Decision
Does a Founder's Salary Qualify for the Cyprus IP Box?
Does a Founder's Salary Qualify for the Cyprus IP Box?: short answer
Last reviewed
We treat a founder's salary as a related party cost and outside qualifying expenditure. The Regulations admit wages and salaries but exclude amounts paid to a connected person for carrying out research and development, and a founder who owns the company and writes the code is both.
| Our position | A founder's salary is a related party cost and outside qualifying expenditure |
|---|---|
| The inclusion | Regulation 4(2)(b) admits wages and salaries generally |
| The exclusion | Amounts paid directly or indirectly to a connected person for carrying out research and development |
| Connected person | Undefined in the Regulations. Taken from the Income Tax Law, where Article 33 turns on participation in management, control or capital |
| Effect on the fraction | Leaves the numerator, stays in the denominator |
| An employed developer | Qualifies, where the developer is not connected to the company |
| Settled | No. The Regulations do not say so in terms, and the contrary reading is set out below |
A two or three founder software company where the founders are the development team. This single question can decide more of the nexus fraction than every other cost combined, and it is decided by who is on the payroll rather than by what the code is worth.
The two provisions that decide it
Regulation 4(2)(b) of K.D.P. 336/2016 lists what qualifying expenditure includes, and the first item is wages and salaries. Flat, with no carve-out for anyone.
The same regulation then lists what it does not include, and the fourth exclusion is amounts paid or payable, directly or indirectly, to a connected person for carrying out research and development, whether or not under a cost sharing agreement.
A founder who owns the company and writes the code is a person being paid wages, and a connected person being paid to carry out research and development. Both provisions have a claim on the same money.
Our position
We treat a founder's salary as a related party cost, outside qualifying expenditure.
Connected person is not defined in the Regulations. Regulation 2(2) provides that terms not specifically defined take the meaning given in the Income Tax Law, and Article 33 of that Law turns on direct or indirect participation in the management, control or capital of an enterprise. A founder-shareholder who is also a director satisfies that on all three counts.
Rulings issued by the Tax Department have reached the same result, excluding the payroll cost of the beneficial owner and of a director of development from qualifying expenditure.
Why it matters more than it sounds
A cost that fails to qualify does not simply drop out. It leaves the numerator and stays in the denominator, so the fraction falls from both directions at once.
Take a company with two founders writing the code and one employed developer who owns nothing.
- Founders' salaries: 200,000 euro
- Employed developer: 80,000 euro
- No acquisition, no related party outsourcing
If all payroll qualified, the fraction would be 280,000 over 280,000, which is one, and the effective rate on qualifying profit would be about 3 percent.
On our reading, qualifying expenditure is the developer's 80,000 alone. Overall expenditure is unchanged, because the founders' salaries are still expenditure on the asset. The uplift of up to 30 percent of qualifying expenditure adds 24,000, but it is capped at the total of acquisition cost and related party outsourcing cost, which here is nil, so it adds nothing.
The fraction is 80,000 over 280,000, or 0.29. Rather than 80 percent of the profit being deducted, roughly 23 percent is, and the effective rate lands near 11.6 percent instead of 3.
Same company, same code, same revenue. The difference is who is on the payroll.
What follows from it
Hiring changes the fraction in a way founder salary does not. A developer with no shareholding is not a connected person, and their salary is qualifying expenditure wherever they sit. A company weighing a founder taking a larger salary against making a hire is not comparing like with like.
Do not solve it by paying the founders nothing. The salary has to be defensible for other reasons, and a company whose directors take no remuneration while running a development programme has a substance problem and a transfer pricing problem in place of a nexus problem. See economic substance.
The fraction is cumulative over the life of the asset, so this is not a single year's issue. Years of founder-only development sit in the denominator permanently, and later hiring improves the fraction slowly rather than resetting it.
Get the position confirmed if the amounts justify it. Where a great deal turns on it, the way to settle the treatment is an advance tax ruling before the spending happens rather than an argument after it. A ruling costs 1,000 euro, or 2,000 euro for an answer within 21 working days.
Common questions
Does a founder's salary count towards the Cyprus IP Box nexus fraction?
We treat it as outside qualifying expenditure. Regulation 4(2)(b) of K.D.P. 336/2016 admits wages and salaries but excludes amounts paid directly or indirectly to a connected person for carrying out research and development, and a founder who owns the company and writes the code is a connected person under Article 33 of the Income Tax Law. Rulings issued by the Tax Department have reached the same result on the beneficial owner and on a director of development.
Does an employed developer's salary qualify for the Cyprus IP Box?
Yes, where the developer is not connected to the company. Regulation 4(2)(b) includes wages and salaries, and the exclusion reaches only amounts paid to a connected person. Where the developer works remotely from another country the position is unchanged, because the test is the relationship rather than the location.
How much does excluding founder salary cost the nexus fraction?
More than the amount, because the cost leaves the numerator and stays in the denominator. A company with 200,000 euro of founder salary and 80,000 euro of employed development has a fraction of roughly 0.29 rather than one, so the effective rate on qualifying profit is near 11.6 percent rather than about 3.
Is the treatment of founder salary under the Cyprus IP Box settled?
No. The Regulations include wages and salaries without a carve-out and the exclusion for connected persons sits among provisions that look aimed at outsourcing, so a narrower reading is arguable. We think it loses, and the Tax Department has excluded founder payroll in rulings, but anyone relying on the point should treat it as a considered position rather than settled law and consider an advance ruling where the amounts justify one.
Technical definition
Regulation 4(2)(b) of K.D.P. 336/2016 includes wages and salaries in qualifying expenditure but excludes amounts paid or payable, directly or indirectly, to a connected person for carrying out research and development. Connected person is undefined in the Regulations, so Regulation 2(2) takes the meaning from the Income Tax Law.
Practical implications
Founder salary that falls outside qualifying expenditure leaves the numerator of the nexus fraction while remaining in the denominator, so the fraction falls twice as fast as the cost suggests. For a founder-led company the effective rate moves a long way from the headline.
Common misconceptions
That the Regulations list wages and salaries without qualification, so all payroll counts. That the answer depends on the size of the salary, when it turns on the relationship. And that hiring a developer and paying a founder are equivalent for the fraction, when only one of them is.