IP box — a favorable tax regime for business at the rate of 2.5%

To fight against tax evasion developed countries have implemented an action plan against hiding profits from taxation. Now, instead of the question “how not to pay taxes”, business is faced with the question “how to save on taxes”. When it comes to the IP Box regime, “how” turns into “where” and the answer is in Cyprus.

The New York Public Library | Unsplash

What is IP Box?

IP Box stands for Intellectual Property Box, also referred to as Patent Box and Knowledge Development Box. It is a favorable tax regime for profits from innovation and investment in intellectual property. This tax regime is extremely beneficial for IT business and companies that develop technology and spend a lot on Research and Development (R&D).


Assets that fall under the IP Box regime are called qualifying - for example, inventions, software, drugs.

Where to find?

Ireland was the first to launch such tax regime. Then it was joined by France, Hungary, the Netherlands, Luxembourg and other countries.

They’ve developed two main IP Box types:
  • reduced tax rate on profits from qualifying assets — Poland, France, the Netherlands, the UK;
  • 0% rate for part of the profits from qualifying assets — Cyprus , Malta, Luxembourg, Ireland.

Tax rate in Cyprus

IP Box regime was introduced in Cyprus in 2012 and updated in 2016. Under the new rules, 80% of income from qualifying assets are tax-free. The remaining 20% is taxed at a rate of 12.5%. It means that income tax can be just 2.5%.

What assets apply to IP Box in Cyprus

Alex Knight | Unsplash

Qualifying assets are:

  • patents for inventions;
  • software;
  • useful models and intellectual property objects related to plants, genetic materials and orphan drugs (drugs for the treatment of rare diseases);
  • other objects of intellectual property that are “non-obvious, useful and new”.

Qualifying assets are not:

  • brand names;
  • trademarks;
  • images;
  • other objects of intellectual property that are used for marketing.

Who can use IP Box regime
  • Cyprus tax resident companies;
  • permanent establishment of foreign companies that pay taxes in Cyprus.
The IP Box regime is applied not to the company's profits, but separately to each intellectual property object.

IP Box important points


The regime can be used only if the qualifying asset is created or modified in Cyprus.


A scheme, when a Cypriot company exists only on paper and the completed qualifying asset is given to it, will not work. For example, a Russian company developed an antivirus, registered a company in Cyprus and handed it a ready-made program to reduce income tax. In this case, the favorable tax regime is not applicable, since the software was not created or modified by a Cypriot company.

Tax rate calculation

To calculate the tax rate under IP Box regime, you take qualifying income. 80% of it is not taxed; the remaining 20% are taxed at a rate of 12.5%. It means, the profit rate varies from 12.5% to 2.5% and depends on developing an intellectual property object costs. The more a company spends on R&D (excluding the services of affiliated companies), the lower the tax is.

Examples



A Cypriot company developed a new battle royale game. It spent € 500 thousand, made a profit of € 1 million and wants to cut taxes as much as possible.

Alex Haney | Unsplash

Case 1: made the game, modified it on the side


The company created the game, paid € 300 thousand to full-time employees and spent € 200 thousand on the services of third-party developers from India, for a total of € 500 thousand.


In this case, the tax will be reduced as much as possible: the company itself created the game, outsourcing was from third-party companies, so all profits are considered qualifying.


Profit - € 1,000,000, tax - € 25,000, effective tax rate - 2.5%.


Case 2: bought the game, modified it on the side


The company bought the game for € 300,000 and spent € 200,000 on the services of third-party developers from India, for a total of € 500,000.


Here the tax will not be reduced to maximum: outsourcing was from third-party companies, but the company did not make, but bought the game, which reduces the qualifying profit.


Profit - € 1,000,000, tax - € 73,000, effective tax rate - 7.3%.


Case 3: bought the game, modified it with a related company


The company bought the game for € 300 thousand and spent € 200 thousand on the services of developers from an affiliated Russian company, for a total of € 500 thousand:


It will not be possible to reduce the tax in this case - the Cypriot company itself did nothing; the game was bought, and was modified by an affiliated company.


Profit - € 1,000,000, tax - € 125,000, effective tax rate - 12.5%.


You can see the tax rate formula and our detailed calculations in examples here.


Profitable/ unprofitable


Examples show how to reduce the tax rate up to 2.5%.


Maximum benefit: the company creates the product itself with the help of full-time employees or third-party developers, or buys and seriously modifies it.


Minimum benefit: we buy a completed product, do not modify it or modify it with related companies.

Why Cyprus?

There are tax benefits for technology companies in different countries, but Cyprus has created extremely favorable conditions for them.
Dimitris Vetsikas | Pixabay

Advantages of IP Box regime in Cyprus



  • Is consistent with the recommendations of the European Union and the Organization for Economic Cooperation and Development.
  • Low tax rate even without benefits — 12.5%.
  • Possibility to cut tax up to 2.5%.
  • Possibility to outsource R&D to third party companies outside Cyprus - this is also considered a qualifying expense.
  • You can provide a scheme of the company's work to the tax authorities in advance and receive a Tax Ruling - the document determining whether the favorable regime is applicable to this business.
  • Cyprus is a member of the European Union and a party to the conventions for the protection of intellectual property.
  • Cyprus signed a Double Taxation Treaty with 65 countries, including Russia.

A short checklist for IP Box

IP-box is a favorable tax regime that encourages companies to invest in innovation and intellectual property. Beneficial for IT business and companies that spend a lot on R&D.


IP Box is applied to:

  • inventions;
  • software;
  • objects of intellectual property.

Rate calculation


In Cyprus, the IP Box regime can significantly reduce income tax - up to 2.5%. To calculate the tax rate, you calculate qualifying income; its 80% is not taxed, the remaining 20% are taxed at a rate of 12.5%. The profit rate varies from 12.5% to 2.5% depending on the cost of R&D


Profitable:

  • spend a lot on R&D;
  • develop objects of intellectual property;
  • outsource the development / modification to unrelated companies, including foreign ones;
  • buy objects of intellectual property and significantly modify them.

Unprofitable:

  • buy ready-made objects of intellectual property and not modify them;
  • modify intellectual property objects, but by affiliated companies.

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