Cyprus: Proposals For Implementation Of The EU Anti-Tax Avoidance Directives In Cyprus In "Global Tax Weekly"

Last Updated: 21 February 2018
Article by Constantinos Christofi

Most Read Contributor in Cyprus, August 2018

Like other EU member states, Cyprus is required to enact legislation to implement the EU's Anti-Tax Avoidance Directives,1 and in November 2017 the Tax Department published draft proposed legislation for consultation. The proposed legislation covers all the issues required under the directives, principally the deductibility of interest expense, controlled foreign company (CFC) rules, a general anti-avoidance rule (GAAR), the introduction of an exit taxation regime, and rules to eliminate cross-border double non-taxation resulting from hybrid mismatches.

Interest Limitation Rule

The practice of groups artificially shifting their debt to jurisdictions with more generous deductibility rules is being discouraged by limiting the amount of interest that the taxpayer is entitled to deduct in a tax year. The consultation document proposes a limit on deductible exceeding borrowing costs, defined in the same way as in ATAD, of 30 percent of profit adjusted for tax purposes before interest, tax, depreciation and amortization (commonly referred to as taxable EBITDA) or EUR3m (USD3.7m), whichever is higher. This rule will be applied at the company level unless the company is a member of a group as defined for Cyprus tax purposes (broadly 75 percent common ownership for the whole of the tax year), in which event the rule will be applied at the Cyprus group level. The interest limitation rule will not apply to wholly independent companies (those which, on a worldwide basis, are not part of a group, and have no associates and no permanent establishments) or to financial institutions.

There is an exemption for financing of certain public infrastructure projects and their associated income, and financial arrangements entered into before June 17, 2016 and not amended since then are outside the scope of the rule. There is an "equity escape rule" replicating Article 4.5(a) of ATAD allowing full deduction of borrowing costs if the local taxpayer's ratio of equity to total assets is not more than 2 percentage points lower than the equivalent ratio for the group as a whole. Interest costs disallowed by reason of the rules may be carried forward for up to five years. The proposed effective date is January 1, 2019, in line with the directives.

CFC Rules

The draft law defines a CFC in the same way as ATAD as an overseas permanent establishment or company directly or indirectly controlled by a Cyprus tax resident company, the corporate profit tax burden of which is less than half of what it would be under the Cyprus tax system. It adopts the approach set out in Article 7.2(a) of ATAD under which specified categories of income including interest, royalties and dividends receivable by the CFC are to be included as current income in the tax base of the Cyprus parent and taxed in accordance with Cyprus rules, unless the CFC is resident in an EU or EEA country and engages in substantive economic activities. The proposed effective date is January 1, 2019, in line with the directives.

Exit Taxation

The provisions regarding exit taxation adopt the text of Article 5 of ATAD, providing for the taxpayer to be liable for tax at an amount equal to the difference between the market value and the value for tax purposes of assets transferred outside the scope of Cyprus taxation while remaining under the same ownership (e.g., if a company transfers a taxable asset from its Cyprus head office to an exempt foreign permanent establishment). The taxpayer will have the right to pay the exit tax by installments over five years in the same way as prescribed in paragraph 2 of Article 5 of ATAD, and subject to the same conditions, with very minor modifications regarding provision of security. The proposed effective date is January 1, 2020, in line with the directives.

General Anti-Abuse Rule

The proposed legislation adds a new Article 33(6) to the Income Tax Law which reproduces the provisions of Article 6 of ATAD, allowing the Tax Department to disregard artificial arrangements (i.e., arrangements not put into place for valid commercial reasons which reflect economic reality) whose main purposes include obtaining a tax advantage that defeats the object or purpose of the tax laws. The proposed effective date is January 1, 2019, in line with the directives.

Hybrid Mismatches

To the extent that a hybrid mismatch results in a double deduction, any Cyprus-resident recipient will be denied the deduction and any Cyprus-resident payer will be denied the deduction, if a deduction is given to an overseas-resident recipient. To the extent that a hybrid mismatch results in a deduction without inclusion, if the Cyprus-resident party is the payer, the deduction will be denied; and if the Cyprus-resident party is the recipient and a deduction is given to the overseasresident payer, the receipt will be included in the Cyprus-resident party's taxable income.

The effective dates for the rules are identical to those set out in the directives, with the provisions regarding mismatches of hybrid instruments and tax residence due to take effect from January 1, 2020, and those relating to reverse hybrid mismatches becoming effective on January 1, 2022.

The proposed provisions are in addition to similar provisions introduced in 2015 to apply the amended EU Parent/Subsidiary Directive.

Next Steps

A draft law will be submitted to the legislature once responses to the consultation have been considered. Given that the initial draft law submitted for consultation closely follows the directives, and given the limited scope of possible derogations from the directives, in practical terms any changes arising from the consultation are unlikely to be significant.

Footnote

1 Council Directive (EU) 2016/1164 of July 12, 2016, laying down rules against tax avoidance practices that directly affect the functioning of the internal market (hereinafter referred to as "ATAD"); and Council Directive (EU) 2017/952 of May 29, 2017, amending Directive (EU) 2016/1164 as regards hybrid mismatches with third countries.

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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