Global Tax Alert | 19 October 2016

Cyprus introduces new rules for application of IP box regime

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Executive summary

On 14 October 2016, the Cypriot Parliament approved the laws amending the Income Tax Law with respect to the application of the Cypriot intellectual property regime (the IP box regime). The provisions of the IP box regime have been aligned with the recommendations of the Organisation for Economic Co-operation and Development (OECD) Action 5 of the Base Erosion and Profit Shifting (BEPS) plan on Countering Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance.

The new legislation is effective as of 1 July 2016. However, the relevant laws and regulations implementing the new IP Box regime will take legal effect once they are published in the Official Gazette of the Republic.

Detailed discussion

Transitional period to existing IP box regime

Under the existing IP box regime, codified in section 9(1)(e) of the Income Tax Law, a notional deduction of 80% has applied to net income and gains derived from patents, copyrights and trademarks as defined in the relevant Cypriot legislation.

The amending legislation provides for a five-year transitional period. The current IP regime will thus be maintained for income tax purposes for a transitional period starting on 1 July 2016 and expiring on 30 June 2021, provided certain conditions are satisfied. The “grandfathered” IP assets will continue obtaining the full tax benefits of the existing IP Box regime until 30 June 2021 without the need to apply the “modified nexus” ratio.

No ‘’new entrants’’ are permitted into the existing regime after 2 January 2016 although there are certain exceptions allowing entrance to the current regime if the IP asset is acquired before 30 June 2016, if certain are conditions are met.

The grandfathering provisions state that the transitional period will expire on 31 December 2016 if the IP asset was acquired between 2 January 2016 and 30 June 2016 from a related party and if the IP asset was, at the time of its acquisition, not already qualified for the Cypriot IP box regime or for a foreign tax regime similar to the Cypriot IP Box regime.

The new IP box regime and nexus approach

The new regulations introduce the OECD recommended “nexus approach.” This approach limits application of the IP box regime if research and development (R&D) is being outsourced to related parties. The approach links the benefits of the regime with the R&D expenses incurred by the taxpayer.

As per the new IP box regime, qualifying taxpayers will be eligible to claim a tax deduction equaling 80% of qualifying profits resulting from the business use of the qualifying assets. A taxpayer may elect not to claim the deduction or only claim a part of it. The qualifying profits shall be calculated by using the following ratio:

Qualifying profits = Qualifying expenditure + Uplift expenditure X Overall income
Overall expenditure

Qualifying assets

It should be mentioned that the provisions of the new IP box regime apply only to patents and patent equivalents, copyrighted software, utility models and other IP assets that are non-obvious, useful and novel (subject to de minimis criteria). This means that any marketing related IP assets such as trademarks will not be treated as qualifying assets. The regulations provide that IP assets must be certified by a relevant authority either in Cyprus or abroad.

Maintaining books and records

The regulations provide that taxpayers should maintain books and records for income and expenditure for each qualifying intangible asset.

Implications

The new legislation is complex and taxpayers should examine the potential impact of the new tax provisions (both existing and new IP box regime) on their IP structures and operations. Taxpayers should also understand the process of calculating the qualifying profits and ensure they have the systems and processes in place to separate out relevant income streams and gather information on R&D spend in order to perform the nexus calculations.

For additional information with respect to this Alert, please contact the following:

Ernst & Young Cyprus Limited, Limassol
  • Philippos Raptopoulos
    +357 22 209 999
    philippos.raptopoulos@cy.ey.com
  • Petros Liassides
    +357 22 209 999
    petros.liassides@cy.ey.com
  • Petros Krasaris
    +357 22 209 999
    petros.p.krasaris@cy.ey.com
  • Panayiotis Tziongouros
    +357 22 209 999
    panayiotis.tziongouros@cy.ey.com

EYG no. 03469-161Gbl