Exemption on Income Derived from Patents

The protection and fostering of intellectual capital is essential to any business, as well as to society in general, in order to motivate further investment in research and development by enterprises as well as to encourage and support the exploitation of knowledge and intellectual property. The successful deployment of intellectual property rights clearly leads to economic returns to the proprietor whilst ensuring that knowledge is utilised and exploited. Accordingly, it is unsurprising that intellectual property has become a key strategic asset that both individuals and enterprise can exploit to generate wealth.

In recognition of this need to incentivise the creation and exploitation of intellectual property, Malta maintains an attractive tax incentive administered by Malta Enterprise (the domestic agency responsible for the promotion of foreign investment and industrial development in Malta) and the relative Maltese tax authorities, which consists of an effective outright exemption from income tax on any royalties derived from the licensing of patents.

The said incentive was introduced by the Maltese legislator back in 2010 by means of the promulgation of the ‘Exemption on Royalties derived from patents rules’ (the “Rules”) issued in the form of subsidiary legislation under the Malta Income Tax Act (Chapter 123 of the laws of Malta).

Qualifying Patents

As such, all royalties and similar income derived from qualifying patents in respect of inventions, including any sum paid for the grant of a licence to exercise rights under a patent, are effectively exempt from tax. In terms of the Rules, a ‘qualifying patent’ is “a patent, which is registered in Malta or elsewhere, in relation to which the research, planning, processing, experimenting, testing, devising, designing, developing or similar activity leading to the relevant invention was carried out in Malta or elsewhere”. Accordingly, the tax exemption applies regardless of the place where the patent is registered and of where any relevant research and development resulting in the qualifying patent may have been carried out. Moreover, the exemption may be availed of both where there is an active trade of licensing of several patents as well as in the case of passive receipt of royalties from patents.

Patent Registration in Malta

The invention, on the strength of which the patent has been obtained, must also be patentable under Maltese law or be the result of fundamental research, industrial research or experimental development. Moreover, the licensing of the patent to an enterprise must be for use in a productive economic activity, such as manufacturing, software development and data processing.

Insofar as it is able to corroborate that the applicant, the patent and the licensing agreement are aligned with the applicable rules, Malta Enterprise will proceed to issue an Entitlement Certificate specifically stipulating that any royalty payments received by the patent holder from the relative licensee are to be treated in terms of the incentive. The tax exemption would then apply from the year of assessment stipulated in the Entitlement Certificate. The Entitlement Certificate has a validity of up to three years, which period may be renewed upon a fresh application.

Tax exemption on royalty income

The tax exemption on royalty income derived from patents is further complimented by other attractive aspects of Malta’s fiscal regime which allow for tax efficient structuring of intellectual property holding and licensing activities including, inter alia, the fact that Malta imposes no withholding taxes on outbound dividends, interest or royalties and access to an extensive double tax treaty network with over 60 countries.

Royalty Exemption

Like other specific exemptions (such as the Participation Exemption) the Royalty Exemption is optional. The taxpayer has the right to renounce the exemption, and have the royalty income assessed to tax.  This income will be charged to tax along with any other income, however, in the case of Companies, and depending on a number of conditions, upon distribution of dividends, the shareholder of the Company will have a right to claim a refund of tax ranging between 5/7^ths and 6/7^ths of the tax paid by the company and imputed to the shareholder by means of the dividend.

In 2012, the Maltese parliament approved amendments to the income tax law that extended the scope of the royalty exemption for patents to cover income from some copyrights, thereby broadening the regime by exempting royalties derived from qualifying copyrights. Such intellectual property includes artistic, audiovisual, literary and musical works, and other copyrights which may be directly relevant to the gaming industry.

This notwithstanding, a legal notice prescribing the terms and conditions necessary to apply the exemption to copyright royalties has yet to be published. The much awaited implementation of the necessary regulations required to apply the extended exemption in practice will certainly bolster Malta’s position as a leading, reputable jurisdiction for the structuring of intellectual property holding and licensing activities.

Dr Richard Bernard - Advocate Corporate, I.P & Financial Services. This article featured in the Lotteries and Gaming Authority (LGA) 2014 Update Publication.