Introduction
The Cyprus parliament has passed a law amending the Income Tax Law to bring its provisions on taxation of income from the use or sale of intangible assets into line with the "modified nexus" approach.
This approach, which was agreed by G20 leaders towards the end of 2014 and adopted by the OECD and the EU, allows a taxpayer to benefit from an intellectual property taxation regime, commonly known as an intellectual property (IP) box, only to the extent that it can show material relevant activity, including a clear connection between the rights which create the IP income and the activity which contributes to that income.
Countries whose IP regimes were incompatible with the modified nexus approach were required to take steps to amend them, and to allow no new entrants to non-compliant IP regimes after June 30, 2016. However, transitional arrangements were permitted to allow taxpayers benefiting from existing schemes to continue to do so until June 30, 2021.
The Ministry of Finance announced in January this year that it would be taking steps to modify the Cyprus IP box regime in order to conform with the modified nexus approach. The new law, Law 118(I) of 2016, makes good on this commitment. It was published in the government gazette on October 27, 2016. Regulations issued under the law, which will have retrospective effect from July 1, 2016, provide detailed guidance on the calculations and application of the new IP regime.
Transitional Arrangements For IP Assets Developed Prior To June 30, 2016
The existing intellectual property law cyprus, which was introduced in 2012, provides for 80 percent tax exemption of income from the use of a wide range of intangible assets. Coupled with Cyprus's low corporate income tax of 12.5 per cent, it gives an effective tax rate on such income of 2.5 per cent or less.
Taxpayers already benefiting from the existing scheme may continue to claim the same benefits until June 30, 2021, subject to certain conditions regarding assets acquired from related parties between January 2, 2016 and June 30, 2016. Assets acquired in this period from a related party will qualify for benefits only until the end of the 2016 tax year, unless at the time of their acquisition they were benefiting under the Cyprus IP box regime or under a similar scheme for intangible assets in another state.
Qualifying income will now include embedded income arising from the sale of products directly related to the IP asset and income from intangible assets for which only economic ownership exists. Taxpayers will also be able to opt from year to year whether to benefit from the IP box regime.
In addition, any gain arising on the disposal of an IP asset that would qualify under the provisions of the new regime but had not previously benefited will be completely exempt from tax. Prior to this amendment, 80 per cent of any capital gain was exempt. However, in practice, full exemption of capital gains on all intangible assets can be achieved by transferring the ownership of the intangible assets to a company and selling the shares in the company.
New Arrangements For IP Assets Developed From July 1, 2016
The arrangements for assets developed after July 1, 2016, follow the modified nexus approach. Qualifying assets are restricted to patents, software and other IP assets which are legally protected. IP rights used to market products and services, such as business names, brands, trademarks and image rights, do not fall within the definition of qualifying assets. Relief is geared to the cost incurred by the taxpayer in developing the IP through its research and development (R&D) activities. Costs of purchase of intangible assets, interest, costs relating to the acquisition or construction of immovable property, and amounts paid or payable directly or indirectly to a related person are excluded from the definition of qualifying expenditure.
As was the case under the existing scheme, 80 percent of the overall profit derived from the qualifying intangible asset is treated as deductible expense, preserving the effective tax rate of less than 2.5 percent on such income.
Qualifying Persons
Qualifying persons include Cyprus tax resident companies and individuals, tax resident permanent establishments of non-tax resident persons, and foreign permanent establishments which are subject to tax in Cyprus. The amending law includes provisions allowing taxpayers to elect for a foreign permanent establishment to be taxable in Cyprus so that it can be classified as a qualifying person.
Qualifying Assets
Qualifying assets (QAs) are assets acquired, developed or exploited by a taxpayer in the course of its business which relate to IP, result from R&D expenditure, and of which the taxpayer is the economic owner, excluding any IP relating to marketing.
QAs include patents as defined in the Patent Law, computer programs, utility models, IP assets which provide protection to plants and genetic material, orphan drug designations and patent extensions, as well as other intangible assets protected by law and certified by a competent authority in Cyprus or overseas as being non-obvious, useful and novel, where the person who exploits these intangible assets in the course of its business does not earn revenue from them of more than EUR7.5m (USD8.2m) (EUR50m in the case of a group of companies) per year. For the purposes of this calculation, revenue is averaged over five years.
QAs do not include trade names, brands, trademarks, image rights and other IP used for the marketing of goods and services.
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