New IP regime
In brief, under the new regime, 80% of qualifying profits generated from qualifying assets will be deemed to be tax deductible expenses.
Qualifying assets are those acquired, developed or exploited by a person in the course of its business and that relates to IP, are a result of R&D expenditure and for which the person is the economic owner, excluding any IP relating to marketing (trade names, brands, trademarks, image rights).
Qualifying intangible assets
The new regime narrows the range of assets that qualify. Broadly speaking, a ‘qualifying intangible asset’ now means an asset which is acquired, developed or exploited by a person to further a business (excluding intellectual property associated with marketing) and which is the result of research and development activities.
These assets include patents (as defined in the Patents Law); computer software; and other IP assets that are non-obvious, useful and novel. The person exploiting the asset must not generate annual gross revenue over €7.5 million, and if the person is a group company, the group’s revenue must not exceed €50 million.
Qualifying profits are calculated based on the “nexus approach”.
More specifically, the level of profits eligible for the 80% tax exemption will depend on the level of R&D expenditure carried out by the taxpayer to develop the qualifying asset.
The qualifying profits are calculated based on the following fraction that captures this:
Nexus Formula for Qualifying profits is as follows:
QP=OIxQE+UEOE
Whereas:
- Qualifying profits QF
- OI is the “overall income derived from the QA”;
- QE is the “qualifying expenditure on the QA”;
- UE is the “uplift expenditure on the QA”; and
- OE is the “overall expenditure on the QA”.
Overall income (OI) derived from qualifying assets is defined as the gross profit from the assets (i.e. gross income less any direct expenditure).
Overall income includes, but is not limited to:
∙ Royalties or any other amounts relating to the use of qualifying assets;
∙ Any amount for the grant of a license for the exploitation of the qualifying assets;
∙ Any amount relating to the insurance or compensation of the qualifying assets;
∙ Trading income from the disposal of the qualifying asset; and
∙ Embedded income on qualifying assets, which is derived from the sale of goods, the provision of services or use of any processes that are directly related to the qualifying assets.
Capital gains arising from the disposal of a qualifying asset under the new IP regime are not included in qualifying profits and are fully exempt from income tax.
Qualifying expenditure
(QE) relating to a qualifying asset is the sum of all R&D expenditure incurred in any tax year wholly and exclusively for the development, enhancement or creation of a qualifying asset and that is directly related to that asset.
Qualifying expenditure includes, but is not limited to:
∙ Salary and wages;
∙ Direct costs;
∙ General expenses associated with R&D activities;
∙ Commission expenditure associated with R&D activities; and
∙ R&D expenditure outsourced to unrelated parties.
Qualifying expenditure does not include:
∙ The acquisition cost of a specific intangible asset;
∙ Interest paid or payable;
∙ Expenditure relating to the acquisition or construction of immovable property that has been paid or is payable directly or indirectly to a related person carrying out R&D, regardless of whether the amounts relate to a cost sharing agreement;
∙ Costs that cannot be shown to be directly associated with a specific qualified asset.
Expenditure for the assignment of R&D activities to unrelated persons, as well as the expenditure of general and theoretical nature for R&D, that cannot be allocated to the qualifying expenditure of a specific qualified asset with which they have a direct connection, may be allocated proportionately to the qualified assets or products.
Qualifying expenditure is included in the nexus fraction in the year in which the expenditure was incurred, regardless of its accounting or tax treatment.
Uplift expenditure (UE) of a qualified asset is the lower of (i) 30% of the qualifying expenditure, and (ii) the total acquisition cost of the qualifying asset and any R&D costs outsourced to related parties.
Overall expenditure (OE) of a qualifying asset is the sum of (i) qualifying expenditure, and (ii) the total acquisition cost of the qualifying asset and any R&D costs outsourced to related parties incurred in any tax year.
The following applies for purposes of calculating the nexus fraction:
∙ Direct costs include all expenditure incurred directly or indirectly, wholly and exclusively, for the production of the overall income;
∙ The deduction granted under a corresponding transfer pricing adjustment as per the ITL that arises from the development or sale of a qualifying asset is treated as a direct expense.
∙ The deduction granted under the notional interest deduction provision in the ITL, which is attributable to a qualifying asset, is considered an indirect expense for calculating the profit.
The taxpayer may choose to forego all or part of the deduction and, where the calculation of qualifying profits results in a loss, only 20% of the loss may be carried forward or group relieved under the ITL.
Qualifying taxpayers that are eligible for the IP regime include Cyprus tax resident persons, permanent establishments (PEs) of non-resident persons and foreign PEs that are subject to tax in Cyprus. Amending provisions have been introduced into the ITL to ensure that a taxpayer can elect whether a foreign PE is taxable in Cyprus, so that the PE can be classified as a qualifying taxpayer. Qualifying taxpayers are required to keep track of the relevant income and expenditure to be able to accurately calculate the nexus fraction.
Where the intangible asset qualifies for both the current and the new IP regimes, the current regime will apply until that regime is fully phased out.
Other changes relating to intangible assets
The amendments to the ITL also include the introduction of capital allowances for all intangible assets (except goodwill and assets qualifying for the current IP regime). As a result, the capital costs of such intangible assets will be tax deductible and will be spread over the useful economic life of the asset, as determined by generally acceptable accounting principles (up to a maximum useful life of 20 years). Upon the disposal of such an intangible asset, a balancing statement will need to be prepared with any balancing addition being subject to income tax and any balancing deduction being tax deductible. The taxpayer has the option not to claim capital allowances for such intangible assets in a particular tax year.
Example
Calculation of Qualifying profits QP for company A:
-Overall income (OI) is €500.
– Overall expenditure (OE) is €300 (Qualifying expenses of IP Company (€200)+Unqualified expenses of IP Company (Cost of acquisition of IP Assets, R&D expenses subcontracted to related company) (20+80)
– Qualifying Expenditure (QE) is €200
-Qualifying expenditure is the sum of all R&D expenditure incurred in a tax year wholly and exclusively for the development, enhancement or creation of a qualifying asset and that is directly related to that asset (i.e. salaries, direct costs, general expenses – commission associated with R&D activities) and R&D expenditure outsourced to unrelated parties.
– Uplift expenditure (UE) is the lower of:
-30% of the Qualifying Expenditure (QE) is (30% x €200 = €60)
–Unqualified Expenditure [Cost of acquisition of IP Assets, R&D expenses subcontracted to related company (20 + 80= €100)]
3. Conclusion
By set as inputs in the Nexus Approach formula the above amounts the formula is formulated as below:
QP=€500x€200+€60€300
Therefore the Qualifying Profit which is the net income to be taxed under the IP regime is €433.
The Company is allowed to notional deduction of 80% (80% x €433 = €346)
Thus, the Qualifying Profit of €433 will be decreased by €346 and the final taxable profit is (€433 – €346 = €87). The total tax to be paid therefore will be €87*12.5% which will equal to €10,88.
LedgerWorth Financial Services can assist all impacted individuals and organizations in assessing their Cyprus tax position and maximize their tax benefit.