Intellectual Property (IP) is a key asset for creating and commercializing innovative products and services protected by patents, copyrights, and other forms of intellectual property. That’s why it occupies a central place in the world of modern technology and business. However, taxing the income generated from IP can be a complex task for companies operating in this sector. To simplify this process, the IP Box was developed—a special tax initiative aimed at supporting innovation development and the commercialization of intellectual property assets.
In this article, we will explore what the IP Box is and its nuances.
What does IP Box mean?
IP Box is a tax regime that involves taxing profits from innovative activities at reduced rates. This regime applies to the creation of intellectual property assets, excluding trademarks. Its main goal is to promote innovation development and increase the commercialization of intellectual assets, including patents, software, innovative algorithms, production practices, design, and many other components.
Key components of IP Box
IP Box has several main elements, including:
- Types of Assets: The IP Box regime can be applied to patents and related rights in all countries where it is in effect. However, copyrights, trademarks, designs, and models may not include this regime in some countries.
- Tax Rate: The tax rate varies from 0% (in San Marino) to 11.5% (in Turkey).
- Application Conditions: The application conditions of IP Box may differ in each country.
- Determination of Tax Base: The tax base may include gross profit or net profit, and expenses related to the creation of intellectual property can be included in the tax base or accounted for as amortization of intangible assets.
Where is IP Box applied?
IP Box is in effect in 13 out of 27 European countries, including Luxembourg, Cyprus, Portugal, and Poland. It should be noted that not all intellectual property assets automatically qualify for IP Box requirements, and this can vary depending on the specific country.
IP Box in Cyprus
Cyprus is recognized as one of the most attractive countries for using IP Box. Its main advantage is that 80% of the profit falling under this regime is exempt from taxation. Only the remaining 20% is subject to tax, which, given a corporate tax rate of 12.5%, results in an effective rate of only 2.5%. In calculating qualified profit of Cyprus company, the Nexus approach is used, which depends on total income, qualifying expenses, additional expenses, and overall expenses. Qualified assets include patents, copyrighted software, and other intangible assets that are new and useful.
Overall Expenses and Nexus Formula
Total income is calculated as gross income minus direct expenses, including royalties and income from the disposal of assets. The Nexus formula is calculated based on total income, qualifying, additional, and overall expenses.
Under this approach, the level of qualifying profit positively correlates with the extent to which the applicant conducts research and development activities related to the qualified asset in the same company.
Qualified assets include:
- Patents
- Copyrighted software
- Other intangible assets that are new and useful, excluding trademarks and copyrights
Qualified entities include:
- Taxpayers who are tax residents of Cyprus
- Permanent establishments of non-residents
- Foreign persons subject to taxation in Cyprus
Total Income (OI):
Total income is calculated as gross income minus any direct expenses, including expenses related to earning such income
Total income includes:
- Royalties received for the use of intangible assets
- Trading income from the disposal of qualifying assets
Qualifying Expenses (QE):
- Salaries and wages
- Direct expenses
- Research and development expenses (R&D)
- R&D expenses outsourced to third parties
Additional Expenses (UE) are the lesser of two values:
- 30% of the total qualifying expenditure (QE)
- Costs for acquiring qualifying assets plus R&D expenses outsourced to related parties through outsourcing
Overall Expenses (OE) are the sum of two values:
- Total qualifying expenditure (QE)
- Costs for acquiring qualifying assets plus R&D expenses outsourced to related parties through outsourcing
IP BOX Luxembourg
In Luxembourg, this regime operates similarly to a similar regime in Cyprus. Under certain conditions, companies can receive an 80% exemption from taxation on the net income derived from intellectual property (IP) assets such as trademarks, software rights, patents, utility models, and more. This is an important tool for stimulating Luxembourg’s innovation and intellectual property development.
- Tax Rate: IP Box vs. Standard Rate
One of the key advantages of the IP Box in Luxembourg is the low tax rate. The effective tax rate is only 4.99%, which is significantly lower than the standard tax rate of 24.94%. This makes Luxembourg an attractive destination for companies involved in innovation and developing new technologies.
- Legislative Changes: What Changed in 2018?
In 2018, Luxembourg enacted a new IP Box law, introducing certain changes to this tax regime. One of the most significant changes was limiting the scope of IP Box-eligible assets in Luxembourg. Now, “qualified assets” in Luxembourg include:
- Patents and functionally equivalent rights
- Copyrighted software
Conditions for using IP Box in Luxembourg
The tax exemption under IP Box is applied only when the global net income from qualified IP assets exceeds the global expenses associated with those rights. This means that companies with net losses from qualified IP rights in previous years can use those losses to offset tax liabilities when they generate a net positive income.
- Research and development expenses related to creating, developing, or improving qualified IP rights
- General and speculative research and development expenses that may be related to or allocated among various qualified IP rights
- Research and development expenses incurred by a taxpayer’s permanent establishment in Luxembourg
- Research and development expenses are conducted “outsourced” to an independent third party
Overall expenses are calculated as the sum of qualified expenses related to acquiring intellectual property and “outsourcing” expenses incurred by third-party companies.
When calculating the income eligible for tax exemption, the same Nexus approach, as used in Cyprus, is applied.
IP Box in Poland: features and nenefits
Poland has an interesting model for calculating tax incentives under the IP Box, which differs from other countries. Instead of paying tax at regular rates, companies can take advantage of a special reduced rate of 5% on qualified income instead of the standard 19%. The Nexus principle and a special formula determining the Nexus index are used to calculate the tax base, which ranges from 0 to 1.
This formula takes into account the following components:
- Research and development activities related to qualified intellectual property
- Research and development results related to qualified intellectual property from an unrelated entity
- Research and development results related to qualified intellectual property from a related entity
- Qualified intellectual property acquired by the taxpayer
To calculate qualified income eligible for the preferential 5% tax rate under the IP Box program, you need to multiply the Nexus index by the income derived from qualified intellectual property rights in a given tax year.
To qualify for this preferential regime, companies must meet several requirements.
Criteria and objects for the application of the IP Box preferential regime in Poland
- Conducting Research and Development: This includes activities related to scientific research and development aimed at creating new intellectual assets
- Creation of Qualified Intellectual Property (IP): This criterion covers the process of creating intellectual assets as part of research and development activities
- Recording Financial Events: This requires maintaining separate records of all financial transactions related to income from qualified IP
- Earning Taxable Income in Poland: The IP Box regime applies only to income earned in Poland from qualified IP
- Acceptable Development Expenses for Intellectual Assets: This implies incurring expenses that are proportionally linked to the creation, development, or improvement of qualified IP
- Patent (patent)
- Right to Protection for a Utility Model (prawo ochronne na wzór użytkowy)
- Right by Registration of an Industrial Design (prawo z rejestracji wzoru przemysłowego)
- Right of Supplementary Protection for a Medicinal Product or Plant Protection Product
- Right to Register a Medicinal Product and a Veterinary Medicinal Product for Sale
- Exclusive Right as Provided by the Plant Varieties Protection Act (prawo z rejestracji prawnej odmian roślin)
- Right to Register the Topography of an Integrated Circuit (prawo z rejestracji topografii układu scalonego)
- Copyright for a Computer Program (autorskie prawo do programu komputerowego)
This list is especially relevant for software developers as it covers key IP objects eligible for preferential taxation under the IP Box regime.
IP Box is a powerful tool for stimulating innovation and supporting the development of intellectual property. Countries offering this special tax initiative become attractive locations for companies operating in the field of innovation and the development of new technologies, contributing to economic growth and the development of new products and services.
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