Investment in a Cyprus company at the initial stages of development, self-financing or third-party investments at further stages of the company's development, as well as financing of related and unrelated parties by a Cyprus company, are the most discussed issues and the main tasks of commercial activity.
FINANCING OF A CYPRUS COMPANY
At the initial stages of development of the company, when it is necessary to invest the initial capital or to raise funds for the start-up or at further stages of development of the company, when self-financing or third-party investments are required due to the exhaustion of the possibilities of domestic financing, (use of profits for the development of the company), the methods that can be applied are self-financing and external financing.
We outline each of the above methods of financing, with their tax and legal consequences, below:
The term "self-financing" includes investment of the shareholder/s' own money in the equity of the company. Such a method requires the authorized share capital of the company to increase in accordance with article 60 of the Companies Law, Cap. 113,in the event that there is available authorized share capital (unissued shares), and then to allot the additional shares to the shareholder/s at a par or at a premium in accordance with articles 47-51A, 55 of the Companies Law, Cap. 113, provided that the value of the additional shares must be equal to the amount of financing. Self-financing is the most appropriate method of financing of a Cyprus company without taxation and legal consequences. It allows the Director of the company to maintain control apart from outside influence as well as allows the company to grow without debt. Moreover, the law provides an easy and relatively quick way of return on invested capital which has not been used for the development of the company, by way of a decrease of share capital or else a premium account under the Court order confirming the reduction in accordance with articles 55, 65, 66 and 67 of the Companies Law, Cap. 113 provided that the Court is satisfied, with respect to every creditor of the company who under article 65 is entitled to object to the reduction, that either his consent to the reduction has been obtained, or his debt or claim has been discharged, or has been determined or secured.
External financing is the method of raising investments in the company from various outside sources. In general, it includes equity investment and debt financing (loans).
Equity investment means that the company, for purposes of raising of financing, must issue shares to outside investors in exchange for investment, which means to accept partial ownership of the business. This method is regulated by the same rules of law as "self-financing" investment of the shareholder/s' own money in the equity of the company. In order to issue the shares to outside investors, the authorized share capital of the company shall be increased in accordance with article 60 of the Companies Law, Cap. 113, in the event that there is available authorized share capital (unissued shares), and then to allot the additional shares to outside investors at a par or at a premium in accordance with articles 47-51A, 55 of the Companies Law, Cap. 113, provided that the value of allotted shares must be equal to the amount of investment. This method is commonly used by business owners who want to quickly grow the business. With equity investment, the company does not take on debt and does not have to repay the investment. The downside of this method, however, is that the owners do give up part of the ownership and control of the business.
Debt financing (loans) includes any debts that the company expects to repay. Generally, the loans are used to purchase assets. An advantage of the loans is that the company can repay the loans over an extended period, which minimizes monthly payment obligations. One drawback to this type of financing is that it is usually secured by property, meaning that if the company cannot repay the loan back, the lender can seize the assets or property of the company.
FINANCING OF RELATED AND UNRELATED PARTIES THROUGH CYPRUS COMPANY
In analyzing the issue of financing of related and unrelated parties by a Cyprus company, it should be noted that there not many methods of financing. We outline only two methods here: financing through contribution to the share capital without or with the issue of shares and the granting of loans.
Financing through contributions to the share capital with or without the issue of shares (equity investment)
The method of financing through contributions to the share capital with the issue of shares means that the subsidiary (related party), for the purpose of raising of financing, must increase the authorized share capital in the event that there is no available authorized share capital (unissued shares), and allot the additional shares to the shareholder-Cyprus company at a par or at a premium. This method does not entail any tax and legal consequences in contrast to the contribution without the issue of shares, where the application of Article 33 of the Income Tax Law N.118 (I)/2002 may lead to the imposition of notional interest on debit balances from related companies, if a subsidiary-recipient of the contribution is the tax resident of Cyprus. In accordance with the Cyprus Tax Department's Interpretative Circular EE 25 dd. 3.09.2018, non-refundable capital contributions from Cyprus companies to non-tax resident companies will not be liable to deductions under Articles 33, 9 and 11 of the Income Tax Law N.118 (I)/2002 provided that all the following conditions are satisfied:
- the contributor has no legal right to request repayment of the contribution;
- repayment of the contribution has been legitimately made by the reduction of capital or through dissolution or liquidation of the recipient, in accordance with the law of the jurisdiction governing the recipient, or if the taxpayer produces satisfactory evidence that the relevant law does not require a formal reduction of capital;
- repayment takes place no earlier than two years from the end of the tax year in which the capital contribution was made;
- the contributor has a direct interest in the recipient's capital;
- the recipient is not entitled to tax relief in the relevant jurisdiction for deemed costs arising as a consequence of non-repayable capital contributions.
As regards the financing through contributions to the share capital of unrelated parties, a Cyprus company–contributor will not be liable to taxation in case of contributions with the issue of shares which, however, will not apply to the contribution without the issue of shares.
The abovementioned contributions can be made as non-refundable contributions or financial assistance, except if in the form of a gift, which is prohibited and void under article 25 of the Contract Law, Cap. 149, apart from some cases as provided for by the article.
Granting of loans
Analyzing the issue of granting of loans, we again refer to article 33 of the Income Tax Law N.118 (I)/2002 which states that such transactions must be undertaken at "arm's length terms", but this article does not regulate intra-group financing transactions regulated by the Circular issued by the Cyprus Tax Authorities (CTA) dd. 30 June 2017, revising the transfer pricing framework for companies carrying out intra-group financing activities in Cyprus on the basis of the Organisation for Economic Co-operation and Development (OECD) Guidelines. Very often a Cyprus company tax resident acts as an intermediate company to borrow and in turn to lend funds to a related non-tax resident company. Such transactions must be carried out between related parties and can be interest-free or with low interest which is not possible in cases of transactions between independent parties when article 33 of the Income Tax Law N.118 (I)/2002 (interest free loans) applies and in accordance with which the notional interest income will be taxed at the market rate of 9%. The Cyprus Tax Authorities set out acceptable profit margins of the Cyprus Company as set out below:
|AMOUNT OF LOAN||PROFIT MARGIN|
|Up to 50m Euro||0,35%|
|From 50m up to 200m Euro||0,25%|
|Over 200m Euro||0,125%|
A profit margin accumulated by a Cyprus company, after receiving loans and then lending them to subsidiaries–related parties, will be taxable at the adjusted rate.
Given all the above facts, it is obvious that the most efficient method of financing of a Cyprus company and through a Cyprus company is equity investment with the issue of shares and the reason is that this method does not entail any tax and legal consequences. As alternative methods of financing, with minimal tax consequences, we outline back-to-back loans between related parties, financial assistance to related parties, non-tax residents of Cyprus, or financial assistance to unrelated parties, again in the form of equity investment.
Originally published 04 February 2019
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.