Cyprus: Cyprus Holding Companies And The Importance Of Substance

The need for tax efficient structures as well as restructuring existing structures has increased with the recent global economic downturn. Nowadays, companies need to carefully select the jurisdiction they use for implementing such structures as well as implement their structuring with a careful look on substance so as to be able to mitigate risks and taxes.

Cyprus is an established international business and financial centre due to the incentives granted the good infrastructure and the existence of over 40 double tax treaties (DTTs). Its EU membership and compliance with EU and OECD standards, in line with its most favorable tax regime and transparent legal system places Cyprus amongst the most favorable holding company destinations.

Cyprus is a prime venue for the worldwide operations of multinational corporations having the lowest corporate income tax (CIT) at the rate of 10% in the EU.

Cyprus, as opposed to other countries in Europe and the Caribbean, is generally not considered as a "low-tax jurisdiction". Therefore, the provisions of numerous national legislations, both in Europe and around the world, requiring increased scrutiny by the tax authorities as well as higher tax rates on payments to residents in low-tax jurisdictions, are not applicable to Cyprus. 

Cyprus is also a vehicle for investment for many countries such as Russia, Poland, Ukraine, the Balkans, India and China. It could easily be said that Cyprus functions as a connecting hub for Europe to Central and Eastern European Countries, Asia and the Far East.

Advantages of Cyprus Holding Companies

The use of Cyprus holding companies is considered a major vehicle for international tax planning due to the following reasons:

  • The provisions of the EU Parent - Subsidiary Directive, as well as Interest and Royalties Directive have full application in Cyprus, resulting in the elimination of withholding tax obstacles.
  • Dividend income received by a company which is a tax resident of Cyprus is exempt from corporation tax (CIT) and in most cases is also exempt from Special Defence Contribution (SDC).
  • Outgoing dividends paid by the Cyprus Company to the ultimate non-resident beneficial owner are exempt from any withholding taxes irrespective of the existence of any DTTs and irrespective of the applicability of the EU Parent - Subsidiary Directive.
  • Interest income is either taxed under CIT or SDC both at the rate of 10%. Where back-to-back loans exist, the 10% tax is levied on the interest spread (i.e. on the difference between interest payable and receivable).
  • Income deriving from royalties is subject to 10% corporation tax.  The 10% tax is levied on the net royalty income (i.e. royalty income minus royalties paid to the licensors).
  • Cyprus provides unilaterally for a tax credit in the absence of a DTT, for any withholding taxes levied at source in the other country.
  • Profits from the sale of securities are generally exempt from taxation in Cyprus. The definition of securities is very broad such as to include ordinary shares, founder's shares, preference shares, bonds and debentures, units in collective investment schemes, options and futures etc.

Management and Control and the Substance consideration

In order for a Holding Company to be able to enjoy the beneficial regime provided both by the local tax legislation and the extensive network of DTTs Cyprus has entered into, it needs to prove that its tax residency indeed is, i.e. that its management and control is indeed exercised, in Cyprus.

In the absence of a formal definition regarding the establishment of the management and control in Cyprus, it is advisable that the following parameters be taken into account. 

  • The majority of the Directors of the Company are residents in Cyprus,
  • Important Company decisions are taken in Cyprus by the local directors,
  • The headquarters of the Company are maintained in Cyprus,
  • The Company has an economic substance in Cyprus

Economic substance has become an extremely important issue. More and more countries are looking deeper into the "substance over form" doctrine. This is especially true after a number of internationally known high court cases recorded such as the Vodafone case in India. What is essentially subject to scrutiny is the real justification for the existence of a holding company. If a company is used in an existing structure already operating, with the obvious reason of gaining access to the benefits of DTTs, chances are that the structure will fail altogether and be regarded as fictitious thereby not be able to obtain those treaty benefits it sought. What is needed in order not to be exposed to this substantial tax risk is proper and sufficient substance.

However in other international cases such as the Canadian Case of Prevost the absence of substance was held not to be an issue. Nevertheless the recent approach of both the OECD as well of most EU States, show that substance is indeed a factor that must not be overlooked and the "substance over form" is gaining more ground.

It is a rather dangerous exercise to try to codify what actions need to be taken by any company to enhance its substance. It simply cannot be an exercise of generalisation. These days are gone for ever. Careful planning and sophisticated tax advice is needed in order to determine the extent of enhancing the substance of a company. A number of important considerations and factors must be taken into account by an experienced tax advisor in this context. Indicatively, the following should be considered:

  • The nature and operation of the company and that of the Group the company belongs to.
  • The business strategy of the Group.
  • The legal and management structure of the Group as a whole.
  • The country the Group's Head Office is located. This is important in order to understand the approach and the tax requirements of the tax authorities of the Head office.
  • The materiality of the transaction/investment of the holding company.
  • The country in which the investment is taking place.

Different approach and emphasis on different relevant matters is needed for a trading structure and for an IP or intra-group financing structure or a holding structure for example.

As a very general remark however, there are some general elements of substance usually referred to by most tax advisors that a company needs to have. These are:

  • Having a real physical presence in Cyprus, whether owned distinct office or via leasing space in a serviced business centre,
  • Having registered with the Cypriot Ministry of Labor as an employer,
  • Having real, live people working in the company's offices (part-time or full-time)
  • Having dedicated telephone, fax, internet lines, a website and email addresses,
  • Having at least one bank account opened in a Cypriot Bank, operated by a Cypriot member of the Board of Directors,
  • Having at all times proper accounting books in Cyprus, and prepare on-time without delays and submit their annual financial statements,
  • Having a company properly capitalised, with any Share Purchase Agreements needed be prepared in Cyprus and in accordance with Cyprus Law,
  • Etc...

The above present only general guidelines and as such they cannot really show the extent that substance can take.

Enhancing substance is a rather tailor-made case by case exercise as explained above. Any attempts to generalise the concept will rather prove dangerous than useful.

Finally one should also keep in mind that Cyprus has its own similar rules as well. The tax authorities may very well disregard a transaction or a company based on "substance over form" or because a transaction is not within the "arms-length principle". However, the source country tax authorities will naturally be more concerned in this respect.

Substance is the key

The recent trends at an International and EU level could well have an effect on Cyprus structures too. Although there is not yet a recorded case where the Cypriot Tax Authorities have examined in-depth a Cypriot holding company, it is wise to be prudent and to take proactive action.

In accordance with the above, it is evident that Cypriot Holding Companies offer a competitive advantage in terms of tax planning. Nevertheless, a foremost consideration in order to use these Cyprus Holding Companies is substance. It seems that the days where a brass-plate inexpensive company bought off-the-shelf in Cyprus, with a standard registered office, local directors common with 500 other companies in Cyprus are starting to become a thing of the past.

Now substance is the solution and the way forward. However every business structure needs careful analysis in order to establish the necessary level of substance to tailor their needs. Companies should perform a cost/benefit analysis as the necessary actions will vary according to the given situation. Proper advice should be sought from experienced tax planners in this regard.

Existing structures must be reviewed in accordance with the above the soonest and restructured accordingly to sustain a potential challenge by Tax Authorities, especially from the source country.  

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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