Intellectual Property in Cyprus
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 intellectual property rights (“IP”). The legislation adopts the beneficial principles of already established and successfully implemented tax legislation in European countries such as Luxembourg, Ireland and UK and gives Cyprus a competitive edge in the tax planning arena when dealing with IP.
The basis of the legislation adopted by governments in relation to the beneficial tax regime on IP is the provision of additional incentives for companies to retain and commercialise existing patents and to develop new innovative patented products, with an indirect benefit to the public such as the example of Nokia and Finland.
The mobility attributes of IP, derived from its non-tangible nature, makes it ideal for cross border planning as it can easily be transferred between different jurisdictions, subject always to prevailing tax legislations and circumstances.
This article analyses the provisions of the new IP tax legislation and sets examples of how a Cyprus company can be used for tax planning purposes in both groups owning IP or individuals entrepreneurs looking to benefit from the registration and development of the IP.
The provisions of the revised tax legislation relating to IP and which became effective from 1 January 2012 are analysed below:
DIRECT TAX BENEFITS
Amortisation period – 5 years
The cost of acquisition or development cost of IP by a Cyprus company (“CypCo”) is now amortised for 5 years, yielding a write down allowance of 20% per year.
The importance of this provision is that amortisation for tax purposes is no longer linked to the useful life of the IP (i.e. a patent with validity of 25 years would get a 4% writing down allowance), which yields considerable cash flow benefits by deferring the tax liabilities, especially if the value of the IP is high.
Exemption of 80% of profits deriving from the IP
80% of the profits earned from the use of IP (including any compensation for improper use) are exempt for tax purposes. The 80% exemption applies on the net profit after deduction of all direct expenses including amortisation.
Exemption of 80% of profits from disposal of the IP
80% of the profits from the disposal of the IP is exempt for tax purposes. The 80% exemption applies on the net profit after deduction of all direct expenses.
Further deduction of indirect expenses resulting in even lower effective tax rate
In addition to the direct expenses being deductible before the 80% exemption, such being the amortisation and the interest costs of financing the acquisition, any indirect expenses that can properly be substantiated are deductible from the remaining profit of the CypCo. Applying the Cyprus corporate tax rate of 12.5% makes the effective tax rate on income derived from IP lower than 2.5%, which is the lowest in EU.
Furthermore any income earned by the CypCo relating to IP and paid to the shareholder in the form of dividends is exempt from any withholding tax in Cyprus thus resulting in minimum tax leakage in Cyprus when a CypCo holds the IP and generates income from it which it then distributes to its shareholders.
TAX BENEFICIAL STRUCTURE
In addition to the benefits provided by the provisions in the new tax legislation, Cyprus has an extensive network of double tax treaties and is also a member of the EU, giving CypCos the benefits of the EU Interest and Royalties directive resulting in low to zero withholding taxes by the payer of the royalties. Any withholding tax on royalties can be used as a credit when calculating the tax payable in Cyprus.
Below is the beneficial tax structure as well as an example for the tax calculation (Click image to enlarge in a new window):
INDIRECT TAX BENEFITS
In light of the increasing court cases questioning the substance of intermediary companies acting as sub-licensees to obtain tax treaty benefits, which are often being viewed as “conduits” such as the case of Russian Monetka , the recent changes in Cyprus tax legislation remove one area of vulnerability from the taxpayer’s point of view, namely the need for an offshore company holding the IP and an intermediate ‘‘conduit’ receiving IP generated income.
Since the CypCo will be the legal owner of the IP and provided that sufficient substance exists in the CypCo, such as skilled Directors not controlled by a Russian company and evidence of the IP being developed or enhanced in Cyprus then the beneficial ownership principle as set in the Russia –Cyprus double tax treaty is more likely to be met.
Note that it is crucial that sufficient documentation exists regarding the IP development that would assist in making assertions for defence during a tax audit.
The attributes that investors seeks from a jurisdiction to hold the IP is the low effective tax rate and also the legal protection of the IP.
Cyprus under the new provisions of the legislation benefits from a very low effective tax rate on the IP generated revenue and also has a mature and sophisticated legal framework based on the English law principles providing the appropriate legal protection on IP. It also has a highly skilled and well-educated IT workforce which can be utilised in the development or enhancement of the IP thus providing additional substance making Cyprus the most beneficial jurisdiction to holding and deriving revenue from IP.
 Element-TradeLLC, a company incorporated and resident in Russia, exploited the trademark MONETKA and paid royalties to a Cyprus company acting as an intermediary licensing vehicle. The Cyprus company paid the royalties it received to the ultimate owner of the trademark, a British Virgin Islands company.
The Russian tax authorities contended that this structure was introduced purely for the purpose of avoiding withholding taxes on royalties paid from Russia to a company in the British Virgin Islands, which is on the Russian Ministry of Finance’s blacklist of tax havens, by routing the royalties through Cyprus. On 17 May , 2012 the Federal Arbitrazh Court of the Urals District in Russia issued its ruling in favour of the taxpayer. That was a marginal “win” on formal grounds and had representation been better in the case the decision could have been different.