Your Taxes: Cyprus for tech companies

Israeli and foreign multinational tech companies are bruised by the efforts of the Israel Tax Authority, in court and outside, to tax “trapped profits” from past Israeli tax breaks, if the profits are invested outside Israel. A country that makes things easier is Cyprus. In May 2012, Cyprus passed an amendment to reduce its 10 percent corporate income-tax rate for tech companies. Cyprus and Israel are friendly neighbors, similar to the United States and Canada.

Cyprus amendment The Cypriot amendment includes the introduction of a new intellectual-property-rights box (“IP box”) in Cyprus. The new regime, which is effective from January 1, 2012, can now compete with any other IP-box regime globally.

The regime will apply to all categories of intellectual property acquired or developed by a Cyprus resident company post-January 1, 2012. All expenditure incurred and income received in relation to the intangible property will be captured by the regime. This includes the cost of acquisition or development of the asset, the income received from the use of the intangible assets and any profit on disposal of the IP rights.

Structuring intellectual-property rights through Cyprus can achieve an effective tax rate of less than 2%. And Cyprus does not tax dividends paid to non-Cyprus-resident shareholders.

When comparing this to the other IP regimes in Israel or the EU, this is by far the lowest rate achievable.

In Israel, by contrast, “preferred enterprises” will generally pay 6%-12.5% corporate income tax, and dividends are taxed at 15% subject to any tax treaty.

Cost of acquisition or development Prior to the amendments made, any cost of acquisition or cost of the development of IP rights by a Cyprus company would need to be amortized over the estimated useful life of the IP. For example, if the life of the IP was deemed to be 25 years, a writing-down allowance (depreciation) of 4% would have been given on a straight-line basis per annum.

The new regime offers a far more beneficial amortization period, and the costs can now be amortized over a five-year period, resulting in a writing-down allowance of 20% per annum.

The change in the accelerated writing-down allowances should immediately result in huge tax benefits for the acquiring company, in particular where the asset is of substantial value.

Royalty income Where the Cyprus resident company has granted licenses to overseas licensees and receives royalties from the exploitation of the IP rights, the income will be taxed at the standard corporate income-tax rate of 10%. However, under the new regime, 80% of the royalties received will be exempt from Cyprus tax after deducting any directly attributable expenses incurred on the amounts received.

Any further general expenses can also be deducted from the profit but are not subject to the 80% rule.

For example, if a Cyprus company derives royalty income of 1 million euros and direct expenses of, say, 20,000 euros, there will be net royalty income of 980,000 euros. Of this, 80% ( 784,000 euros in this example) is exempt, leaving gross taxable income of 196,000 euros. From this, other general expenses of, say, 6,000 euros may be deducted, leaving only 190,000 euros liable to the 10% corporate income tax in Cyprus. So the tax will be 19,000 euros.

This example shows that an effective tax rate of 1.9% may be achieved from the holding and exploitation of intellectual-property rights in Cyprus. The rule is also applicable to any compensation received in Cyprus for the misuse of such property.

Profit on disposal Under the new Cyprus IP-box regime, any profit on disposal of the acquired or developed intellectual property is eligible for further tax benefits.

A general deduction of 80% will be available on the net profit on disposal (gross sale price less cost of purchase and amortization deductions claimed in prior years).

The remaining profit will be taxable at the standard corporate income tax rate of 10%.

Planning There are further tax-planning opportunities that will result in a tax-free disposal. This can be achievable if, as an alternative to the disposal of the IP directly, the shareholder of the Cyprus company disposes of the shares in the Cyprus company that holds the IP rights. Any gains arising from the disposal of shares are totally exempt in Cyprus, providing that the company in which the shares are being disposed of does not contain any immovable property that is situated in Cyprus.

Other benefits Any distributions made from a Cyprus company to its overseas shareholder would be fully exempt from tax in Cyprus.

Cyprus is an EU member state and has an extensive tax-treaty network with other countries.

There is no tax treaty between Israel and Cyprus, but negotiations about such a treaty are reported to have begun.

Israeli taxation Israeli residents who use a Cyprus company should check the interaction between Cyprus and Israeli taxation. Israeli residents are taxable on their worldwide income and gains. Israel has rules for granting a foreign tax credit against Israeli taxes arising. Any Cyprus company should have substance (activities, offices, personnel, etc.) and not be controlled and managed in Israel; otherwise, it may be deemed to be resident and taxable in Israel.

Israel also has rules for taxing distributed and undistributed profits of certain foreign service companies owned 75% or more by Israeli residents and passive-controlled foreign investment corporations. Nevertheless, advance tax planning can sometimes remove or defer such taxation until the relevant income is received by Israeli residents.

Conclusion A Cyprus-Israel structure can be beneficial from the tax perspective for multinational tech groups and for companies in other sectors.

As always, consult experienced tax advisers in each country at an early stage in specific cases.

C.Theodorou@bakertillyklitou.com leon@hcat.co Chris Theodorou is a tax manager at Baker Tilly in Nicosia, Cyprus. Leon Harris is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd. in Ramat Gan.