Intellectual Property Rights – Cyprus Tax Structures
OPPORTUNITY WINDOW CLOSES 31 December 2015
In July 2012 the Cyprus Income Tax Law, Law 118 of 2002 was amended to provide, amongst others, very beneficial tax incentives and exceptions relating to income deriving from the intellectual property rights (“IP”). The provisions of the revised tax legislation relating to IP and which became effective from 1 January 2012 were analyzed in our previous newsletter.
In February 2015, the Organization for Economic Cooperation and Development (OECD) published a paper titled ‘ Action 5: Agreement on Modified Nexus Approach for IP regimes’ as part of the Base Erosion and Profit Shifting (BEPS) review which was based on the September 2014 progress report on “Countering Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance”, which discussed possible approaches to requiring substantial activities in the context of intangible property (IP) regimes such as patent boxes.
Under the above the “modified nexus approach” was adopted under which emphasis is placed on the existence of a substantial economic activity in order for the owner of the IP to enjoy the preferential tax regime.
On 5 October 2015 the OECD released the final papers of its Base Erosion and Profit Shifting (BEPS) Action Plan. Included within the paper related to IP boxes (Action 5) are further details regarding the OECD recommended transitional rules for existing IP boxes moving to the OECD recommended ‘modified nexus approach’.
It was expected that the OECD’s proposed transitional rules for existing IP boxes would continue to allow IP which joins the relevant IP box by 30 June 2016 to continue to benefit until 30 June 2021 (the latest). However, the OECD’s latest recommendation in this area for most cases of IP acquired directly or indirectly from related parties is that the transitional rules (applying until 30 June 2021, the latest) should only apply to IP already within the relevant IP box by 31 December 2015 (six months earlier than expected).
The OECD further recommends that there is enhanced transparency of IP joining existing IP boxes as from 6 February 2015 and benefitting from the transitional rules by way of exchange of information between tax authorities.
It is expected that the Cyprus IP box will be amended in line with the recommendations of the OECD in this area and you should consider whether action should be taken now prior to 31 December 2015.
Even though each country can maintain its preferential IP regimes, under the “nexus approach” a particular emphasis is placed on the existence of a substantial economic activity in order for the owner of the IP to enjoy the preferential tax regime.
In particular under the “nexus approach” the benefits of the IP regime will be conditional on the extent of Research and Development (R&D) activities of the taxpayer receiving the benefits. The proportion of the expenditures which will directly relate to the development activities of the IP and which demonstrate the real value added by the taxpayer will act as a proxy of how much substantial activity the taxpayer undertook.
Under the nexus approach the proportion of the income relating to IP that can benefit from the IP regime is the same proportion of “qualifying expenditure” and “overall expenditure”. The income that may receive the benefits is defined in the below calculation:
Qualifying expenditures are defined as expenditure that must have been incurred by the taxpayer and must be directly connected to the IP asset.
These expenditures should only include expenditure that are necessary for actual R&D activities and they would not include interest payments, building costs or acquisition costs.
Overall expenditures are defined as expenditures that are directly connected to the IP asset and only include expenditure that are necessary for actual R&D activities.
The difference between Qualifying expenditure and Overall expenditure is that the Qualifying expenditure must have been incurred by the taxpayer whereas Overall expenditure include also expenditure incurred by related parties and also the acquisition costs are included in the Overall expenditure.
Outsourcing the development of the IP would be possible however only development costs incurred by unrelated parties would count as qualifying expenditure. Outsourcing the development of the IP to related parties would count towards overall expenditure and not qualifying expenditure.
Overall income is limited only to IP income and includes royalties capital gains and other income from the sale of IP assets.
MODIFIED NEXUS APPROACH
The modified nexus approach addresses the issue of groups having to develop the IP in limited number of entities including the company owning the IP in order to qualify. This could impose restructuring costs on groups which have dedicated R&D companies in order for them to retain the relief in future.
In order to address the above issue the “modified nexus approach” countries can allow a qualifying expenditure up-lift up to 30% on the qualifying expenses.
This means that Overall expenditure incurred which are not also Qualifying expenditure (i.e. acquisition costs or costs paid to related parties for the development of IP) can be included in Qualifying expenditure up to the level of 30% on the already existing Qualifying expenditure.
Qualifying expenditure (R&D incurred by the taxpayer): EUR100,000
Acquisition costs: EUR10,000
R&D expenditure by subsidiary: EUR40,000
Maximum up-lift amount: EUR100,000 * 30% = EUR30,000
Total Qualifying expenditure in example: EUR130,000
CLOSE OF OLD REGIME FOR NEW ENTRANTS
Under Article 5 of BEPS there can be no “new entrants” to any existing IP regime after the date that a new regime consistent with the modified nexus approach takes effect and no later than 31 December 2015. “New entrants” include both new taxpayers not previously benefiting from the regime and new IP assets owned by taxpayers already benefiting from the regime.
In order to give protection for taxpayers benefiting from existing regimes, countries are allowed to introduce grandfathering rules. Under such rules, all taxpayers benefiting from an existing regime may keep such entitlement until a second specific date (“abolition date”).
The abolition date would be 30 June 2021. After that date, no more benefits stemming from the respective old regimes may be given to taxpayers.
LIMITED OPPORTUNITY – 31 DECEMBER 2015
There is only a limited time to enter into the Cyprus scheme, since it and all similar schemes will be closed to new entrants from 31 December 2015. However, companies that join the scheme before then can benefit from substantial savings until June-2021.
Cyprus’s IP box regime provides for a maximum tax rate of 2.5% on income earned from IP assets. The comparable rate in its nearest competitor, the Netherlands, is twice that amount, at 5%. Luxembourg (5.76%) and Belgium (6.8%) follow close behind the Netherlands, but far behind Cyprus.
The Cyprus IP box regime also applies to a wider range of income than any other European scheme, most of which restrict benefits to income from patents and supplementary patent certificates.
Even though any “new entrants” to the IP regime prior to 31 December 2015 (or before a new regime consistent with the modified nexus approach takes effect if earlier) will enjoy the benefits of such regime until 30 June 2021, nevertheless OECD is currently discuss measures to mitigate the risks that new entrants seek to avail themselves of existing regimes with a view to benefiting from grandfathering.
Such measures include monitoring of new entrants and imposing possible restrictions to these entrants.
It would therefore benefit any business with significant IP assets or income to promptly examine the option of benefiting from Cyprus’s favorable IP taxation regime while the opportunity lasts.
HOW CAN LSTS ASSIST YOU
LSTS may assist in:
i.) The establishment of a suitable Cypriot structure for holding intellectual property and the transfer of the business’s intangible assets into it.
ii.) Provide further guidance on the new provisions in relation to the IP regimes
iii.) Keep you updated on the developments on the matter