Cyprus: Cyprus: Changes in the Tax System

Last Updated: 4 January 2002

Article by Andreas Neocleous and Maria Kitromilidou

On the 9th of January 2001, the Minister of Finance of the Republic of Cyprus introduced to House of Representatives the proposed changes to the existing tax system. The proposals took the form of a preliminary document titled ‘Tax Reform 2001’. The final draft will be presented and for discussion in Parliament after the Parliamentary elections due in May 2001.

Nine years after the last tax reform, (see Tax Planning International Review, June 1991) the Government justifies the proposed changes as being necessary (a) to fulfill Cyprus’ European Union (EU) commitments especially in the context of custom duties and harmonization of Cyprus tax practices with the EU, (b) to satisfy the OECD requirements for the elimination of harmful tax practices, while at the same time maintaining its antagonistic position as an international business center, (c) to promote social justice, (d) to create a simpler and more efficient taxation system especially as regards the imposition and collection of taxes and (e) to provide tax incentives for the achievement of economic priorities.

A. EU Commitments

  1. The current VAT rate in Cyprus is 10% substantially lower than the 15% minimum according to the 6th EU Directive. The proposed change will have the effect of initially increasing VAT to 13% bringing it to a level of 15% at a second stage by January 1st, 2003.
  2. To offset the increase in VAT rates the government proposes to abolish or partly- abolish the emergency defense levy.
  3. Currently Cyprus has much lower excise taxes on products such as petrol, alcohol and tobacco than European Union guidelines commands. This will change with a steep increase in excise taxes on all such products for example tobacco’s 40% tax rate will increase to 57% and alcohol’s excise tax of £1.19 per litre will rise to £3.20.
  4. The drawback system which provides for the return of money paid in duties or excise taxes on raw materials will be abolished for goods exported with EUR 1 certificates.
  5. Along the lines of (4) above, duty exemptions will also be abolished.
  6. Refugee tax now levied on agricultural products and some manufacturing products will be abolished.
  7. Consolidation of losses for different companies in the same group relief. This is expected to help improve the groups organization, operations and future growth.
  8. Current legislation provides very limited tax breaks for companies that go through reconstruction, mergers or acquisitions in order to modernize or enhance the efficiency of their operations. New measures are proposed, which together with (7) above are aimed at preparing Cypriot companies or groups of companies against the increased competition that will flow from accession to the EU. It should be noted that legislation allowing group relief was introduced in 1989 but regulations required by the law to operate such relief were never introduced. The Government with these proposed changes is now rectifying this anomaly.
  9. Currently there are tax incentives for the import of foreign capital to Cyprus. The imminent liberalization of exchange controls necessitates the abolition of such tax breaks.

B. OECD commitments:

  1. Currently the tax regime as regards corporation tax is 20% for profits of up to CYP 40,000 and 25% on profits over CYP 40,000. The proposals provide for the decrease of corporation tax on profits over 40,000 from 25% to 23%. This is seen as a step towards leveling corporation tax in relation to local and international business companies. Currently the later are treated much more favorably, in that they are taxed at only 4.25%, amidst OECD’s calls for reforming Cyprus favorable tax regime.
  2. Under present legislation dividends received from "local" companies are subject to a 20% withholding tax, which no tax is withheld from dividends paid by international business companies. It is now proposed that all companies will be obliged to withhold 20% income tax from dividends paid to shareholders irrespective of the identity of the shareholders or the source of income from which the dividend was paid. Where double taxation agreements are in force the lowest rate will be enforced. This tax will be withheld at the source and it will be final.
  3. Current practice provides for a tax break for dividends that are paid from profits that are brought from abroad. The proposal is that dividends should be taxed at source whatever the origin of the profits from which they are distributed.

C. Promotion of Social Justice:

  1. Increase in the threshold of taxable income from £6,000 to £8,000.
  2. Tax credits will be abolished and these will be incorporated in the tax-free income.

D. Simplification of the taxation system

  1. Gradual abolition of employees tax files and their transfer to the pay as you earn method (PAYE) used by employers. The new system will be introduced first for civil servants, moving-on later to semi-government and other big organizations such as banks and listed companies. This change will save the Inland Revenue a substantial number of staff.
  2. End to the current system of expenses or costs for the use of private cars for business purposes and entertaining expenses.
  3. Payment of tax after the due date is subject to 5% interest if paid within six months of the due date and 9% interest if paid after six months. The proposals call for the abolition of the 5% rate.
  4. All revenue from interest will be taxed at the source, i.e. at the banks, co-ops, saving societies and bonds traded on the CSE. This will reverse the current practice where the onus was on the tax payers to declare the interest earned in their forms and be taxed accordingly. Individuals who are under the tax threshold will be able to apply for a certificate from the tax office which they will present to the banks so that the tax will not be withheld.
  5. There will be a new tougher method of valuing property prior to a sale. Under this proposal, transfer duties will be paid on the Land Registry’s valuation, not that declared by the parties to the agreement.
  6. Immovable property tax will be raised to 0.5‰ with a parallel abolition of other taxes levied on property.
  7. A consumer tax on luxury goods such as smoked salmon and yachts will also be abolished.

E. Tax Incentives

  1. Provision of professional services abroad. Currently 60% of profits that are brought into the country are not taxed. This percentage will be reduced to 40% but at the same time the same exemption will apply to several services provided from Cyprus abroad.

Other proposed changes include the change of the governments’ contribution to the Social Security Fund, increase in the car license of diesel cars and further introduction of social benefits.

Effects of Proposals:

It is generally felt that tax reform is both necessary and essential both in order to streamline the tax system of Cyprus with European and OECD standards and also because as a general principle as society evolves the financial and other circumstances of a country and its citizens also change and so the tax system must react proactively to meet these changes.

This should be reflected in a comprehensive tax reform package that balances the government’s objective of raising revenue to fund its expenditure and the need for any such measure not to be overly burdensome on a particular group. At the same time the taxation system should enable and not curtail business activities, as these are the cornerstones of all healthy economies. As such the only criticism we make of the proposed measure is that a more comprehensive package as far as corporation tax is concerned and perhaps a greater reduction in the percentage payable on the profits of companies. Currently, profits over £40,000 are taxed at a 25% rate be reduced to 23% if the proposals are implemented. Even with this change there is a large discrepancy between the taxation of international business companies that are currently taxed at a rate of 4.25% and local companies. A further reduction of tax paid by local companies and an increase to the tax paid by international business companies for example at a compromising 10% level would do much to please local businessmen, the EU and OECD in particular and any negative impact on the position of Cyprus as an international business center would be minimal.

Furthermore, it is asserted in the Minister of Finance’s statement that ‘if implemented the government-proposed tax package will benefit the average citizen who at the end of the day will have more money in his pocket’ has yet to be achieved. The statement is mainly based on benefits that may occur for lower and medium income tax groups that are currently subject to a tax exemption threshold of £6,000 about to increase to possibly £8,000. Yet, whether this will have any real effect in the light of the fact that at the same time tax credits are abolished and VAT increases to 13% and eventually 15% as such making life for consumers, especially ones with big families, more expensive is not hard to predict. Furthermore, the proposed abolition of consumer tax on luxury goods such as smoked salmon and yachts is unlikely to have much effect on the tax group said to benefit more from the changes. Perhaps if the increase in social benefits that the report proposes, albeit rather vaguely in its last page, is substantial so as to make a difference in the quality of life of such groups (i.e. supplementary benefits if a taxpayers income is less than a minimum amount) then there may be some benefit for lower and medium income earners. For the time being it seems that there might even be a negative impact of these changes to lower income families or taxpayers, especially the ones that are already under the £6,000 per year threshold as these will see no benefit from the changes while at the same time their life will become more expensive. Perhaps an increase in the minimum salary to reflect the rising prices would be a compromising solution.

Having made the above comments, overall it should be noted that the main objectives of the Ministers proposals i.e. the simplification of the tax system, harmonisation with EU and compliance with certain OECD requirements have been achieved.

 

Main changes

  1. VAT rise from 10 to 15% (with an intermediary stage of 13%)
  2. Defence levy to be scrapped
  3. Income tax to be withheld from interest payments
  4. Steep rise in excise taxes
  5. Tax free threshold to rise to £6,000 to £8,000

 

The content of this article does not constitute legal advice and should not be relied on in that way. Specific advice should be sought about your specific circumstances.

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