The Intellectual Property (IP) box regime

The Cypriot Income Tax Law provides for an Intellectual Property (‘IP’) box regime which is effective as of 1 July 2016.

IP Box is a preferential tax regime for profits from innovation and investment in intellectual property. This tax regime greatly benefits IT businesses and companies that develop technologies and spend much on Research and Development (R&D).

In essence, the Cyprus IP box regime offers a tax benefit of up to 80% on qualifying IP profit, by way of notional expense deduction.

Provisions of the Cyprus IP box regime

The IP box regime complies with the provisions of the modified ‘nexus approach’, whereby for an intangible asset to qualify for the benefits of the regime, there needs to be a direct link between the qualifying income and the own qualifying expenses contributing to that income.

In brief, an amount equal to 80% of the qualifying profits earned from qualifying intangible assets will be allowed as a tax deductible expense.

Qualifying intangible assets

As per the amended legislation, “qualifying intangible asset” is defined as an asset which was acquired, developed or exploited by a person within the course of carrying out his business (with the exception of intellectual property related to marketing), which is the result of research and development (R&D) activities, and which includes intangible assets for which only economic ownership exists.

Qualifying intangible assets comprise of:

➢ Patents, as defined in the Patents Law

➢ computer software and mobile applications

➢ utility models, intellectual property assets which provide protection to plants and genetic material, orphan drug designations (drugs for the treatment of rare diseases) and extensions of protections for patents

➢ non-obvious, useful and novel and which are certified as such by an appropriate authority, in Cyprus or abroad

The definition of qualifying intangible assets specifically excludes business names, brands, trademarks, image rights and other intellectual property rights used for the marketing of products and services.

Qualifying profit

Qualifying profit (QP) is defined as the proportion of the overall income (OI) derived

from the qualifying asset, corresponding to the fraction of the qualifying expenditure

(QE) plus the uplift expenditure (UE) over the overall expenditure (OE) incurred for the

qualifying intangible asset. The amount of qualifying profit can be derived through the

application of the following formula:

QP = OI x (QE + UE) / OE

Overall Income (OI): Overall income is defined as the gross income earned from qualifying intangible assets during the tax year, minus any direct costs incurred for generating the income. Overall income includes, but is not limited to:

➢ royalties or other amounts resulting from the use of qualifying intangible assets;

➢ license income for the operation of qualifying intangible assets;

➢ any amount received from insurance or as compensation in relation to qualifying intangible assets;

➢ income from the disposal of qualifying intangible assets, excluding profits of a capital nature;

➢ embedded income of qualifying intangible assets arising from the sale of products or services, or from the use of procedures that are directly related to the assets.

For the purpose of calculating overall income, direct costs include:

➢ all costs incurred, either directly or indirectly, wholly and exclusively for the

purpose of earning the income from qualifying intangible assets;

➢ the amortization of the cost of the assets;

➢ notional interest on equity contributed to finance the development of the assets

(being a notional interest tax deduction allowed by Cyprus tax provisions).

Qualifying Expenditure (QE): Qualifying expenditure for qualifying intangible assets is defined as the sum of all R&D costs incurred during any given tax year wholly and exclusively for the development, improvement or creation of qualifying intangible assets, and which costs are directly related to such assets. Qualifying expenditure includes, but is not limited to:

➢ wages and salaries

➢ direct costs

➢ general expenses relating to installations used for R&D

➢ commission expenses associated with R&D activities

➢ costs associated with R&D that has been outsourced to non-related persons

However, qualifying expenditure does not include costs for acquisition of intangible assets, interest paid or payable, costs for acquisition or construction of immovable property, amounts paid or payable directly or indirectly to a related person to conduct R&D activities, regardless of whether such amounts relate to cost sharing agreements and costs which cannot be proved directly connected to a specific qualifying intangible asset.

Any expenditure for R&D that has been outsourced to non-related parties, as well as any expenses of a general nature for R&D which cannot be allocated to the qualifying expenditure of a specific qualifying intangible asset, can be apportioned pro rata to the qualifying intangible assets.

Uplift Expenditure (UE): An uplift expenditure is added to the qualifying expenditure, which will be equal to the lower of:

a. 30% of the qualifying expenditure; and

b. the total cost of acquisition of the qualifying intangible assets, plus the cost of outsourcing to related parties of any R&D activities in relation to such assets.

Overall Expenditure (OE): Overall expenditure relating to qualified intangible assets is defined as the sum of:

a. the qualifying expenditure; and

b. the total cost of acquisition of the qualifying assets, plus the cost of outsourcing to related parties of any R&D activities in relation to these assets, incurred during any tax year.

Calculation of the rate by example

A Cypriot company developed a new game application. Spent €500,000 on it, made €1 million revenue and wants to reduce the tax as much as possible.

Option 1: make the game themselves

The company created the game, paid €300,000 to full-time employees, and spent €200,000 on third-party services from India, a total expense of €500,000.

In this case, the entire amount of the overall income is considered to be qualifying profit, due to the fact that part of the development of the asset was carried out internally and part was outsourced to third-parties from India.

Taxable profit will be decreased by €800,000 notional expense.

Option 2: bought the game and finalized on the side.

The company bought the game for €300,000 and spent €200,000 on third-party services from India, a total expense of €500,000.

Here the tax will not be reduced by the maximum — outsourcing was to third-party companies, but the company did not develop but bought the game, which reduces the qualifying profit.

Taxable profit will be decreased by €416,000 notional expense.

Option 3: bought and finalized through a related company.

The company bought the game for 300,000 € and spent 200,000 € on the services of developers from an affiliated Russian company. The total is 500,000. €

Here none of the profit qualifies for the regime — the Cypriot company did nothing. The game was bought and finalized by the affiliated company.

No notional expense applies.

Why choose Cyprus for business investments?

There are tax benefits for technology companies in different countries, but in Cyprus, taxation is highly favorable.

Benefits of the IP Box regime in Cyprus:

1. It fully complies with the recommendations of the European Union and the Organization for Economic Cooperation and Development.

2. Low tax rate even without benefits — 12,5%.

3. IP Box deduction: 80% of the qualifying profits arising from a qualifying asset (subject to conditions, as discussed below) pushing the effective tax rate to as low as 2.5%.

4. Outsourcing R& D to third-party companies outside Cyprus is possible — this also counts as a qualifying expense.

5. You can provide a scheme of the company’s work to the tax office in advance and get a Tax Ruling — the document determines whether the preferential treatment applies to the business.

6. Cyprus is a member of the European Union and a party to intellectual property conventions.

7. Cyprus has double taxation treaties with 67 countries.

Other incentives available and description of benefits

8. R&D super-deduction: all expenses for scientific research, and all R&D expenses, as recognized by international accounting standards, that have been incurred by a person who carries on a business and has the economic ownership of the relevant intellectual property asset will be treated as tax deductible. An additional deduction equal to 20% of the actual amount of the relevant R&D expenses is available for R&D expenses incurred during the tax years 2022, 2023 and 2024 (including expenses of a capital nature) to taxpayers that do not claim a deemed deduction under the IP Box regime.

9. Corporate Income Tax (CIT) exemptions:

➢ Gains from the disposal of IP assets is not subject to CIT provided they are of a capital nature transaction (recommended to be confirmed in a tax ruling).

➢ Gains from the sale of shares are unconditionally exempt from CIT in Cyprus. This exemption applies irrespective of the holding period, number of shares held or trading nature of the gain.

➢ Dividend income is conditionally exempt from tax.

➢ Foreign exchange (‘FX’) differences are tax neutral for CIT purposes in Cyprus. Any FX gains should not be taxable and FX losses should not be deductible.

10. Personal Income Tax (‘PIT’) exemptions:

a. 20% or €8.550 exemption (lower of) An Individual can claim the above exemption on the remuneration that is generated from first employment that is exercised in Cyprus if all the below apply:

• The Individual was employed outside of Cyprus for an employer not resident in Cyprus for 3 consecutive years prior to the commencement of his/her employment in Cyprus.

• The exemption can be claimed for maximum 7 years following the year of employment.

• Applies to employment which commenced after 26/07/2022 and up until the year 2027 inclusive.

b. 50% exemption

• Is granted in any year in which the remuneration from first employment in Cyprus exceeds €55.000, irrespective of whether in any tax year the said remuneration falls below €55.000, provided that during the 1st or 2nd year of employment in Cyprus the said remuneration exceeded €55.000 annually.

• Is granted for a period of 17 years, commencing as of the year of employment in Cyprus.

• The Individual should have been resident outside of Cyprus for at least 10 consecutive years prior to the commencement of his/her employment in Cyprus.

• Applies to the employment which commenced after 01/01/2022.

11. Notional Interest Deduction (‘NID’) on new equity capital: This deduction applies to businesses which generate taxable income (income generated from IP activities should in general qualify). NID is restricted to 80% of the taxable income resulting from the use of the new capital before NID. NID does not apply in case of tax loss/break even position.

12. IP Amortisation Period: All intangible assets (excluding goodwill), irrespective of whether they are qualifying assets or not, are eligible for amortisation over their useful economic life for a maximum period of up to 20 years (the exact amortisation period to be confirmed in a tax ruling).

13. Tax credits: Foreign tax paid or withheld on profits and gains of a Cypriot tax resident company can be credited against any Cypriot tax payable provided sufficient and appropriate evidence exists. Such tax relief cannot exceed the Cypriot tax payable on the same income or gain in the same income tax year. Any excess foreign tax credits which are not utilised cannot be set-off against other sources of income and cannot be carried forward to future periods.

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