This trend applies to various companies, from the largest multinational IT corporations to small start-ups. At the same time, software or inventions often form the basis of the whole business and are its most valuable assets. The peculiarity of intellectual property is that it is easily portable: for example, software can be created by developers remotely from anywhere in the world, and the program itself can be sent to the customer by e-mail or uploaded in a cloud service. Therefore, one of the major factors when companies choose a jurisdiction to locate and then commercialize their intangible assets is the tax regime.
To increase the attractiveness of the jurisdiction for tech companies, some countries create special, more favorable, tax regimes for income from usage of intellectual property – the so-called IP Box regimes. In this article we will talk about the most popular IP Box regimes and how they work.
What is the IP Box and how it works
IP Box is a general name for preferential tax treatment, under which part of the profits from the use of intellectual property is exempt from taxation. As a rule, the IP Box regime applies to patents for inventions and utility models, as well as software, in rare cases, to other intellectual property.
The IP Box regime allows companies engaged in the development of patentable solutions and software, as well as research and development activities to significantly reduce their tax burden.
The first steps towards the introduction of IP Box regimes were taken back in the early 2000s, when some European countries began to introduce some form of tax relief for intellectual property, and often the amount of relief was not linked to the cost of development of such objects. This situation created unhealthy tax competition among jurisdictions, which was of concern to the Organisation for Economic Development and Cooperation and Development (OECD) and the EU.
In order to reduce tax competition among countries, in 2014 it was decided to switch to the so-called nexus approach, which restricts the application of the IP Box regime if research and development is outsourced to affiliated companies. OECD member countries committed themselves to establish by June 30, 2021 a legal link between companies’ expenditures on development of intellectual property and the scope of tax preferences under the IP Box regimes. The application of tax exemptions under the previous regimes has to be terminated.
IP Box in Cyprus
Before the introduction of the new regime based on the nexus approach, Cyprus was the most attractive jurisdiction to locate IP objects in. However, even after switching to the new regime from July 1, 2016, Cyprus remains one of the most favorable jurisdictions for doing IT business.
Applicants who may apply for preferential treatment:
(1) tax residents of Cyprus, including
(2) Permanent establishments of non-resident companies; and
(3) foreign permanent establishments which are subject to taxation in Cyprus.
Under the rules of the new regime, 80% of the qualifying profits derived from certain types of intellectual property (qualifying assets) are not subject to income tax. The remaining 20% of income from these assets is taxed at the standard rate of 12.5%.
The list of qualifying assets includes:
– patents and similar intellectual property;
– other intellectual property, which is “non-obvious, useful and new”.
In this case, IP must be certified by the competent state authority of Cyprus or another state.
Trademarks and copyrighted works (excluding software), as well as other IP related to the promotion of goods and services in the market, under the new regime cannot be used to obtain benefits.
Qualifying profit is calculated by a formula:
overall income x (qualified expenditure + additional expenditure) ÷ overall expenditure.
Overall income is calculated as revenue less any direct expenditure. Overall revenue includes royalties received under license agreements and revenue from any sale of IP. Qualifying expenditure includes salaries and other expenses associated with the development of the asset, including funds paid to third parties for development. Such third parties may not be affiliated with the company applying the preferential tax treatment.
It will not be possible to include in the qualified expenditure any costs for the purchase of IP that has already been developed, dividends paid or payable, any amounts payable to affiliates for development, or costs for which their connection with the development of a particular IP item cannot be confirmed.
The lower of the following values is used as additional expenditure:
– 30% of the total qualified expenditure;
– acquisition costs of qualifying assets plus development costs incurred by interdependent parties as part of outsourcing.
Overall expenditure is defined as the sum of the following values:
– total amount of qualified expenditure;
– acquisition costs of qualifying assets, plus development costs incurred by related parties as part of outsourcing.
Qualifying profit is calculated similarly in other jurisdictions that have introduced the nexus approach.
Patent Box in Switzerland
As of 1 January 2020, a new regime will be introduced in Switzerland, the Patent box. The terms for this regime are stricter than the ones of the Cyprus IP Box regime. Thus, only the following intellectual property is eligible for the benefits:
– Swiss and foreign patents;
– comparable rights, which include additional protection certificates (extension of patent protection for medicines and plant protection products after the expiration of the main patent), topography (protection of semiconductors), plant varieties protected under the Plant Variety Protection Law and documents protected under the Federal Act on Medicinal Products and Medical Devices.
As a general rule, therefore, unpatented software is not subject to the Patent box regime.
Furthermore, it must be borne in mind that preferential treatment can only be applied to patents already obtained, and not to patents pending before the competent authorities.
Under this regime, up to 90% of qualifying income from the commercialization of intellectual property is tax exempt at the cantonal level. The cantons may, however, provide lower tax exemptions on profits. At the federal level, profits are subject to general taxation, so the effective tax rate for IP can be up to 10%.
Innovation Box in the Netherlands
The new Innovation Box mode has been in force in the Netherlands from January 1st, 2017.
As under the previous regime, the application of the Dutch Innovation Box requires that the company applying for it carries out direct development and that qualifying income from development is associated with patents or other intellectual property rights that may be registered. At the same time, the profits must be properly documented.
It is important to note that, under the rules of the new regime, software that could be protected by copyright law is a qualifying asset.
For the purposes of application of the new regime, small and large taxpayers are distinguished.
Small taxpayers include companies:
– the total (group-wide) net turnover of which is less than 250 million euros over five years;
– qualified intangible assets with a profit of less than €37.5 million over five years.
Taxpayers which exceed any of these thresholds are considered large taxpayers.
If small taxpayers only need to have a public development certificate in order to qualify, large taxpayers can qualify only if they meet additional criteria in addition to the development certificate, e.g. they have an EU license to trade in medicines, a patent, a certificate for additional protection or a certified utility model.
As far as patents were concerned, they could also be applied during the processing of a patent application if the application was ultimately approved.
If these conditions are met, profits from qualifying assets will be taxed at a reduced rate of 7% rather than the normal tax rate (25%). However, from January 1, 2021, this rate will be increased to 9%.
In addition, restrictions on this treatment are imposed on those taxpayers which contract more than 23% of their development activities to other group companies.
Knowledge Development Box in Ireland
Ireland is also a country with a preferential tax treatment for income from IP. At the same time Ireland traditionally holds a leading position in the ranking of the most favorable jurisdictions for commercialization of IP. It is no coincidence that European centers of such technological giants as Microsoft, Apple and Google are located in Ireland.
According to the rules of the Knowledge Development Box regime, up to 50% of profits from IP may be exempt from taxation, which means that the effective tax rate can be reduced to 6.25%.
Qualifying assets include copyrighted software, patented or similarly protected inventions. Small companies are also entitled to preferential treatment for registered inventions that have been certified by the Controller of Patents as new, unobvious and useful. Small companies with income from IP of less than EUR 7.5 million are considered to be small for the purposes of the Knowledge Development Box.
Preferential tax regimes for intellectual property are applicable not only in the jurisdictions mentioned above. With the introduction of the nexus approach within the OECD, all European countries have tightened the rules and narrowed the application of IP Box regimes. Nevertheless, even after the transition to the nexus approach, tax optimization using IP Box modes remains a relevant tool for technological companies, including small start-ups that create IP with high margin.
When choosing a specific jurisdiction to create a technology center, you should first of all take into account the list of qualifying assets, as this list may vary depending on the chosen jurisdiction. Thus, while patents, as a rule, refer to qualifying assets in all jurisdictions, the software is not always subject to preferential treatment.
In addition, tax rates under IP Box regimes should be taken into account when choosing a jurisdiction, as they also differ significantly from country to country. For example, in Cyprus the preferential rate is 2.5%, when in France the rate is 10%.
Finally, we recommend that you pay attention to the requirements for supporting documents. In some countries, such requirements can be a serious bureaucratic barrier to the application of preferential tax treatment.