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Foreign companies are often used as IP exploitation companies. Generally speaking, one can distinguish two structures.
One is a structure under which the IP is owned by an onshore company, based in a low (effective) tax country such as Cyprus or Malta or in a high tax country such as The Netherlands or Luxembourg benefiting from a special tax regime for IP exploitation companies in such country. Under this scenario the IP company directly licenses the IP to its global customers (these may be external customers or, in case of group licensing companies, affiliated companies), making use of the low tax rate for the related IP exploitation income and the network of double tax treaties of the country of establishment, which treaties may enable the IP company to receive its income against reduced withholding tax rates.
Another structure is one under which the IP is owned by an offshore company, not liable to any taxation over its income. The offshore company licenses the right to use the IP to an affiliated company, established in a country with a wide treaty network (The Netherlands is a good example). The onshore company then sub-licenses the IP to global customers. The onshore company receives all the relevant income and pays the vast majority of such income to the IP owning offshore company, after deduction of an arm’s length ‘spread’ for its own services. A benefit of a scenario of using the onshore company as intermediary versus a scenario under which the offshore company directly licenses the IP is that, in the latter scenario, due to the lack of availability of double tax treaties in the offshore country, payments to such company may suffer significant withholding taxes in the countries of the licensees. The onshore intermediary company would then be interposed to make use of the double tax treaty network of this company’s country of establishment with (still) low taxation over the overall income (taxation, albeit at high rate, over a relatively small spread due to the limited functions and risks of the onshore intermediary).
1. Reasons for setting up foreign IP companies
There are various reasons for setting up foreign IP companies. An important reason for using this kind of special purpose vehicles may be risk insulation; companies often strive to separate risk-bearing activities legally from other operations. In addition, and this may specifically be important for licensing operations, if risk-bearing activities involve the use of valuable assets (such as patents), companies may want to separate ownership of these assets from the operations for which these assets are used. Such separation can be established by using a separate company for the ownership of the asset. The assets can then be licensed to the group company using the asset in its commercial operations (or directly to external customers).
Fiscal reasons for setting up foreign licensing companies are mainly the possibility to qualify for a low tax rate (or tax exemption) for profits derived from the activities in question. Furthermore, in certain cases, a low VAT rate may give a country a fiscal benefit.
2. Important characteristics for a country to be regarded as tax advantageous jurisdiction for IP companies
it should either have a low general corporate income tax rate or a special low effective tax rate for (group) licensing activities
it should have a large double tax treaty network, in many cases providing for reduction of (and preferably exemption from) withholding tax over license payments made to licensing companies established in such countries. Many countries levy withholding taxes. These taxes are usually levied over payments of dividends, interest and/or royalties made by residents of those countries. The rates of these taxes vary, but in some countries they may rise to 30% (or higher). The availability of double tax treaties, which may provide for reduction of such withholding taxes in case of payments to companies in countries that have tax treaties with the countries of residence of the paying parties, is an essential element in international tax planning
in EU-context, establishment of the company in an EU jurisdiction may lead to important fiscal benefits, since the so-called ‘EU Interest and Royalty Directive’ may under circumstances provide for exemption from withholding tax over royalty payments between affiliated EU-companies
it should not levy withholding tax over royalty payments
ideally, the country of establishment of the licensing company would not have withholding taxation over dividend payments (or it should be relatively easy to circumvent such taxation)
ideally, the country of establishment of the IP company would not levy tax over gains upon the sale of shares in local companies by non-resident shareholders either.
3. Issues to consider
Before deciding to incorporate a foreign IP exploitation company, other issues need to be considered as well. Below you will find an overview of a few of these issues.
One issue to consider is the possible blacklisting of certain jurisdictions in the countries of residence of the licensee companies. Such blacklisting may have as consequence that license payments to companies based in certain jurisdictions will be denied deduction in the former countries. This is also an issue that must be discussed with tax specialists in the licensee countries.
Furthermore, the issue of transfer pricing is of outmost importance. In case of group licensing, at the risk of (partial) denial of deduction of the license payment in the licensee countries, it has to be ascertained that the conditions of the licensing agreements between the group licensing company and the licensee companies meet the so-called ‘arm’s length standard’; in general terms, these conditions should be equal to those that would have been agreed between independent parties in comparable circumstances. This is also an issue that must be considered by local tax experts in the countries involved.
The investor’s home country may also have so-called ‘CFC (controlled foreign corporation) legislation’, under circumstances leading to immediate taxation over profits realized by foreign licensing companies (even without distribution of such profits) in certain countries (so-called ‘blacklisted countries’) owned by such investor. Therefore, it is always advisable for investors to liaise with local tax specialists before setting up foreign licensing structures.
Investors should also be prepared for a possible challenge of the licensing company structure by the tax authorities in their home countries. The risk of such challenge depends on various factors, such as the attitude of these authorities in general towards foreign financing structures, their available audit tools and policy etc. Tax authorities could argue that the management and control of a foreign licensing company is de facto exercised in the country where the investor/ultimate owner of the company is based. A way to reduce the risk of success of such challenge usually is the creation of as much ‘substance’ (office space, qualified employees etc.) in the licensing company’s jurisdiction.
Especially in case of so-called ‘back to back structures’, there is in certain countries the risk that the tax authorities will disallow double tax treaty based reduction of withholding tax over the license payments to licensors in treaty countries, as they may disregard the latter persons as beneficial owners of the income. This has to be judged on a case by case basis.
Finally, in case the IP in question is developed in a high tax country, investors should be aware of the risk of taxation over the difference between the book value of the IP (if any) and its fair market value at time of the transfer of such IP to a low tax company. Also for that reason, it is always advisable for investors to liaise with local tax specialists in their home countries before setting up foreign licensing structures.
4. What we can do for you
Consulco has all the relevant experience and expertise in the field of the fiscal- and legal guidance of licensing companies in Cyprus.
We are able to assist clients using this kind of companies in all the relevant areas, such as incorporation, domiciliation, taxation, legal matters and accounting matters.