The Royalty Routing Company Structure

Contributed by Aspen Trust Group. [www.aspentrust.com]

Introduction

Royalties are the payment of licence fees or commissions by one individual or entity to another for the use of intellectual property (IP).

For many multinationals, developing and licensing intellectual property is one of their key activities.

Intellectual property can take several forms:

• Patents that protect inventions or new processes;
• trademarks that relate to the names of products and perhaps also their design and packaging;
• copyright, which attaches to any original creative idea expressed in words or pictures;
• image rights.

Proper structuring of the ownership of the intellectual property and channelling of the license payments can lead to substantial tax benefits.

This report highlights how to optimise IP management in a tax-efficient manner using Cyprus royalty structures.

How royalty routing works

A company owning the IP donates or sells it to a company in a zero or low tax jurisdiction (offshore company). This is preferably done when the IP is still of little value.

The offshore company then licences some or all of the rights for the use of the IP to an intermediary or agency company created in a jurisdiction offering tax benefits such as a tax treaty network, withholding tax exemption for royalty payments and other advantages.

The intermediary company then sub-licenses this right to customers in various countries. This way the royalty fees are remitted to the intermediary company, which may be subject to zero or a low withholding tax rates due to double tax treaty provisions.

The intermediary company retains a licence fee for the work done in negotiating the contracts and will pay tax on this sum

Finally, the intermediary company remits the balance to the offshore company free of any further withholding taxes.

Choosing the intermediary company

When choosing where to set up the intermediary company in a royalty structure, it is essential to consider the applicable double tax treaties, the costs for setting up the company and the capital requirements.

Cyprus for royalty routing structures

Centralising IP management in one location is a proven way to improve a company’s competitiveness and make substantial profits. This is why a growing number of companies are choosing Cyprus as the ideal place to make use of the multiple advantages that the jurisdiction offers.

Cyprus companies are being used extensively for IP holdings, licensing and sub-licensing.

Cyprus is ideal for royalty routing structures, because as a jurisdiction it offers the following advantages:

• Cyprus is firmly established and has been recognised as an international financial centre for the past 30 years.
• It has a favourable tax and legal system, excellent infrastructure and a convenient time zone.
• The cost of acquisition of the IP can be amortised for tax purposes.
• No withholding taxes are imposed on royalty payments to licensors outside Cyprus, provided that the Cyprus Company uses the IP outside Cyprus..
• Tax is only paid on the license fee retained by the Cyprus company and the applicable corporate tax rate is only 10% - the lowest in the European Union.
• The license fee retained by the Cyprus company will typically be 5%. Therefore, the corporate tax paid in a structure like the one in our example below is a maximum of 10% on 5% of the royalty income generated: i.e. a net 0.5%. The balance is routed to the offshore company.
• Any source tax withheld over the royalties received by the Cyprus company is available as a tax credit against the Cyprus corporation tax on the royalty income.
• Cyprus has a vast network of double tax treaties, and since Cyprus’s accession to the European Union, the EU Interest and Royalties Directive (2003/49/EC) provides for 0% withholding tax on royalty payments made to the Cyprus company by affiliated companies in different EU countries.

Other advantages

• Competitive fees
• Fast incorporation
• Low capital requirements

Key advantages of the Cyprus tax system

• Corporate tax rate at 10% (the lowest in the EU).
• Tax exemption on disposal of shares and similar titles.
• All expenses incurred wholly and exclusively for the production of income are deducted before arriving at the taxable income.
• Tax exempt dividend income (subject to certain conditions).
• No withholding tax on dividends interest and royalties paid by a Cyprus company to non resident shareholders – including individuals and corporations.
• No controlled foreign corporation (CFC) legislation.
• No thin-capitalisation provisions.
• Tax neutral reorganisations for EU and non-EU members.
• Exemption of profits from a permanent establishment/fixed place of business abroad (subject to certain conditions)
• Full adoption of EU directives.

Legal benefits of royalty structuring through Cyprus

• Flexible and business-friendly legal system - modelled on the English legal system, common law and equity apply.
• Domestic legislation is fully harmonised with EU legislation.
• The intellectual property (IP) legal framework covers and protects all recognised IP rights such as: trade and service marks, patents, industrial design and copyrights.
• Full adoption of EU directives and regulations.
• Member of all relevant IP international treaties and protocols including: the Madrid Agreement, the TRIPS Agreement, the European Patent Convention, the Patent Cooperation Treaty, the Berne Convention, and the WIPO Copyright Treaty.
• Cyprus is a particularly popular register for trade marks under the Madrid Agreement. The registration procedure is simple and fast.
• Enforcement of IP rights is strict in Cyprus with the Police and Customs Authorities having wide legal powers to enforce rights and prosecute offenders.
• Cyprus courts have the power to grant ‘ex parte’ temporary injunctive relief and restrictive orders, as well as, final judgements and orders.
• Cyprus court orders and judgements are enforceable automatically in every EU member country pursuant to the applicable EU regulation; and in many other countries by virtue of bilateral or international treaties that Cyprus has signed.

Practical considerations

The ideal candidate for royalty routing is a client who has a new IP right, when there is a minor difference between the fiscal book value and the real value of the right and it can therefore be transferred to an offshore company at nominal value.

Once the intellectual property rights are registered under the offshore company they are then licensed to other intermediary companies.

Royalty structuring possibilities

Basic structure
An EU or non-EU parent company establishes a Cyprus company to collect royalties from an EU group of companies.

The Cyprus company is the owner of the intangible assets:

Cyprus holding company

A Cyprus company used as a holding company of IP companies for a tax free exit route:

Practical example of a royalty structure through Cyprus

A European technology company is developing a product for which it intends to register the patent rights.
The European company registers the patent under the name of a British Virgins Islands (BVI) Company. The BVI Company subsequently enters into a license agreement with a Cyprus company for these technologies patent rights.

The Cyprus company now has the ability to exploit these patent rights in Europe and enters into contracts with European customers:

1. The first contract is with an Italian company to be able to use these patent rights.
2. The second contract is with a UK company to be able to use these patent rights.
   
   In these cases, the royalty income is remitted fully to the Cyprus company without withholding taxes in any EU country.
   
   
3. A third contract is signed with a Russian software company to be able to use these patent rights. In this case, the royalty income is remitted fully to the Cyprus company from Russia without any withholding tax in accordance with the double tax treaty.

The Cyprus company retains a 5% license fee and pays corporate tax on this income, but it will be able to remit 95% of its royalty income to the BVI Company where no further tax will be levied.

Additionally, the EU company will pay the Cyprus company for the right to use the patent. This will be considered as an expense for the EU company and, consequently, the taxable profit will be reduced.

If the EU company had negotiated these contracts directly, it could have suffered over 30% income tax in its country of residence. Furthermore, had the EU company disposed of the patent rights directly, the gain from such transaction would be taxed at the capital gains tax applicable (over 30%). However, if the BVI Company sells the patent rights, the capital gains tax is nil.

Owning vs Sub-licensing IP.

This table offers a comparison between two different scenarios: In the first scenario the Cyprus company owns the IP; whilst in the second scenario the Cyprus company sub-licenses the right to market the IP from the offshore company:

Conclusion

Cyprus offers multiple benefits that are attractive to a growing number of international companies who manage brands and intellectual property across borders.

Companies looking to optimise the advantages of centralising their key IP management functions in a tax-efficient jurisdiction should consider the use of Cyprus royalty structures.

Our services

Our team has the necessary expertise and is in the position to offer an integrated range of professional services and advice on the formation of a structure that is tax efficient and tailored to your specific needs.

We excel on the implementation and management of practical tax solutions aimed at meeting your business objectives.

What we can do for you:

• We can source the tax advice and assist in the architecture of the optimal structure for your business needs.
• Implement the structure in accordance to the advice.
• Offer the day-to-day administration and back office support in line with the agreed advice.
• Liaise with third party auditors to ensure financial reporting and tax compliance in line with the tax advice.

Contact Details
Elia House, 77 Limassol Avenue, 2121 Nicosia, Cyprus
Tel: +357 22418888 | Fax: +357 22418890
E-mail: info@aspentrust.com | Web: www.aspentrust.com

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