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

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.

Concept

The following can be done to manage the flow of income arising from IP rights in the most tax efficient manner possible.

The owner of the IP donates or sells it to an offshore company (ideally when the IP is still at a low value).  The offshore company licences some or all of the rights for the use of the IP to an onshore intermediary or agency company created in a jurisdiction offering tax benefits (ie. tax treaty network, withholding tax exemption for royalty payments and other advantages).  The onshore intermediary company then sub-licenses this right to customers in various countries.  Royalty fees pass to the onshore intermediary company, which may be subject to zero or a low withholding tax rates due to double tax treaty provisions.

The (small) percentage kept by the onshore intermediary company for work done in negotiating contracts are subject to tax.  The balance after tax is passed on by the onshore intermediary company to the offshore company free of any further withholding taxes.

Ideal intermediary companies

Ideal intermediary companies are Malta companies or Cyprus companies because of their extensive double tax treaties.  We recommend Cyprus IBCs or Malta ITCs for royalty routing structures because of the following advantages:

• No withholding taxes on payments of royalties to licensors outside Cyprus/Malta, provided that the property is used outside Cyprus/Malta by the Cyprus/Malta onshore company.

• Tax is only paid on the licence fee retained by the Cyprus/Malta company and the applicable rate is only 10%/4.2% respectively, the lowest within the European Union.

• The license fee to be retained by the Cyprus/Malta company will typically be 5%. So, the tax paid in a structure like that in our examples below is a maximum of 10%/4.2% on 5% of the income generated: i.e. a net 0.5% (Cyprus) / 0.21% (Malta). The balance is routed to the offshore company in a zero tax or low tax area.

• Both Cyprus and Malta enjoy a wide network of double tax treaties, and since their accession to the European Union, the EU-Interest and Royalty Directive may provide for 0% withholding taxes on royalty payments made by affiliated companies in different EU- countries to the Cyprus/Malta company.

Other advantages include:

• Competitive fees

• Fast incorporation (Cyprus company 3-7 days, Malta company 1-4 days)

• Low capital requirements (Cyprus company CY£1000, Malta company EUR250)

Practical Considerations

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

Once the intellectual property rights are vested in the offshore company they are then licensed to other, usually onshore, intermediary corporations.

Case Study

A software company develops software and registers the patent not under its own name but under the name of a (indirectly) 100% owned offshore company (e.g. a BVI company).  The offshore company then enters into a license agreement with a Cypriot/Maltese company for the offshore company’s European patent rights.

The Cyprus company now has the exclusive ability to exploit the offshore company’s IP in Europe.  The Cypriot company then enters into contracts with European customers, through which it exploits the rights, which it now owns.   Contract 1 is with a German software company for the right to subscribe to the software for which the Cyprus company holds the rights.  The second contract is with an Italian company.  The income passes fully to the Cypriot company without withholding taxes in any of the EU-countries.  The Cypriot company retains a 5% licence fee and pays tax on this income but it will be able to pass 95% to the offshore company where no further tax will be levied.
If the software company had negotiated these contracts directly it could have suffered up to 35% income tax on the income.  If the US company sells the rights, any gains may be taxed at 35 %. However, if the offshore company sells the rights, the capital gains tax is 0%.

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See also:

Double Taxation Treaties

International Business Companies