Interesting article by Auditchart!
The Cyprus Parliament has voted on October 14, 2016 for the amendment of the existing Intellectual Property Regime (IP Regime), to be in line with the latest provisions of the Action 5 under the OECD’s BEPS Project. Moreover, on the same date changes on the treatment of foreign Permanent Establishments (PEs) of Cyprus tax residents have also been introduced. The announcement in the Official Gazette of the Republic of Cyprus on the above was published on the 27th of October 2016.
1. Amendments to the existing IP Box Regime to incorporate the OECD’s latest Nexus approach
The current IP Box in Cyprus
Under the existing IP Regime, an 80% exemption is applied on the Net Profits arising from the exploitation of Intellectual Properties. Specifically, the exemption is applied on the result deriving from the deduction from the IP income generated of all the directly related expenses linked to it and the deduction of a 20% capital allowances.
In connection with the Cyprus’ Corporation Tax, the existing IP regime allowed for an effective taxation of maximum 2.5%. The new approach does not provide for a modification of this situation, but instead it aims to provide a new understanding on what is defined as a qualifying asset and the application of the Nexus approach. What is more, it also provides for transitional arrangements to be applied for the current IP regime. Details are set out below.
Closing the existing IP regime and introducing the amendments
The main changes of the amended regime, relate to the introduction of rules that limit the entrance of new players in the existing regime and to ensure that this will only be applicable until 30 June 2021.
Specifically, the current IP regime is applied only for Intellectual Property that meets the following criteria:
The IP qualified for the existing regime before January 2, 2016.
The IP was purchased from a non-related person or has been developed within the period from January 2, 2016 and June 30, 2016.
Directly or indirectly acquired IP from related parties during the period from 2 January 2016 and 30 June 2016, provided that the IP was already eligible for qualification under the existing IP regime or a similar in another country and has not been acquired in order to avoid taxation mainly.
Note: The above are applied until 30 June 2021 as stated above
The new IP regime
Fully applied from 1 July 2016, the new regime applies on the qualifying profits generated from qualifying assets (IPs). In particular, an exemption of 80% applied on the qualifying profits is provided which in essence is similar to the phased out IP regime, however the focus is on the definition of the qualifying assets upon which the exemption will be applied and how the qualifying profits will be modified to be compatible with the Nexus approach.
Qualifying IP types include patents, copyrighted software and other IPs that are legally protected. In general, qualifying IPs are any IPs that are acquired, developed or exploited in the normal course of the business of any person, excluding IPs relating to the marketing of the business such as trademarks, brands, image rights etc.
The qualifying profits are calculated based on the so called Nexus approach. Particularly, there should be a ‘nexus’ between the IP expenses, the qualifying profits and the qualifying assets. Under this approach, the profits that are eligible to the IP regime depend on the R&D expenditure incurred on the development of the qualifying asset.
The Nexus formula that figures out what profits are eligible for the IP regime is set out below:
Qualified expenditure incurred
to develop IP Asset Overall income Income receiving
---------------------------------------------- x from IP Asset = tax benefits
Overall expenditure incurred
to develop IP Asset
Refer to the sum of all the R&D costs incurred exclusively for the development of the qualifying asset in any tax year, which are also directly related to that asset. In addition, the ‘uplift expenditure’ is included within the scope of the qualifying expenditures. The uplift expenditure is defined as the lower between the 30% of the qualifying expenditure and the total acquisition cost of the qualifying asset plus any R&D costs outsourced to related parties.
The sum of any expenditure falling within the qualifying expenditure definition above, including any R&D costs incurred for the development of a qualifying asset in any tax year.
Refers to the gross profit derived from the qualifying assets, being the gross income generated less any directly related expenses. It is worth to note that gains on the disposal of a qualifying asset do not fall within the scope of the definition of overall income and are fully exempt from income tax.
Further points on the calculation of the Nexus formula:
Direct costs, are those costs incurred wholly and exclusively for the direct or indirect generation of the overall income.
Any deduction accorded under a particular transfer pricing adjustment during the production or sale of a qualifying asset is deemed as a direct expense.
The deduction provided under the Notional Interest Deduction (NID), attributable to a qualifying asset, is deemed as an indirect expense.
A taxpayer may elect not to enjoy all the available 80% deduction for a particular year. Moreover, in the occasion where a person ends up with a loss in the calculation, only 20% of the loss can be carried forward or relieved in a group structure.
Who can be seen as a Qualifying Taxpayer
Cyprus tax resident persons
Permanent Establishments of non-resident individuals or legal persons
Foreign Permanent Establishments subject to Cyprus tax.
Note: the qualifying taxpayers should keep track of their incomes and expenditures for each of their qualifying assets, if many, so as to easily be able to calculate the Nexus fraction.
Changes on the Intangible assets
Capital allowances have been incorporated in the amended regime relating to all intangible assets except goodwill and assets already qualified under the current regime. The capital allowances are tax deductible expenses and are spread over the useful life of the intangible assets as stated in accepted accounting principles, with a cap of 20 years.
Following the disposal of such intangible assets, any balancing addition result needs to be subject to corporation tax whilst any balancing allowance is tax deductible.
The taxpayers may elect not to claim all the tax allowances for a tax year.
Effective date: 1 July 2016
2. Foreign Permanent Establishments of Cyprus Tax Residents
The current treatment
At present, any profits generated by foreign PEs are exempt from Cyprus taxation subject to certain criteria. In addition, tax losses incurred from those PEs may be utilized in Cyprus and are subject to the Recapturing rules that are applied once the foreign PE generates profits in the future
Taxpayers can opt to elect on the taxation of the profits of foreign PE.
A tax credit is available on foreign taxes incurred abroad without the need of a double taxation arrangement.
In the absence of the taxpayers’ election, the default method will be the exemption of taxation in Cyprus.
Effective date: 1 July 2016