Cyprus: The New Cyprus–United Kingdom Double Tax Agreement: An Article By Article Analysis

On March 22, 2018, Cyprus and the United Kingdom signed a new double taxation agreement (DTA). Once it has been ratified by both parties it will replace the current agreement, which dates back to 1974. Most of the main provisions of the new agreement are substantially the same as those of the agreement it will replace, but the new agreement, which is based on the 2014 OECD Model Convention, introduces modern-day standards on exchange of tax information and base erosion and profit shifting. The key features of the new DTA and its protocol are summarized below.

Article 1 – Persons Covered

Article 1 includes a new paragraph dealing with fiscally transparent entities. It provides that income or gains derived by or through an entity or arrangement that is treated as wholly or partly fiscally transparent under the tax law of either country is to be treated as income or gains of a resident of a country on the same terms as other residents of the country concerned.

Article 2 – Taxes Covered

The agreement follows the wording of the OECD Model Convention. The list of taxes covered in the two countries has been updated to include taxes introduced since it was concluded, but it is exactly the same as the 1974 agreement in effect. In the UK, the taxes covered are income tax, corporation tax, and capital gains tax; in Cyprus, they are income tax, corporate income tax, special contribution for defense, and capital gains tax.

Article 3 – Definitions

The definitions of Cyprus and the UK have been expanded to include their offshore waters, in line with current practice, and the wording has been aligned with the OECD Model Convention.

Article 4 – Residence

The definition of resident has been extended beyond the definition in the OECD Model to include legal persons organized under the laws of a contracting state that are not liable to tax or are generally exempt from tax in that state and are established either for a religious, charitable, educational, scientific or other similar purpose, or to provide pensions or other similar benefits to employees. The inclusion of this provision, which is common to many of the UK's DTAs, is intended to clarify the generally accepted practice of treating an entity that would be liable for tax as a resident under the internal law of a country except for a specific exemption from tax (either complete or partial) as a resident of that state.

The "tie-break" provisions for determining residence for individuals who are resident in both countries are the same as in the OECD Model Convention, namely permanent home and center of vital interests, country of habitual residence, and nationality, in descending order. If none of these criteria is decisive, residence is to be settled by mutual agreement between the two countries' tax authorities.

For legal persons resident in both countries, the competent authorities of the two countries will determine residence by mutual agreement, having regard to the entity's place of effective management, the place where it is incorporated or otherwise constituted, and any other relevant factors. If the authorities cannot agree, the entity will not be considered a resident of either for the purposes of claiming any benefits provided by the agreement, except those provided by Articles 22 (elimination of double taxation), 24 (non-discrimination), and 25 (mutual agreement procedure).

The protocol to the agreement sets out the factors to be taken into account in determining the residence of legal persons as follows:

  1. Where the senior management is carried on;
  2. Where the meetings of the board of directors or equivalent body are held;
  3. Where the headquarters are located;
  4. The extent and nature of the entity's economic links with each country; and
  5. Whether determining that the entity is a resident of one country but not of the other would entail the risk of an improper use of the agreement or inappropriate application of the domestic law of either country.

Although this list of factors is not exhaustive, the first four factors will generally be decisive unless the final factor applies. The determination of residence is to be made on a case-by-case basis. As circumstances may change over time, the competent authorities may revisit agreements, particularly where there are significant changes in the relevant facts. Where a company was resident in both the UK and Cyprus under the domestic law of those countries before the new agreement enters into force and its residence was determined by Article 4(3) of the 1974 agreement (which uses the criterion of place of effective management), the existing determination will not be revised as long as all the material facts remain the same. In the event of a material change in circumstances and a consequent revision of an entity's residence status after the new agreement enters into force, the new determination will not be retrospective, and will apply only to future income or gains.

Article 5 – Permanent Establishment

Article 5 of the DTA, which defines a permanent establishment, is identical to the corresponding article of the OECD Model Convention. The effect of the article is the same as under the 1974 agreement.

A building site or construction or installation project will constitute a permanent establishment if it lasts more than 12 months. If an enterprise has a representative in the territory of a country who has, and habitually exercises, authority to conclude contracts in the name of the enterprise, the enterprise concerned is deemed to have a permanent establishment in respect of any activities which the person undertakes for it. An independent broker or agent who represents the enterprise in the ordinary course of business will not fall within the scope of this provision.

Care needs to be taken regarding the issuing of general powers of attorney so as not to risk inadvertently creating a permanent establishment, with potentially unfavorable consequences.

Article 6 – Income From Immovable Property

Article 6, which deals with income from immovable property, reproduces the corresponding article of the OECD Model Convention verbatim, allowing for income derived by a resident of one of the parties derived from immovable property situated in the territory of the other to be taxed in the state in which the property is located. The effect of the article is the same as under the 1974 agreement.

Article 7 – Business Profits

The new agreement includes a word-for-word reproduction of the corresponding article of the OECD Model Convention, with profits (apart from profits of a permanent establishment in the other country) being taxable only in the country in which the enterprise is resident. As with the preceding articles, the effect of the article is the same as under the 1974 agreement.

Article 8 – Shipping And Aviation

This is a slight rewording of Article 10 of the 1974 agreement, but its effect is exactly the same, namely that profits from the operation of ships or aircraft in international traffic, including profits from participation in a pool, a joint business or an international operating agency, are taxable only in the contracting state in which the enterprise concerned is resident.

Article 9 – Associated Enterprises

The article dealing with associated enterprises is a word-for-word reproduction of the corresponding article of the OECD Model, providing for the adjustment of profits from transactions between associated enterprises carried out other than on arm's length terms. The effect of the article is the same as under the 1974 agreement.

Article 10 – Dividends

The article has been considerably shortened and simplified, and aligned with that of the OECD Model Convention.

If the beneficial owner of dividends paid by a company which is a resident of one country is a resident of the other country, the dividends are exempt from any withholding tax, unless the dividends are paid out of income (including gains) derived directly or indirectly from immovable property by an investment vehicle which distributes most of this income annually and whose income from such immovable property is exempted from tax, in which case withholding tax is limited to 15 percent of the gross dividends. However, if the beneficial owner of the dividends is a pension scheme established in the other country, no withholding tax is payable. These provisions are relevant only to dividends paid from the UK, since Cyprus does not impose withholding taxes on dividends.

This exemption does not apply if the dividends derive from a permanent establishment in the country from which the dividends are paid, through which the beneficial owner of the income (who is also a resident in one of the contracting states) carries on business.

Article 11 – Interest

The wording of the article on interest has been aligned with the OECD Model Convention, but the effects of the article are unchanged.

Interest arising in one contracting state and paid to a resident of the other who is its beneficial owner is exempt from withholding tax. This exemption is limited to interest calculated on an arm's length basis. It does not apply if the interest derives from a permanent establishment in the country from which the interest is paid, through which the beneficial owner of the interest (who is also a resident in one of the contracting states) carries on business.

Article 12 – Royalties

The article has been considerably shortened and simplified, and aligned with that of the OECD Model Convention. The withholding tax of up to 5 percent on cinema films and video media for television provided for in the 1974 agreement has been removed.

Under the new agreement, if the beneficial owner of royalties paid by a resident of one country is a resident of the other country, the royalties are exempt from withholding tax. This exemption is limited to royalties calculated on an arm's length basis. It does not apply if the royalties derive from a permanent establishment in the country from which the interest is paid, through which the beneficial owner of the interest (who is also a resident in one of the contracting states) carries on business.

Article 13 – Capital Gains

The 1974 agreement does not include any provisions regarding taxation of capital gains. Under the new agreement, gains derived by a resident of one country from the alienation of immovable property (or of movable property associated with a permanent establishment) situated in the other, or from the alienation of unlisted shares deriving more than 50 percent of their value directly or indirectly from immovable property situated in the other country, may be taxed in the country in which the property is situated. Gains derived from the alienation of all other property (including ships or aircraft operated in international traffic) are taxable only in the country of which the alienator is a resident.

Articles 14–19 – Personal Remuneration

Articles 14–16 and 19, which respectively deal with income from employment, directors' fees, entertainers and sportspersons, and students, replicate the corresponding articles of the OECD Model Convention and do not alter the existing arrangements.

Article 17, which deals with pensions, replicates the basic principle from the OECD Model Convention that in general pensions are taxable only by the country in which the recipient is resident. This is no different from the current provision. In addition, the article introduces new provisions regarding tax deductibility of pension contributions. Contributions made by or on behalf of an individual who is employed or self-employed in one country ("the host state") to a pension scheme that is recognized for tax purposes in the other country ("the home state") are treated as if they were made to a recognized pension scheme in the host state, both for the purposes of determining the individual's tax liability in the host state and for determining the taxable profits of the employer, if any, in the host state.

There is also a substantive change to the provisions for taxation of pensions paid in respect of government service (e.g., pensions paid to retired civil servants or military personnel). Under the 1974 agreement, all pensions, including those payable in respect of government service, are taxed only in the country in which the recipient is resident. Under the new agreement, pensions payable in respect of national or local government service will be taxable only in the country from which they are paid, unless the recipient is both a national and a resident of the other country, in which case the pension is taxable only in the country in which the recipient is resident. This aligns the pension provisions with those in the UK's other DTAs.

Article 20 – Offshore Activities

The new agreement includes comprehensive provisions regulating the taxation of offshore hydrocarbon exploration and exploitation activities, intended to ensure that each state's taxation rights in respect of offshore activities are preserved in circumstances where they might otherwise be limited by other provisions of the agreement, such as those dealing with permanent establishment and business profits. Special rules are required because of the short duration of some of these activities.

A resident of one country undertaking activities offshore in the other country for more than 30 days in any 12-month period in connection with the exploration or exploitation of the seabed or subsoil or their natural resources is deemed to be carrying on business in that other country through a permanent establishment.

Profits from offshore supply and transport operations in connection with the exploration or exploitation of the seabed or subsoil or their natural resources of a country are taxable only in that country. The article also includes rules for determining when the 30-day threshold is exceeded in respect of offshore activities undertaken by associated enterprises.

Salaries, wages and the like earned by a resident of one country from employment in the offshore zone of the other country are taxable in the country in which the activities are carried out. However, the remuneration is taxable only in the country in which the individual is resident if all three of the following conditions are satisfied:

  • The employer is not resident in the country in which the activities take place;
  • The remuneration is not borne by a permanent establishment there; and
  • The recipient's presence there does not exceed 30 days in aggregate in any 12-month period beginning or ending in the tax year concerned.

Salaries, wages and similar remuneration derived from employment aboard ships or aircraft engaged in offshore supply and similar activities are taxable in the country in which the individual is resident.

Gains derived by a resident of one country from the alienation of exploration or exploitation rights, or of property situated in the other country and used in connection with the exploration or exploitation of the seabed or subsoil or their natural resources situated in the second country, or shares deriving more than half their value directly or indirectly from such rights or such property, may be taxed in the second country.

Article 21 – Other Income

In addition to setting out the general principle contained in the OECD Model Convention that other income not dealt with elsewhere in the agreement that is beneficially owned by a resident of a contracting state should be taxed only in the state in which the recipient is resident, the article also includes provisions attributing trust income and tax paid on it to the beneficiaries and, in the case of transactions between connected persons, limiting the benefit of the article to income calculated on an arm's length basis.

Article 22 – Elimination Of Double Taxation

In the UK, Cyprus tax payable, whether directly or by deduction, on profits, income or chargeable gains from sources within Cyprus will be credited against any UK tax computed by reference to the same amounts. Profits of permanent establishments in Cyprus of UK-resident companies and dividends paid by Cyprus-resident companies to UK-resident companies are exempt from UK tax, subject to satisfying the conditions for exemption under UK law. In the case of a nonexempt dividend paid to a UK-resident company which controls 10 percent or more of the voting power of the company paying the dividend, relief for Cyprus tax will be given under the credit method, taking account of the Cyprus tax payable by the company on the profits out of which the dividend is paid.

In Cyprus, credit will be given for UK tax payable, up to the amount of the Cyprus tax on the income concerned.

Article 23 – Entitlement To Benefits

Article 23 is a principal purpose test anti-abuse rule identical to the one set out in paragraphs 1 and 4 of Article 7 of the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting.

Articles 24–28

Articles 24–28 replicate the provisions of the corresponding articles of the OECD Model Convention as regards non-discrimination, the mutual agreement procedure, exchange of information, assistance in the collection of taxes, and members of diplomatic missions and consular posts.

Article 29 – Entry Into Force

The new agreement will enter into force once both countries have completed their respective domestic ratification procedures. It will take effect in Cyprus from the beginning of the following calendar year. In the UK, it will take effect from the same date in respect of taxes withheld at source. In respect of corporation tax, it will take effect from April 1 following its entry into force; in respect of income tax and capital gains tax, it will take effect from April 6 following its entry into force.

Article 30 – Termination

The DTA will remain in force until terminated. Either country may terminate it by giving written notice of termination through diplomatic channels at least six months before the end of any calendar year beginning no earlier than five years after the agreement entered into force. The DTA will cease to have effect in Cyprus from the beginning of the following calendar year. In the UK, it will cease to have effect six months after the date notice of termination is given for taxes withheld at source, from April 1 following the date notice of termination is given for corporation tax, and from 6 April following the date notice of termination is given for income tax and capital gains tax.

Conclusion

The current agreement between Cyprus and the UK is one of Cyprus's oldest agreements that is still in force. Although the changes introduced in the new agreement will have little direct effect on the tax liability of most taxpayers when it enters into effect, their importance should not be underestimated. The modernization of the provisions, particularly those relating to permanent establishments, the emphasis on beneficial ownership and arm's length pricing, and the introduction of up-to-date information exchange and anti-abuse provisions, align the agreement with present-day best practice, ensuring that it provides clarity and certainty.

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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