Cyprus IP Box

What the regime does

The Cyprus IP Box allows a company to deduct 80 percent of the qualifying profit it derives from a qualifying intangible asset. The deduction is notional, meaning no cash is spent to obtain it. The remaining 20 percent is taxed at the standard corporate rate.

Because the deduction applies to qualifying profit rather than to gross income, the size of the benefit depends on two separate questions:

1. Is the asset a qualifying intangible asset?
2. What proportion of the income from it counts as qualifying profit?

The first question is about the nature of the asset. The second is about how the asset was developed and paid for.

The deduction itself is one sentence of the Income Tax Law, and it carries a feature most summaries leave out.

(κ) Ποσοστό ύψους ογδόντα τοις εκατόν (80%) των επιλέξιμων κερδών που παράγονται από επιλέξιμο άυλο περιουσιακό στοιχείοˑ πρόσωπο δύναται για κάθε φορολογικό έτος να αποποιείται ολόκληρης ή μέρους της έκπτωσης που χορηγείται δυνάμει της παρούσας παραγράφου:

Article 9(1)(κ), Income Tax Law N.118(I)/2002. In translation, and the translation is ours because the Law is enacted in Greek: eighty per cent (80%) of the qualifying profits generated from a qualifying intangible asset; a person may, for each tax year, waive the whole or part of the deduction granted under this paragraph.

So the relief is elective and the election is annual. It is claimed rather than applied, and a company can take part of it. Nothing in the paragraph says how qualifying profits are computed; that is left to Regulations made under its third proviso, which is why the nexus fraction lives in K.D.P. 336/2016 and not in the Law.

One proviso is worth knowing before any asset is assessed, because it is an ordering rule rather than a choice.

Νοείται περαιτέρω ότι, σε περίπτωση που το περιουσιακό στοιχείο δυνατό να εμπίπτει στις διατάξεις της παραγράφου (ε) και στις διατάξεις της παραγράφου (κ), τότε εφαρμόζονται οι διατάξεις της παραγράφου (ε):

Where an asset could fall within paragraph (ε), the earlier regime, and within paragraph (κ), the provisions of paragraph (ε) apply. Which of the two reaches a particular asset is a question of fact about that asset, and it is settled before the fraction is reached rather than after.

Which assets qualify

Qualifying intangible assets are legally protected assets that arise from research and development activity. In practice the categories that matter to technology businesses are:

• patents granted under Cyprus or foreign law
• copyrighted software, including source code and the systems built from it
• utility models and other legally protected technical rights

Marketing intangibles are outside the regime. Trademarks, brand names, logos and goodwill do not qualify, however valuable they are commercially.

How qualifying profit is calculated

The calculation runs in a fixed order. Reversing any two steps produces the wrong answer.

1. Establish overall income from the asset, net of direct costs.
2. Establish qualifying expenditure, being research funded by the company through its own staff or through unrelated contractors.
3. Add uplift expenditure, capped at 30 percent of qualifying expenditure.
4. Divide by overall expenditure to give the nexus fraction, capped at one.
5. Multiply overall income by the nexus fraction to give qualifying profit.
6. Deduct 80 percent of qualifying profit.
7. Tax the remainder at the corporate rate.

The nexus fraction is the step that decides the outcome. It is a ratio of spending, not of revenue, and it is measured cumulatively over the life of the asset rather than annually.

Why the 3 percent figure needs qualifying

Three percent is the effective rate where the nexus fraction is one. That requires substantially all qualifying expenditure on the asset to have been incurred by the company itself, or paid to unrelated parties.

The arithmetic is straightforward. On 1,000 of qualifying profit, 80 percent is deducted, leaving 200 taxable. At 15 percent, tax is 30, which is 3 percent of the original 1,000.

Where the nexus fraction is lower, the effective rate rises proportionally, because only the profit inside the fraction attracts the deduction and the remainder is taxed in full. The relationship is linear and can be stated as a single expression:

Effective rate = 15 percent × (1 − 0.8 × nexus fraction)

Each 0.10 lost from the fraction adds 1.2 percentage points to the rate. That is the whole of the regime's sensitivity, and it is why the fraction matters more than the headline deduction.

The IP Box calculator produces the effective rate for a given set of figures, which is the only way to know which of those two numbers applies to a particular company.