How to manage intellectual property by optimizing the taxation of royalties

After having addressed in detail in the last article the foundations of withholding taxes and double taxation agreements, we are now going to enter into another complex issue: fees and licenses. To better understand this article we recommend that you read the previous article, since here we will not repeat what was explained there.

Licensing fees (also called royalties; we will use the names interchangeably in this article) are, together with interest income and dividends, one of the three categories of income that may be subject to withholding taxes.

In turn, royalties can be divided into several subcategories that present a different tax treatment depending on the applicable double taxation agreement. While in many small countries royalties are treated equally, there are some countries, such as the United States, that differentiate between them according to the license type.

In its double taxation agreements, the US differentiates between the withholding taxes on royalties through licenses of:

• Industrial equipment (industrial goods)
• Technical knowledge (know how) and other industrial licensing fees
• Patents
• Film and Television
• Copyright

Many of the subcategories of licensing fees are irrelevant to the common Librestado reader. But in the world of online business especially there is a type of royalty that is always relevant. It has to do with intellectual property, in particular, copyrights for electronic and physical books, but also for video courses and other digital works.

What royalties are subject to withholding taxes?

Electronic books and courses in video format do not have to be affected by withholding taxes. The important thing is the sales process.

In the case of Librestado, for example, we have opted to work without publishers since we do not consider them very useful; we sell our ebooks by ourselves through different collection systems.

Although the issue of the VAT on automated digital products must be taken into account, when processing the sales yourself you have the advantage that no withholding tax is applied.

However, this all changes if we transfer the rights of our work to a publisher. The publisher pays a licensing fee previously agreed upon for the exploitation rights that were transferred to them; after all, they deal with commercialization.

Depending on where the publisher is located, the withholding tax may be applicable.

Retention on royalties amounts to 25% in Mexico, 21 to 28% in Argentina, 19% in Spain, 30 % in Chile… Of course, depending on the countries to which the money flows, the withholding can be reduced to 0% thanks to the double taxation agreements.

Of course, this withholding on royalties has nothing to do with company taxes, taxes that must be paid according to the country in which the company is located. Nor do they have to do anything with the VAT, which is charged according to the country of residence of the end user or the company that markets it.

In digital market places like Digistore24.com or Elopage.com (in Germany), no withholdings apply. These are resellers, and as such they are not subject to credit card processors’ license requirements or to the retention obligation at the publisher’s origin.

They have not obtained exploitation rights from the authors that sell, so you do not have to pay licensing fees. In these cases it is rather a commission free of withholding taxes.

Withholding taxes in the case of publishers

This is different when you work with the Internet giant, Amazon, which in its beginnings was mainly dedicated to the sale of books. Also, those who sell through Android or Apple Store apps should pay attention to the same points as Amazon.

Here, the copyright stays with the creator, but the operating costs are transferred to the market place. Thus, Amazon, Apple Store or somebody else deals with processing the VAT and then pays royalties according to who has the licensing rights.

In the case of the sale of electronic books through Amazon Kindle Direct Publishing , it is normally 70% for books less than € 9.99 and 35% from that price. Keep in mind that the VAT is already included.

Of course, this involves a great loss of profit that comes straight out of Amazon’s pocket, if we compare it to an independent processing of collections and commercialization.

Another problem is that withholding taxes are assigned to the distribution side of Amazon, although Amazon KDP is actually based in Luxembourg, where the withholding tax is not applied.

This is due to the fact that Amazon, up until the introduction of VAT charges according to the customer’s country in 2016, could have applied the lowest VAT in the EU, of 17%, or even negotiated to reduce it even more.

However, considering that Amazon is ultimately an American company, all sellers must complete the famous W8BEN forms; otherwise, this would be a problem in every sale involving the US-Kindle-Shop.

There are only three Spanish-speaking countries with agreements that reduce withholding taxes.

In the double taxation agreement between the US and Mexico, a 10% retention rate is stipulated on this type of royalties, as in the case of Venezuela. For Spain the withholding is 5%.

Of course, a businessman who lives in one of these countries and moves his residence to Panama, Costa Rica, Paraguay or any other country in which he does not pay taxes on foreign income will get a big surprise when, due to the lack of double taxation agreements with the US in these countries, he sees that a 30% withholding tax on royalties is applied.

Now, the big question: what can be done in these cases?

Taxation of intellectual property according to residence and registered office

Of course, there are many countries that have signed agreements to reduce or even cancel completely the retention on copyright.

For example, this agreement with Germany, Finland, France or Greece stipulates 0% in this type of revenues.

However, you have to keep in mind that avoiding the withholding tax is of no use if the local income or company tax is still high.

Therefore, it is about finding a country that has an interesting double taxation agreement, which minimizes the retention over the US, and in which taxes for this type of income are kept as small as possible.

Here, we must pay attention again to the differentiation in the use of the double taxation agreement between the place of personal residence and the registered office.

As explained in the previous article about the withholding on dividends, to be able to use double taxation agreements, a tax certificate is required, a certificate that is generally only granted after 183 days of stay.

As for the company, simply being a capital company with commercial establishment in the country is sufficient to take advantage of a double taxation agreement.

Charging licensing fees through companies not only makes us more flexible, but the corporation tax is also usually lower than the income tax on individuals.

Here it is worth mentioning that in many countries there are special regulations on licensing fees from intellectual property, both for individuals and corporations.

In the case of individuals, this works through global deductions, in which intellectual property income is often taken into account with a certain percentage.

The taxation of the IP-Box and its elimination

The so-called Patent Boxes were often used in companies. However, the taxation of IP was attacked in 2016 by the BEPS law (Erosion of the tax base and transfer of benefits) because it favored tax avoidance.

Currently IP-Boxes are in extinction and only those companies that already used them in 2016 can still use them until 2021.

In IP-Boxes, amortizations of almost 80% were applied, equivalent to an effective tax of only 2.5%.

While in some countries the taxation of the IP-Box was from the beginning limited to patents and industrial technical knowledge, Cyprus defined intellectual property in a much broader way.

Also, all the books and video courses fell into the category of intellectual property and, thanks to the IP-Box, were only taxed at 2.5%. To this it was added that Cyprus still had a double taxation agreement with the United States, which left the withholding tax at zero.

Despite the elimination of the IP-Box, Cyprus is still a good option for entrepreneurs working with Amazon KDP thanks to its 12.5% corporate tax and its many optimization possibilities.

However, the IP-Box will not return. Modified and addressed to patents and other issues relevant to large groups, it still exists in Holland in the form of an “Innovation” Box, which includes, for example, software development but does not serve as books or courses. To use the 5% special tax, the requirements are numerous.

The best residences for authors and developers

Which countries are left, in terms of personal and company residency, in which the 30% withholding tax on American licensing fees can be reduced?

A residence in the Czech Republic is a good candidate as a home due to the global deduction of 40% on the income for intellectual property and a 0% quota of the double taxation agreement. Although the global deduction is limited.

We can find countries with 0% in Western Europe, but ironically also in the former States of the USSR.

Thus, Georgia, a country with a territorial tax, can benefit from good double taxation agreements. But Georgia is not the only country with territorial taxation that can allow you total freedom of taxes on licensing fees.

Within the EU, above all Ireland is the first choice for writers. This is due, in addition to the double taxation agreement that leaves the withholding at 0%, to the non-dom system, under which foreign income is tax-free under certain circumstances.

Ireland has gained some notoriety because income from literary creations is tax free across the country up to € 50,000, but not unlimited, as has been falsely stated.

However, using the non-dom status can achieve an effective tax release. Only income introduced and used in Ireland is taxed.

As described, a tax certificate is needed to use the 0% double taxation agreement with the US.

In Ireland this is achieved after a stay of 183 days, but it is easier in the following years. With 280 days it is sufficient for three years, and whoever has had tax liability in Ireland for three years in a row will continue to have it for three more years even if he is totally absent from the country.

Other countries with an interesting tax system for individuals are Great Britain (also has its non-dom), Switzerland and Slovakia, which nevertheless have a tax on income that generally reaches 15%.

Bulgaria and Thailand (territorial taxation) have a withholding tax of 5% on their double taxation agreement with the US.

Whoever lives in Thailand for 183 days would be tax-free in Thailand on income earned abroad, but will pay only 5% withholding tax at source from US license fees. Of course, getting a tax certificate in Thailand can be difficult for foreigners.

People who live in Bulgaria pay 10% tax + 5% retention on royalties in the US.

Optimizing licensing fees through capital partnerships

The path through flexible and useful capital companies is more realistic, but not necessarily more lucrative. It is rare to reach a zero tax burden with them, but you can optimize a lot by deducting business expenses.

An interesting option already mentioned, despite the suppression of the IP-Box, was Cyprus with 12.5%. Also Ireland, with the same quota, is interesting.

Other interesting capital companies are, for example, Bulgaria (10% + 5%), Romania (1-3% for micro companies + 10%), Hungary (9% + 0%) and Switzerland (12,5% + 0%).

Of course, do not forget the withholding taxes of the capital companies of these countries, such as, for example, 35% of Switzerland or 15% of Hungary. However, these can be optimized to zero percent.

Here it is difficult to distinguish a clear winner; it is usually best to study each case in a personal consultation because the best option depends more on the level of benefits and one’s personal situation.

In case you were wondering, the LP’s of Canada, as personal companies, can not use the 0% double taxation agreement with the US.

Finally, we cannot forget to mention United States. There, the withholding tax is only applied to payments abroad, not to US companies. But in the case of capital companies, dividend withholding is at stake, while LLCs are subject to a higher income tax in the case of US license fees. Of course, the LLC disregarded could be a very interesting option.

In conclusion

Whoever wants to completely avoid taxes and withholdings on US royalties will have to move their residence in most cases (in our encyclopedia of the emigrant you can read about more than 60 countries to emigrate to and in which it is possible to live free of taxes).

Regarding copyright income, the most favorable countries are mainly Ireland, the United Kingdom and Thailand thanks to their non-dom regimes and good double taxation agreements with the United States.

Of course, you will have to spend a big part of the year in these countries to obtain the necessary tax certificate.

The other way through capital partnerships is simpler, but it will always force you to pay a minimum in taxes.

Writers and other creators of intellectual property should think very hard if they really want to cede the rights of exploitation of their works to American companies, which already require a large part of the income.

Without a doubt, the simplest thing is to take care of the distribution of oneself.