Cyprus Tax & Legal Services 27 October 2016 Issue 14/2016 Cyprus Tax News Amendments to Cyprus s IP regime INTRODUCTION On 14 October 2016, the House of Representatives enacted into law significant amendments to Cyprus s IP regime. The amendments introduced in the Income Tax Law (ITL) were published in the Gazette on 27 October 2016 and provide for the gradual phase out of the current IP regime and the introduction of a new IP regime that is in line with the latest international developments on the taxation of IP income and OECD s action plan on fighting base erosion and profit shifting (BEPS). The ITL amendments are supported by Regulations which provide detailed guidance in the calculations and application of the new IP regime. SUMMARY Below, we summarise the key amendments introduced in the ITL as well as the relevant regulations. Amendments to the current IP regime The main amendments to the current IP regime include the introduction of grandfathering provisions to limit entrants to the current regime and ensure that the current regime is phased out by 30 June 2021. IPs existing as at 1 January 2016 and those developed or acquired from non-related persons between 2 January and 30
June 2016, will continue to benefit from the old IP regime until 30 June 2021. IPs acquired from related persons between 2 January 2016-30 June 2016 will be entitled to the benefits of the old regime only until 31 December 2016. Introduction of a new IP regime A new IP regime is introduced that defines the IP assets that are eligible to the tax benefits offered by the IP regime (qualifying assets) and applies the so called nexus approach in calculating the amount of profits on which the 80% tax exemption is calculated (qualifying profits). Qualifying assets under the new regime include patents, copyrighted software programs and other intangible assets that are non-obvious, useful and novel but do not include trademarks and copyrights. Qualifying profits are calculated in accordance with the nexus fraction, where the higher the R&D expenditure incurred to develop the qualifying asset the higher the amount of profits qualifying for the 80% tax exemption. Capital gains arising from the disposal of a qualifying asset under the new IP regime are not included in the qualifying profits and are fully exempt from income tax. Qualifying taxpayers that are eligible for the abovementioned tax benefits include Cyprus tax resident persons, permanent establishments (PEs) of non-tax resident persons as well as foreign PEs which are subject to tax in Cyprus. Other amendments relating to intangible assets In addition to the above, amendments were voted into the ITL, introducing capital allowances for all intangible assets (excluding goodwill and assets qualifying for the existing IP regime). In accordance with these amendments, the capital costs of the assets will be tax deductible (as a capital allowance) and will be spread over the useful economic life of the asset, as determined by generally acceptable accounting principles (with a maximum useful life of 20 years). IN DEPTH ANALYSIS Below, we analyse in detail the amendments voted into the ITL as well as the relevant regulations. Amendments to the current IP regime The main amendment to the current IP regime is the
introduction of grandfathering provisions limiting entrants to the current regime and ensuring that the regime is phased out and cannot be used beyond 30 June 2021. Grandfathering provisions The grandfathering provisions provide as follows: The provisions of the current IP regime will apply until 30 June 2021 with respect to intangible assets that: i) fell within the provisions of the current regime before 2 January 2016, or ii) were acquired directly or indirectly from a related person during the period 2 January 2016-30 June 2016 and which prior to their acquisition either fell within the provisions of the current regime or within the provisions of a similar regime for intangible assets in another country and were not acquired with the main purpose, or one of the main purposes, being the avoidance of tax, or iii) were acquired from an unrelated person or were selfdeveloped during the period 2 January 2016-30 June 2016 The provisions of the current IP regime will apply until 31 December 2016 with respect to intangible assets acquired directly or indirectly from a related person during the period 2 January 2016-30 June 2016 but that do not fall in (ii) above. Other provisions An amendment was voted to exempt from income tax any capital gains arising on the disposal of an IP asset that would qualify under the provisions of the current IP regime but had not previously benefited from the regime. Any embedded income relating to the IP asset will be entitled to the provisions of the current IP regime. Income arising from a qualifying IP as defined under the provisions of the new IP regime for which economic ownership exists can benefit from the provisions of the current IP regime. The taxpayer may chose each year whether to benefit from the provisions of the IP regime.
Introduction of a new IP regime Provisions introduced in the Income Tax Law A new IP regime has been introduced that is fully compliant with international developments in the tax treatment of IP income and OECD s guidance. Under the new IP regime, 80% of the qualifying profits generated from the qualifying assets is deemed to be a tax deductible expense. In calculating the qualifying profits, the new regime adopts the Nexus approach. According to this approach, the level of the qualifying profits is positively correlated to the extent the claimant performs R&D activities to develop the qualifying asset. The taxpayer may choose to forego the whole or part of the deduction. Furthermore, where the calculation of qualifying profits results in a loss, only 20% of this loss may be carried forward or group relieved in accordance with the provisions of Article 13 of the ITL. In addition, where the intangible asset qualifies for the provisions of both the current and the new IP regimes, the provisions of the current IP regime will apply until this is fully phased out. For the purposes of applying the amended provisions of the ITL, the Council of Ministers has issued Regulations (not yet published in the Gazette) which determine the qualifying assets as well as the calculation of qualifying profits. Provisions introduced in the Regulations In accordance with the Regulations: A Qualifying asset (QA) is one which was acquired, developed or exploited by a person in the course of its business and that relates to intellectual property, is a result of research and expenditure and for which the person is the economic owner, excluding any intellectual property relating to marketing. Qualifying assets under the new IP regime include: Patents as defined in the Patent Law (as amended) Software computer programs Other intangible assets protected by law which fall under either (a) or (b) below:
(a) utility models, intellectual property intangible assets which provide protection to plants and genetic material, orphan drug designations and patent extensions (b) that are non-obvious, useful and novel where the person who exploits these intangible assets in the course of its business does not earn revenue in excess of 7,500,000 per year from these intangible assets. In addition, in the case of a group of these persons, the group does not earn more than 50,000,000 in global turnover. For the purposes of the above calculation, an average of 5 years is used. Intangible assets under paragraph (b) above should be certified by a competent Cypriot or overseas Authority. Qualifying assets do not include trade names, brands, trademarks, image rights and other intellectual property used for the marketing of goods and services. Qualifying profits (QP) are calculated in accordance with the following nexus fraction: Where: 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 the QA is defined as the gross profit from the QA (i.e. the gross income less any direct expenditure). Overall income includes but is not limited to: Royalties or any other amounts in relation to the use of the intangible asset Any amount for the grant of a license for the exploitation of the QA Any amount relating to the insurance or compensation of the QA Trading income from the disposal of the qualifying intangible asset Embedded income on the QA which is derived from the sale of goods, services or use of any processes which are directly related to the qualifying asset.
Capital gains arising from the disposal of a QA are not included in overall income and are fully exempt from tax. Qualifying expenditure (QE) in relation to a QA is the sum of all research and development (R&D) expenditure which was incurred, in any tax year, wholly and exclusively for the development, enhancement or creation of a QA and are directly related to this QA. 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 R&D expenditure outsourced to unrelated parties Qualifying expenditure does not include: The acquisition cost of a said intangible asset Interest paid or payable Expenditure relating to the acquisition or construction of immovable property amounts that have been paid or are payable directly or indirectly to a related person carrying out R&D, irrespective if these amounts relate to a cost sharing agreement Costs which cannot be proved to be directly associated with a specific QA. The regulations provide that expenditures for the assignment of R&D activities to unrelated persons, as well as the expenditures of general and theoretical nature for R&D, that cannot be allocated to the qualifying expenditures of a specific QA with which they have direct connection, can be allocated proportionately to the QAs or products. It is further noted that the qualifying expenditures are included in the nexus fraction in the year that they have been incurred, irrespective of their accounting or tax treatment. Up-lift expenditure (UE) of a QA is the lower of: 30% of the qualifying expenditure and The total acquisition cost of the QA and any R&D costs outsourced to related parties Overall expenditure (OE) of a QA is the sum of: Qualifying expenditure and The total acquisition cost of the QA and any R&D costs
outsourced to related parties incurred in any tax year For the purposes of calculating the nexus fraction: direct costs include all the expenditure incurred directly or indirectly, wholly and exclusively, for the production of the overall income. the deduction which is granted in accordance with the provisions of Article 33(5) of the ITL (corresponding transfer pricing adjustment) which is derived from the development or sale of an QA, is treated as a direct expense the deduction which is granted in accordance with the provisions of Article 9B of the ITL (notional interest deduction), which is attributable to an QA, is considered as an indirect expense for the purposes of calculating the profit. Any person interested in benefiting from the IP regime is required to keep track of the relevant income and expenditure in order to be able to accurately calculate the nexus fraction. Qualifying persons include Cyprus tax resident taxpayers, tax resident PEs of non-tax resident persons as well as foreign PEs which are subject to tax in Cyprus. Amending provisions have been introduced into law to ensure that the taxpayer can elect whether a foreign PE is taxable in Cyprus, so that the PE can be classified as a qualifying taxpayer. The Regulations should come into force from 1 July 2016. Other amendments relating to intangible assets In addition to the above, amendments were voted into the ITL, introducing capital allowances for all intangible assets (excluding goodwill and assets qualifying for the existing IP regime). In accordance with these amendments, the capital costs of the assets will be tax deductible (as a capital allowance) and will be spread over the useful life of the asset, as determined by generally acceptable accounting principles (with a maximum useful life of 20 years). Upon the disposal of such an intangible asset, a balancing statement should 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.
Amendments to Article 36 of the Income Tax Law Amending provisions have been introduced into the ITL to ensure that the taxpayer can elect whether a foreign PE is taxable in Cyprus, so that the PE can be classified as a qualifying taxpayer. Additionally, the provisions of Articles 35 and 36 of the ITL in relation to relief from double taxation will not be granted to the extent that the taxpayer has chosen to claim losses in accordance with Article 13(9) and not Article 13(1) of the ITL. Nicosia Offices infonicosia@deloitte.com tel: +357 22 360300 Limassol Offices infolimassol@deloitte.com tel: +357 25 868686 Larnaca Offices infolarnaca@deloitte.com tel: +357 24 819494