Cyprus was one of the first 68 countries which formally signed the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (otherwise known as the multilateral instrument, or "MLI") on June 7, 2017.
The adoption of the MLI is one of the actions set out in the BEPS Action Plan endorsed by the G20 finance ministers and leaders, and comprises measures to combat treaty abuse and "shop- ping," to improve dispute resolution, to neutralize the effects of hybrid mismatches, and to pre- vent artificial avoidance of permanent establishment status.
Signatories may choose which of their existing tax treaties they wish to modify using the MLI. In the terminology of the MLI these treaties are known as "covered treaties." If both parties to a treaty have signed the MLI and included it in their list of covered treaties then it is automatically amended in accordance with the provisions of the MLI. At the date of signing, a total of 2,363 treaties had been listed by all signatories, out of which 1,103 were "matched" in the sense that the contracting parties had both elected for the same optional provisions.
To be accepted as a signatory to the MLI, jurisdictions must abide by minimum standards agreed as part of the BEPS Package in November 2015, namely prevention of treaty abuse (BEPS Action 6) and the improvement of dispute resolution (BEPS Action 14). However, jurisdictions are given discretion to choose whether to apply certain optional provisions. They can opt out of specified provisions through what is known as a "reservation," or opt in through what is referred to as a "notification."
Cyprus has made reservations to align the implementation of the MLI provisions with its own tax policies. The specific provisions it has opted out of are:
- Transparent entities (Article 3); Dual residence entities (Article 4);
- Application of methods for elimination of double taxation (Article 5); Dividend transfer transactions (Article 8);
- Capital gains from alienation of shares or interests of entities deriving their value principally from immovable property (Article 9);
- Anti-abuse rule for permanent establishments situated in third jurisdictions (Article 10); Application of tax agreements to restrict a party's right to tax its own residents (Article 11); Artificial avoidance of permanent establishment status through commissionaire arrangements and similar strategies (Article 12);
- Artificial avoidance of permanent establishment status through specific activity exemptions (Article 13);
- Splitting-up of contracts (Article 14); and
- Definition of a person closely related to an enterprise (Article 15).
It has also adopted a modified form of Article 35, governing entry into force.
Signatories have the right to "opt-in" at a later stage if they choose, so in future Cyprus may elect for any of the excluded provisions to be incorporated in its existing tax treaty network, as long as the other contracting state is also a signatory to the MLI and has not made a reservation regarding the provision.
Key Changes For Cyprus
The main impact on Cyprus-resident companies will result from the application of Articles 6 and 7 of the MLI, relating to treaty abuse.
i. Purpose of a covered tax agreement
Article 6 provides for the amendment of the preamble of tax treaties to include the purpose of a covered tax agreement. Cyprus has notified the contents of the preamble in all 61 of its covered tax treaties. Assuming that the other contracting state is also a signatory to the MLI and has not made a reservation, the preamble will automatically be amended to expressly state that the purpose of the covered tax agreement in question is to eliminate double taxation without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance, including through treaty-shopping arrangements. Cyprus's most recently signed double tax treaty, with Luxembourg, includes this modified preamble.
ii. Principal purpose test
Article 7 sets out a general anti-abuse rule based on the principal purpose of transactions or arrangements. Cyprus has chosen to apply Article 7(4) of the MLI, which provides for a principal purpose test ("PPT"). Tax benefits will be denied if one of the principal purposes of a transaction or an arrangement is to directly or indirectly obtain a tax benefit, unless the granting of that benefit in the circumstances would be in accordance with the object and purpose of the relevant treaty provisions.
Signatories to the MLI may opt to supplement the PPT with a simplified limitation-on-benefits ("LOB") provision. Alternatively, countries can negotiate bilateral detailed LOB provisions. Cyprus has not made any notification to adopt a LOB provision.
iii. Improving dispute resolution
The MLI introduces minimum standards to improve the effectiveness of the mutual agreement procedure ("MAP"). Covered bilateral tax agreements concluded between two signatories to the MLI will automatically be amended to allow a taxpayer to present a case to the competent authority of either contracting state within three years from the first notification of the action resulting in taxation which was imposed in contravention of the provisions of the covered tax agreement, if they did not already contain such provisions on dispute resolution.
The MAP requires parties to endeavor to resolve the dispute, but it does not provide any means of ensuring that a resolution will be reached. This is a perceived shortfall of the MAP which is addressed by Part VI of the MLI with the introduction of mandatory binding arbitration. If countries have opted for mandatory binding arbitration, unresolved MAP cases are submitted to an independent arbitrator, whose decision is binding, for resolution. Twenty-five signatories initially committed to the mandatory binding arbitration provisions provided in the MLI, including Greece, Malta, Liechtenstein, Luxembourg, and the United Kingdom. Cyprus has yet to do so, but may make the appropriate notifications later.
The first modifications to covered treaties are expected to take effect in 2018 as the timing is linked to completion of the ratification procedures in the signatory countries. Signatories can modify their MLI positions (notifications and reservations) at any time until ratification, and Cyprus may opt for additional provisions to apply. In any case, jurisdictions can subsequently amend their MLI positions which will become effective upon notification.
The signing of the MLI by Cyprus, together with its increasing focus on substance and its alignment with global initiatives aiming at preventing "treaty shopping" as well as combating tax- evasion and unlawful tax avoidance practices, underlines the island's commitment to conforming with the highest international standards and consolidating its position as a reliable international business center.
This article first appeared in the 27 July 2017 issue of "Global Tax Weekly", published by Wolters Kluwer, and is reproduced by kind permission of the publisher.
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