
(a+ b ) / (a + b + c +d) where:
a – represents R&D expenditures incurred by the taxpayer itself (can be uplifted by 30% from actual numbers),
b – represents expenditures for unrelated-party outsourcing,
c – represents acquisition costs, and
d – represents expenditures for related-party outsourcing.
Qualifying expenditures must have been incurred by the qualifying taxpayer, and they must be directly connected to the IP asset.
Qualifying expenditure, excludes the R&D costs of outsourcing to related parties, contrary to the cost of outsourcing to unrelated parties which are considered as part of ‘qualifying expenditure”. In addition, the amendments provide for a maximum 30% up-lift of “qualifying expenditure”, thus allowing qualified taxpayers to include all or part of non-qualifying R&D costs to be included as part of the “qualifying expenditure”.
Foreign Permanent Establishments (PEs)
Under the modified nexus regime, foreign PEs of Cyprus tax resident companies engaged in R&D activities give rise to “qualified expenditure” provided that they make an election so that their profits are taxed in Cyprus. It should be noted that such an election is irrevocable. In the instance where the profits of the foreign PEs are taxed abroad, a unilateral tax credit relief will be afforded in Cyprus, up to the amount of the tax payable in Cyprus on such profits.
Tracking of income and expenditures
Taxpayers are required to maintain books and records in relation to income and expenditure per qualifying asset so as to track expenditure and income to ensure that the income receiving benefits did, in fact, arise from the qualifying expenditure incurred.
Note: The Regulations regarding the application of the modified nexus regime have not yet been voted by the House of Representatives to date.
Why is the Cyprus IP Box so beneficial?
- Effective rate of tax is maximum 2,5%
- Very wide range of qualifying IP types
- IP does not need to be developed in Cyprus, R&D can take place anywhere in the world
- Also applies to acquired IP and not just self-developed IP
- Includes not only royalty incomes but also gains on disposal
- No cap on the amount of income/gains which may benefit
May be combined with the newly introduced notional interest deduction (NID)