Cyprus: Corporate Tax 2017

1 INTRODUCTION

The years 2015 and 2016 have seen some significant amendments and refinements of existing legislative provisions in the field of taxation, as well as the introduction of new provisions aimed at providing incentives for investment in Cyprus and ensuring fairness, effectiveness and efficiency. In addition to domestic legislation, within the past couple of years Cyprus has also demonstrated its full commitment to comply with EU and international initiatives including the Organization for the Economic Cooperation and Development ("OECD") initiative on tackling harmful tax practices and unjustified tax avoidance, by introducing appropriate mechanisms and closing any remaining loopholes in its domestic legislation. The main reforms undertaken during 2015, 2016 and early 2017 are outlined below.

2 TYPES OF CORPORATE TAX WORK

Tax practitioners in Cyprus, including those in our firm, have been kept busy over the past year advising on and implementing the attractive incentives introduced during 2015, including the notional interest deduction on new equity investment, income tax exemptions for individuals relocating to Cyprus and exemptions for individuals who are resident but not domiciled in Cyprus. The tax authorities issued detailed guidance on implementation of several of these issues during 2016.

In addition, the new intellectual property box regime, amended to follow the modified nexus approach, has received considerable interest. While the changes restrict the range of qualifying IP assets from mid-2016, there are grandfathering provisions to cover the transition. Our firm has recently assisted in setting up a corporate structure holding and managing valuable intangible assets and software tools used by international firms involved in the automobile industry which gives favourable tax treatment in Cyprus under the revised regime.

We have also seen increased interest in the establishment of alternative investment funds in Cyprus following the modernisation of the legal framework relating to funds, which can be very effectively combined with the tax and non-tax benefits that Cyprus offers. Cyprus law is based on English law, which is familiar to international investors. The mutual funds industry in Cyprus is developing well, and law and accounting firms are establishing specialist departments and independent firms specialising in funds are also springing up.

The tax landscape on a global and domestic level is changing at an unprecedented rate, with an enormous volume of new practices and standards imposed by European and international initiatives for tax practitioners to keep abreast of, analyse and assess. Cyprus has made significant progress in amending its primary and secondary legislation to align its tax practices with the OECD's project on base erosion and profit shifting ("BEPS"), demonstrating its full commitment to complying with the new global demands. It is equally important for Cyprus to offer fair, effective and competitive solutions to entrepreneurs wishing to invest in Europe through the island, and to meet their expectations to the fullest extent possible.

3 SIGNIFICANT DEALS AND THEMES

Notwithstanding the many confident predictions of the demise of tax planning and tax mitigation, Cyprus holding companies continue to be utilised by investors wishing to combine the already attractive features of Cyprus' tax laws with the newly introduced provisions. Cyprus does not impose withholding taxes on dividends or interest paid to non-residents. Royalties paid to non-residents are subject to withholding taxes (at 10%, or 5% in the case of cinema films) only if they arise from use of an intellectual property asset within Cyprus. There is no tax on capital gains, apart from gains tax on the sale of immovable property situated in Cyprus or on the sale of shares in a company directly or indirectly owning such immovable property. The sale of shares is generally exempt from income tax in Cyprus, except in some limited circumstances.

These long-established features of the Cyprus tax system, in combination with the new incentives, have prompted investors and multinational corporations alike from all over the world to include Cyprus holding companies in their structures and in some instances set up a significant economic presence in Cyprus or relocate to the island.

A recurring theme during 2016 was requests for advice and assistance from a Cyprus law and tax point of view with respect to the correct application of the new Notional Interest Deduction ("NID") regime. Projects the authors were personally involved in included the incorporation of Cyprus tax resident companies by USA-based multinational corporations with an annual turnover exceeding $1bn and the subsequent contribution of debt instruments into the share capital of the Cyprus companies as consideration in kind for the issue and allotment of shares to shareholders. In parallel, we also provided detailed in-depth advice on operational and management substance and anti-avoidance issues in order to ensure that the proposed structures will comply with applicable requirements.

In addition to activity arising from new developments and initiatives, there is a constant flow of work on restructurings aimed at improving governance, operational effectiveness or tax-efficiency. Many substantial international businesses make use of Cyprus holding and finance structures and the Cyprus aspects are often central to the entire restructuring. These restructuring projects may not only involve companies, but also trusts, foundations, partnerships and other structures registered or resident in any of a wide range of jurisdictions. Our analysis focuses on domestic legislation, anti-avoidance provisions, procuring tax rulings, existing DTTs and informing clients on international initiatives which may affect the proposed transactions.

Key developments affecting corporate tax law and practice

Double tax treaties (DTTs)

The years 2016 and 2017 have seen Cyprus' already large network of DTTs expand even further, offering great opportunities to facilitate business with rising economies such as Iran, with which a new DTT was signed in 2015, and India, with which an updated DTT was signed in 2016.

The new DTTs with Guernsey and Switzerland entered into effect at the beginning of 2016. Both were signed in 2014 and entered into force in 2015. In addition, ratification of several DTTs was completed in 2016, triggering their entry into force. The DTTs with Georgia and Bahrain, which were signed in 2015, and with Latvia and India, which were signed in May 2016, entered into force on 4 January, 26 April, 27 October and 14 December 2016, respectively, and their provisions took effect from the beginning of 2017. They closely follow the 2014 OECD Model Tax Convention. A new DTT with Jersey was also signed in 2016. Ratification was completed on 17 February 2017 and its provisions will take effect from the beginning of 2018. Ratification of the DTT with Iran was also completed in early 2017 and its provisions will take effect in Cyprus from the beginning of 2018.

The conclusion of new DTTs has continued into 2017, with new agreements with Barbados and Luxembourg, and a protocol to the DTT with San Marino having been signed during the first five months of the year.

One of the most significant developments regarding DTTs was not the conclusion of a new agreement, but the deferral of the implementation of amendments to the DTT with Russia, one of Cyprus's most important DTTs. As 2016 drew to an end, the Cyprus Ministry of Finance announced that the Russian government had agreed to defer the introduction of new provisions allowing for source-based taxation of capital gains on shares in "property-rich" Russian companies, which were due to take effect on 1 January 2017.

Under the 1998 double taxation agreement between Cyprus and Russia, gains on disposals of shares are taxable only in the country of residence of the person disposing of the shares. Since Cyprus does not impose any capital gains tax on disposals of shares in companies unless they own immovable property in Cyprus, this makes Cyprus a very advantageous location for holding shares in Russian companies.

The Protocol to the 1998 double taxation agreement, which was signed in 2010, provided that gains on the disposal of shares in companies which derive their value principally from immovable property in Russia (so-called "property-rich" companies) would be subject to tax in Russia after a transitional period, which was due to expire at the end of 2016. Shares in other companies were not affected.

However, the application of this provision of the Protocol has now been deferred until similar provisions are introduced into Russia's double taxation agreements with other European countries, and disposals of shares in property-rich companies will continue to be taxable only in the country of residence of the person disposing of the shares, in the same way as other shares. According to the official announcement, an additional Protocol is being prepared in order to formalise the deferral.

Notional interest deduction – NID

In order to align the tax treatment of debt and equity finance, the Income Tax (Amendment) Law introduced a notional interest deduction on new equity capital (paid-up share capital and share premium) contributed after 1 January 2015 into companies and permanent establishments of foreign companies in order to finance business assets.

NID is deducted from the taxable profit of the Cyprus tax resident entity and is limited to 80% of its total taxable profit. Unclaimed NID cannot be carried forward to be offset against future years' profits.

For the purposes of NID, new equity may be contributed in cash or in the form of other assets, in which case the value of assets should be supported by an independent valuation report. An independent valuation is not necessary under certain circumstances such as if the assets are listed on an open market on which similar assets are sold on a regular basis or if the registrar deems it unnecessary since the assets have been recently acquired from a third party and no event has occurred from the date of their acquisition which would significantly affect their value. No NID is available in respect of capitalisation of reserves, revaluation of assets or for companies benefiting from the re-organisation exemptions included in the tax laws. NID may be refused if the Tax Department considers that the transaction concerned has no economic or business purpose.

The NID is calculated by applying a so-called reference rate to the new capital. For capital introduced during a year, a time-apportionment is carried out. The reference rate is the 10-year government bond yield of the country in which the assets funded by the new equity are utilised, plus 3 percentage points, or the 10-year Cyprus government bond yield plus 3 percentage points, whichever is the higher. The bond yield rates to be used are as at December 31 of the year preceding the year of assessment.

In February 2017, the Tax Department announced the 10-year government bond yields at 31 December 2016, which will be used as the basis for the notional interest deduction for the 2017 tax year, for the following countries:

Country Bond yield rate Reference rate for 2017
Cyprus 3.489% 6.489%
Czech Republic 0.414% 3.414%
Germany 0.204% 3.204%
India 6.878% 9.878%
Latvia 0.894% 3.894%
Poland 3.627% 6.627%
Romania 3.748% 6.748%
Russia

(Expressed in US dollars)
8.380%

4.409%
11.380%

7.409%
Ukraine 8.705% 11.705%
United Arab Emirates 3.326% 6.326%
United Kingdom 1.326% 4.326%

SDC tax anti-avoidance

Individuals who are resident and domiciled in Cyprus are liable to pay Special Defence Contribution, commonly referred to as SDC tax, on dividends, passive interest and rents received. SDC is also levied on Cyprus tax resident companies. Dividends and passive interest (but not rents or active interest) are exempt from personal or corporate income tax.

The SDC Amendment Law of 2015 introduced a new anti-avoidance measure to deal with a common device used to reduce or postpone the payment of SDC tax on dividend income of a Cyprus tax resident individual. The newly enacted provisions insert a new article 3(4) into the Special Defence Contribution Law, enabling the tax authorities to disregard the interposition of a company without any real business or economic purpose between an individual and a company making profits, if this has been done with the principal objective of reducing or deferring the payment of SDC tax.

Improvements to the tax rulings procedure

In preparation for the automatic exchange of tax rulings, in October 2015 the tax authorities issued a circular introducing new procedures for obtaining advance tax rulings and setting out the terms on which they are binding. The new arrangements took effect on 1 October 2015. Advance tax rulings are a key element in giving taxpayers and their advisors the assurance they desire, and the clarification and formalisation of the advance rulings procedure is highly beneficial.

Substance requirements

At around the same time, the tax authorities announced a new procedure for companies to obtain a certificate of tax residence. Applications for tax residence must be made on the prescribed form, which essentially comprises a questionnaire setting out the factors which the tax authorities regard as decisive in determining the location of management and control. These include the location of board and shareholders' meetings, the location of the company's records, whether the board of directors exercises control and makes key management and commercial decisions necessary for the company's operations and whether the company issues general powers of attorney.

The new procedures have been welcomed as further progress in implementing Cyprus's commitment to modernisation, with a more sophisticated method of evaluating applications for tax residence certificates on a case-by-case basis. They also align Cyprus's approach with international best practice and the approach followed by other EU jurisdictions, giving investors the reassurance of a stable, responsive and reliable business environment.

Tax incentives

The government has also been proactive in offering incentives aimed at encouraging wealthy individuals to relocate to Cyprus or encouraging companies to relocate their operations to the island.

The "non-domiciled" regime

Up until and including 15 July 2015, both Cyprus-resident individuals and Cyprus-resident companies were liable to pay Special Defence Contribution, commonly referred to as SDC tax, on dividends, passive interest and rents received, at rates of 17%, 30% and 3% (applied to 75% of the rent) respectively. Dividends and passive interest (but not rents or active interest) are exempt from personal or corporate income tax.

With effect from 16 July 2015, the Special Defence Contribution (Amendment) Law exempts individuals who are not domiciled in Cyprus for the year of assessment concerned from liability to SDC tax. Coupled with the income tax exemptions applying to such income, this provides individuals who are resident but not domiciled in Cyprus with complete exemption from any form of Cyprus tax on dividends and passive interest, regardless of source. Companies are not affected by the change.

For the purposes of determining liability to SDC tax, the principles set out in the Wills and Succession Law regarding domicile, which follow the principles of English common law, apply. In summary, an individual acquires a domicile of origin at birth. It is generally the same as the domicile of the father at the time of birth, and, in exceptional cases, that of the mother. A domicile of origin may be replaced by a domicile of choice if in actual fact an individual permanently establishes himself or herself in another country with the intention of living there permanently and dying there. An individual will be deemed to be domiciled in Cyprus if he or she has been a tax resident for 17 or more of the 20 tax years immediately preceding the year of assessment.

The amendments are very attractive to individuals with investment income who consider re-locating to Cyprus and conducting their business from the island.

Incentives for new taxpayers

For many years there has been an exemption available to new taxpayers relocating to Cyprus, with 20% of the total emoluments or €8,550 (whichever is the lower) exempt from taxation for five years following the commencement of employment in Cyprus, provided that the individual concerned was not a tax resident of Cyprus during the previous tax year. This exemption may be claimed until 2020 but will then be withdrawn.

An alternative exemption was introduced in 2015, aimed at high-paid employees. For employees with total annual earnings of €100,000 or more, 50% of the emoluments earned from employment in Cyprus are exempt from income tax. The exemption is available for the first 10 years from the commencement of employment in Cyprus, provided that the individual was not a Cyprus tax resident during the tax year preceding the year in which the employment began, or for three or more of the tax years preceding the year in which the employment began.

Alignment with international initiatives

As an EU member, Cyprus is committed to implementing EU initiatives such as ATAD2 and automatic exchange of information and international initiatives adopted by the EU. In addition, although it is not a member of the OECD, Cyprus is fully committed to implementing OECD best practice, including the BEPS initiative.

Changes to the IP box

In October 2016, the Cyprus parliament passed Law 118(I) of 2016, which amended the Income Tax Law to align its provisions on taxation of income from the use or sale of intangible assets with the "modified nexus" approach. This approach allows taxpayers to benefit from an intellectual property taxation regime, commonly known as an IP box, only to the extent that they can show material relevant activity, including a clear connection between the rights which create the IP income and the activity which contributes to that income. Regulations issued under the law, which had retroactive effect from 1 July 2016, provide detailed guidance on the calculations and application of the new IP regime.

Transitional arrangements for IP assets developed prior to 30 June 2016

The original IP box, which was introduced in 2012, provided for 80% tax exemption of income from the use of a wide range of intangible assets. Coupled with Cyprus's low corporate income tax of 12.5%, it gives an effective tax rate on such income of 2.5% or less.

Taxpayers already benefiting from the existing scheme may continue to claim the same benefits on all assets within the scheme from 30 June 2016 until 30 June 2021, subject to certain conditions regarding assets acquired from related parties in the first six months of 2016. Assets acquired in this period from a related party qualified for benefits only until the end of the 2016 tax year, unless at the time of their acquisition they were benefiting under the Cyprus IP box regime or under a similar scheme for intangible assets in another state.

New arrangements for IP assets developed from 1 July 2016

The arrangements for assets developed after 1 July 2016 follow the modified nexus approach. Qualifying assets are restricted to patents, software and other IP assets which are legally protected. IP rights used to market products and services, such as business names, brands, trademarks and image rights, do not fall within the definition of qualifying assets. Relief is geared to the cost incurred by the taxpayer in developing the IP through its research and development activities. Costs of purchase of intangible assets, interest, costs relating to the acquisition or construction of immovable property, and amounts paid or payable directly or indirectly to a related person are excluded from the definition of qualifying expenditure.

As was the case under the existing scheme, 80% of the overall profit derived from the qualifying intangible asset is treated as deductible expense, preserving the effective tax rate of less than 2.5% on such income.

Transfer pricing – back-to-back financing arrangements

In February 2017, the tax authorities announced their intention to abolish the minimum margin scheme which had applied on back-to-back financing arrangements between related companies since 2011.

The minimum margin scheme provides for a deemed interest rate to be imputed for tax purposes on back-to-back finance arrangements between group companies. The imputed rate ranges from 0.125% for loans of more than €200m to 0.35% for loans of less than €50 million. The scheme will continue to apply until 1 July 2017 and from that date it will be replaced by detailed transfer pricing legislation for intra-group financing transactions, based on the OECD Transfer Pricing Guidelines. The new rules, which have yet to be announced, will apply both for the purposes of issuing tax rulings as well as for the purposes of tax assessments. The rationale behind this development is to reduce base erosion and profit shifting by ensuring that transfer prices are based on real economic activity and valuation.

Taxable profits for intra-group financing schemes which are in existence at 1 July 2017 will have to be re-calculated based on two different sets of rules. The minimum margin scheme will apply for the first six months of 2017 and the new transfer pricing rules will apply for the second six months. Any tax rulings already obtained in relation to such arrangements will no longer apply from 1 July 2017.

Country-by-country reporting

On 30 December 2016, the Minister of Finance issued a ministerial order requiring large multinational enterprise groups (defined as having a consolidated annual turnover exceeding €750 million) to report their results on a country-by-country basis. A revised ministerial order, issued on 26 May 2017, contains detailed guidance on implementation. Every "ultimate parent" entity or "surrogate parent" company of a large multinational enterprise group that is resident in Cyprus for tax purposes is required to file an electronic country-by-country report on behalf of the group.

Cyprus tax resident companies belonging to a multinational enterprise group that does not exceed the turnover threshold may also be required to submit country-by-country reports in certain circumstances. The format of the report follows the template of the OECD and EU Directive 2016/881.

A constituent entity of an MNE group must notify the Cyprus tax authorities of the reporting entity within the group. The deadline for the first notification is 20 October 2017.

Anti-avoidance provisions on hybrid mismatches

Cyprus has already transposed the anti-avoidance provisions set out in the new EU Parent Subsidiary Directive, allowing the tax authorities to disregard artificial or fictitious transactions and withhold the corporate tax exemption on dividends received by companies in Cyprus from elsewhere in the EU if the dividend is treated as a tax-deductible expense in the accounts of the company paying it.

Anti-Avoidance Directive

Like all other EU Member States, Cyprus will also be required to implement the EU Anti-Tax Avoidance Directive (EU) 2016/1164 by 1 January 2019. The directive combats abusive tax practices in the field of corporate taxation and contains rules aimed at addressing some of the practices most commonly used by large companies to reduce their tax liability, including:

  • a controlled foreign company (CFC) rule to deter profit shifting to low tax jurisdictions;
  • an exit tax to prevent tax avoidance;
  • an interest expense limitation;
  • a broadly worded anti-avoidance rule; and
  • a rule targeting hybrid mismatches among Member States. A further directive (ATAD II) extending the rule to hybrid mismatches with non-EU countries will have to be implemented by 1 January 2020.

Common reporting standard ("CRS")

As a member of the EU, Cyprus is required to implement Directive 2014/107/EU in its national legislation. This directive effectively incorporated the Common Reporting Standard within EU Council Directive 2011/16/EU as regards administrative cooperation in the field of taxation.

Cyprus signed the Multilateral Competent Authority Agreement for the automatic exchange of financial information in its own right on 29 October 2014.

The requirements of the common reporting standard (CRS) were transposed into domestic law by The Assessment and Collection of Taxes (Amendment) Law 79(I)/2014 and ministerial orders issued under the Assessment and Collection of Taxes Law.

The first reports, covering the 2016 tax year, must be submitted by 30 June 2017.

Developments affecting Cyprus's attractiveness as a jurisdiction for holding companies

The strategy adopted by successive governments to develop Cyprus as an international financial centre has been to offer a competitive environment in terms of tax rates and incentives, while maintaining an impeccable reputation in terms of not allowing any abuse of the system for money laundering, tax evasion and other criminal activities. While the new international initiatives, which are driven by the larger economies, create increased reporting and compliance burdens, the Cyprus tax authorities are committed to minimising the impact on taxpayers by modernising their internal systems to make the process as trouble-free as possible.

Cyprus's geographic position, its membership of the EU and the Eurozone, its common law legal system and familiar business infrastructure, combined with the benign tax environment, mean that it should always be on the shortlist when choosing a holding company jurisdiction.

A Cyprus company which meets the necessary substance requirements can offer significant benefits, and the quality of life and low operating costs compared to other destinations make Cyprus an attractive proposition.

4 INDUSTRY SECTOR FOCUS

The Cyprus economy is largely built on tourism, financial and professional services, shipping and agriculture. Cyprus is one of the world's leading shipping centres. The Cyprus registry ranks tenth among international fleets and the island is among the world's top five ship management centres. One of its attractions is a very competitive EU-approved tonnage-based system of shipping taxation, which can give substantial savings for Cyprus-resident shipping and ship management companies.

5 THE YEAR AHEAD

The Cyprus government recognises that one of the most desirable features of a holding company jurisdiction is stability and predictability, so major changes of direction are unlikely. We see the emphasis being on implementing international initiatives as efficiently as possible, and modernising the operations of the Tax Department to improve interaction with taxpayers and eliminate delays.

Originally published by Global Legal Group.

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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Authors
Philippos Aristotelous
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