Cyprus, an interesting jurisdiction through which one can route their stream of royalty income.
Typically we tend to connote the term royalty income with big name corporations or artists who receive payments for the use of their names, trade secrets, or units of their software or songs sold or downloaded from the Internet.
But one of the developments in royalty payments, due to penetration and increased Internet usagethat have grown substantially, is micro-globalization. Micro-globalization has facilitated an increase in the number of small companies and independent professionals receiving royalty-related income from international business partners and clients.
Royalties are payments that are received for the use or sale of units of your property. Property either can be tangible, which means anything physical, orit can be intangible, also referred to as intellectual property, such as trademarks, patents, photographs, customer lists, or copyrights.
Over the years, countries have adopted measures to ensure a fair share of revenues and to discourage outflow of funds. The type of taxation applied to achieve these means is referred to as withholding tax. Withholding tax, also called retention tax, is a government requirement for the payer of an item of income to withhold or deduct tax from the payment and to pay that amount to the government as tax. Withholding tax applies when royalties are paid.
Royalty income is exposed to double taxation. This income is taxed at source in the country of the payers (withholding tax) and typically the recipient of the income is also taxed in his home country. To address this issue of double taxation, countries enter into Double Taxation Avoidance Agreements (DTAA), also commonly referred to as tax treaties. Very few countries have favorable tax treaties in place to address the problem of double taxation of royalty income.
If you are a resident of a country, or your business is based in a country, that does not have a favorable tax treaty with the country from where the royalty income is being paid, you need to seek out international tax planning, which means finding and implementing an effective, legal, and compliant way to lower the tax burden on your royalty income.
Over the years, the Netherlands has been regarded as one of the best countries through which to structure and lower taxation on royalties. However, an excellent and perhaps less expensive alternative would be Cyprus. With access to EU Directives, a substantial network of tax treaties with 40 or more countries, an overall corporate income tax rate of 10%, a properly designed tax structure could lead to an effective withholding tax rate of less than 2%.
However, care must be exercised when designing and implementing these types of structures. In addition, professional guidance is essential, as almost all modern tax treaties have so-called Limitation of Benefits clauses to prevent inappropriate use of tax treaties. The Limitation of Benefits clauses deny the benefits of the tax treaty to those that do not meet certain requirements. For example, if an Italian resident is the owner of the Cyprus-based company mentioned in the structure, he or she could not benefit of the Cyprus tax treaty benefits as the Cyprus-based company is not owned by a resident of Cyprus. Limitation of Benefits articles vary widely from treaty to treaty and are often quite complex, so this needs to be checked on a case by case basis.
A summary of the benefits, which could be attained through a properly developed royalty payment structure in Cyprus, would include:
– Absence or reduction of withholding tax on royalties paid to the Cyprus-based company under a Double Taxation Avoidance Agreement or Royalty Directive;
– Lower overall effective tax burden;
– Tax deduction of royalty payments;
– Effective tax depreciation of investments in intellectual property;
– Absence of withholding tax on royalty payments (including to offshore companies) for rights used outside Cyprus, which is usually the case;
– Neutral VAT treatment;
– Reasonable level of “margin” required by tax authorities;
– Effective protection of intellectual property rights by legislation and the participation of Cyprus in international agreements.
A typical structure would entail the transfer of the rights on the royalties to a special purpose company, which on its turn will license these rights to a Cyprus-based company and that Cyprus-based company will enter into sub-license agreements with the final user located in the EU or a country with which Cyprus has a Double Taxation Avoidance Agreement in place.
