Cyprus: changes in intellectual property tax regime
As is known, the corporate income tax rate in Cyprus is 12.5%.
At the same time the law provides a special tax regime for income from intellectual property (hereinafter – IP), which allows 80% deduction from profit received by a Cypriot company from use or disposal of an IP asset.
In this case the effective tax rate (i.e. the rate under which a company is virtually taxed) may come down to 2.5%. What is more, until quite recently the mentioned allowance had covered rather wide range of IP assets (copyrights, trademarks, patents, designs, know-how and others) whether created or acquired by a company.
The mentioned rules along with the reduced rates and exemptions from withholding tax on royalties provided by Cyprus’s double tax treaties or the relevant EU Directive, made the Cyprus IP tax regime particularly attractive. However, in recent two years these opportunities have been substantially restricted.
First, there was established a deadline (30 June 2016) before which Cypriot companies could use the preferential IP regime under the old rules (with an opportunity to preserve it for the following five years).
Second, there was introduced a provision under which a preferential IP regime must be conditioned by a substantial economic activity of a taxpayer, in particular – by his expenditures for research and development (R&D) within Cyprus. The main changes are as follows.
In order to bring the existing IP regime in line with the “BEPS Action 5” recommendations (series of the OECD analytical documents containing steps for countering taxable base erosion), Cyprus on 14 October 2016 introduced the amendments to the IP regime, that apply retroactively from 1 July 2016.
1. The amendments do not affect the existing effective 2.5% tax rate applicable within the IP regime, however they provide a new “modified nexus approach” as well as narrow the definition of a “qualified” IP asset.
The amendments set forth the transitional provisions extending the existing IP regime until 30 June 2021. The existing IP regime will continue to apply in respect of:
- existing IP assets (i.e. IP assets that enjoyed the IP regime as on 2 January 2016);
- IP assets acquired from related parties from 2 January to 30 June 2016 provided that such assets comply with the new IP regime requirements;
- IP assets acquired from an unrelated party or created from 2 January to 30 June 2016.
2. The amendments limit the definition of “qualified” IP assets (i.e. IP assets, the income from which fall under the preferential tax regime) to
- software, and
- IP assets that are non-obvious, useful and novel, and the taxpayer’s income from which does not exceed EUR 7 500 000 a year within a 5-year period.
The following IP assets are not considered “qualified”:
- business names;
- image rights; and
- other intellectual property rights used for promotion of goods or services.
3. According to the “modified nexus approach” the use of preferential IP regime requires:
- substance (sufficient physical presence) in Cyprus, and
- substantial connection between the expenditures for IP assets, the IP assets and the income derived therefrom (the amount of profit subject to preferential IP taxation is determined by using a special formula).
To apply this, taxpayers will have to maintain accounts of income and expenditures related to a “qualified” IP asset, which enable to ascertain that the income qualifying for relief emerges as a result of the expenditures related to such IP asset.
Therefore, the preferential IP regime will be limited to R&D activities only, exercised in Cyprus by a qualified taxpayer (a Cypriot resident company or, subject to certain conditions, by a Cypriot company’s permanent establishment abroad).