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What makes a jurisdiction favourable for IP holding companies?
IP rights add value to businesses. When forming an IP company proper due diligence is essential in order to recognise 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 an extensive range of agreements for the avoidance of double taxation so that IP rights can be exploited in a number of countries. In addition, due to the Double Tax Treaties (DTT) a favourable withholding tax (WHT), if any, will be imposed on 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. Cyprus is a tax jurisdiction offering more advantages rather than disadvantages and is therefore deemed favourable for IP companies.
Taxation of royalty income
Taxation of royalty income is regulated by the Income Tax Law 118(I)/2002 (as amended), whereby a Cyprus IP company will be subject to income tax if it receives royalty income for the use of intellectual property in Cyprus.
In most cases nevertheless, when a Cyprus IP company is used for the purpose of international tax structuring, the IP rights are not being used in Cyprus but abroad. 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 amendments to the aforementioned Income Tax Law in May 2012. These new amendments 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 meaning the amount to be paid may be reduced even further.
With regard to capital expenditure it should be noted that a Cyprus IP company will be able to write off any capital expenditure for the purpose of the acquisition or development of IP rights. Such a write off will be permitted for the initial 5 years of use. Straight line capital allowances at the rate of 20% will also be applicable for the first 5 years of use. Consequently, a Cyprus IP company will effectively be liable to a maximum tax rate of 2% as it is only taxed on 20% of its profits in case of royalty income.
The amendments to the law came 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 EUR 10,000 before any taxes are imposed
- The Cyprus IP company has gained a profit of EUR 10,000 from licensing their IP rights
- Applying the favourable tax regime, the Cyprus IP company will be liable to an amount of EUR 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
The right jurisdiction for an IP company needs to offer a wide double tax treaty network as well as the lowest possible tax rate. Cyprus is deemed as a beneficial IP company tax jurisdiction as it offers a flat tax rate of 12.5% on only 20% of the royalty income.
Cyprus also has an extensive double tax convention network with leading countries as well as with the emerging economies, with 49 treaties 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.
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