It is a recognised rule that wealth-creating assets may well rest on Intellectual Property (IP) rights, as all companies have them, but few take advantage of them. IP rights originate from the legal system and include registered rights, trade marks, etc.
IP rights add value to businesses. When forming an IP Company, proper due diligence is essential in order to recognize and identify all possible IP rights that could exist. An important step is the consideration of finding the most suitable jurisdiction for the IP Holding Company. The jurisdiction in question must offer a extensive range of agreements for the avoidance of double taxation (DTT) so that IP rights can be exploited in a number of countries. In addition, due to the DTT a favourable withholding tax (WHT) if any will be imposed on the royalty income that the IP Holding Company is entitled to receive. Above all, however, the country of tax residence of the IP Holding Company must offer a beneficial tax regime.
There is no perfect jurisdiction for an IP Company. Each case should be assessed on its own merits as all jurisdictions offer advantages and disadvantages. A professional tax advisor should ensure that the benefits his client receives exceed the costs to the greatest possible extent.
Cyprus is a jurisdiction that offers much more advantages rather than disadvantages.
Taxation of Royalty Income
Taxation of royalty income is regulated by the Income Tax Law 118(I)/2002 (as amended), in accordance with which the Cyprus IP Company will be subject to WHT if it receives royalty income from the use of intellectual property in Cyprus.
In most cases nevertheless, when a Cyprus IP Company is used for the purpose of international tax structure, the IP rights are not being used in Cyprus, but are used outside the territory of the country. If the IP rights are not used in Cyprus, no WHT will be imposed in Cyprus when the Cyprus IP Company, in its capacity as sub-licensee, proceeds with making a payment from the sublicensing of the IP rights to the licensee located abroad.
The House of Representatives passed the amendments to the aforementioned Income Tax Law in May of 2012. These new amendments amongst all, intend to establish Cyprus as a favourable jurisdiction for IP rights, by creating an appealing tax regime for an IP company.
The amendments to the law provide that 80% of any income generated from IP rights will be exempt from Corporate Income Tax (CIT); therefore only 20% of the profits generated from IP rights (royalties) will be subject to CIT at the rate of 12.5%.
This tax treatment is also applicable to any profit derived from the future sale of the IP rights.
Moreover, the law permits the deduction of all expenses resulting from the production of the royalty income, so, the amount to be paid may be reduced even further.
With regard to capital expenditure it should be noted that the Cyprus IP Company will be able to write off any capital expenditure for the purpose of the acquisition or development of the IP rights. Such a write off will be permitted for the initial five years of use. Straight line capital allowances at the rate of 20% will be applicable for the first five years of use. Consequently, a Cyprus IP Company will effectively be liable to a maximum tax of 2%, as it is only taxed on 20% of its profits in case of royalty income.
The amendments to the law have come into force on 6 July 2012 and have a retroactive effect as of 1 January 2012.
The benefits gained when using a Cyprus IP Company are shown in the illustration below, which uses Russia as an example.
The illustration shows an initial royalty income of €10,000 before any taxes are imposed. We have indicated that the Cyprus IP Company has gained a profit of €10,000 from licensing the IP rights. Applying the favourable tax regime, the Cyprus IP Company will be liable to an amount of €250 tax on the royalty income. It will then distribute its profits by way of dividends to the Group headquarters, free of any WHT in Cyprus.
As noted, the right jurisdiction for an IP Company needs to offer a scope of treaty network as well as the lowest possible tax. Cyprus satisfies all the requirements of a very beneficial IP Company jurisdiction;
A non offshore jurisdiction that offers a flat tax rate of 12.5% only on 20% of the royalty income.
Moreover, Cyprus has an extensive DTT network with leading countries as well as with the emerging economies. Cyprus has concluded DTT with G20 countries , with the former Eastern Bloc countries ,EU countries, and the BRICs (Brazil, Russia, India, China) as well as with the countries of the Arab World (UAE, Egypt etc). Cyprus has 49 treaties that are currently in force.
Tax complexity arises when a company is involved in international operations, due to their multi-jurisdictional environment. With the proper structuring however, international operations will offer better flexibility.
When it comes to IP rights the lowest possible tax makes a Cyprus IP company one of the best tax planning tools in the hands of a tax advisor in the area of IP rights.
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