Substance is defined as the actual presence of a company in its country of registration. In order for a company that operates in Cyprus to be able to claim double tax treaty advantages and have rights to the EU Directives, the company must have adequate substance. A company must be able to prove that it has economic substance and that it conducts real business.
Cyprus follows the Organisation for Economic Cooperation and Development (OECD), where companies' qualify for tax treaty benefits if the company is a tax resident of the country it is registered in and the company is the "Beneficial Owner" of the income distribution. Income here refers to dividends, interest, royalties etc. The importance of substance has increased in the last few years following OECD action plan of the Base Erosion and Profit Shifting (BEPS) project. The European Union Code of Conduct Group commenced investigation into low corporate income tax regimes following OECD's project and has instructed regimes to place laws to address the issue of economic substance. Such laws are enforced to ensure that these countries do not end on the EU Blacklist for non-cooperation.
General definition: A company is considered to be a resident in the country in which management and control is located and implemented. When speaking about where management and control is located, the general idea and also according to OECD criteria are the following:
- Is the location of the board of directors meetings, in which all strategic decisions and major contracts are agreed upon, in Cyprus?
- Are the majority of directors Cyprus tax resident individuals? Directors must be qualified, with the appropriate experience and expertise to take on all business decisions;
- Does the company hold or rent an office in Cyprus in which it maintains employees which carry out daily duties? Company should have a physical address of its space and hire employees for operational activities;
Along with the above, there is also a list of guidelines for a Cyprus company to follow in order to achieve full substance. Not all the below are requirements; however they are a general parameter that should be followed:
- A full set of all record keeping and administration must be maintained in Cyprus. For instance all agreements must be signed in Cyprus;
- All bookkeeping work, along with preparation of audited financial statements and management accounts should all be performed in Cyprus by local professionals. In addition to this, all invoices issued from the company and all receipts obtained should be kept in the company's offices in Cyprus;
- Directors of the company should be employed, receive a salary and perform actual duties. The directors salary should be appropriate and in line with their duties. As discussed above, directors must have experience and knowledge. This is important, since if it is proven that the director does not have sufficient expertise, then this may validate that the director is not the actual decision-maker and therefore the company may be viewed as lacking substance. In addition to this, it is important to avoid appointing directors that hold multiple positions, since this may raise red flags;
- The company should hold or rent an office space in Cyprus. The office should have a business telephone line, an email account, a fax number etc. The office should also have furniture and all other equipment that are necessary for an office to function properly;
- Board meetings should be held in Cyprus. A minimum of 3 board meetings should take place per year and all directors must attend these meeting;
- Business records should be kept in the company's office in Cyprus. Records such as minutes of meetings, share register, company seal and all other administrative documents;
- The company should hold a tax number allocated from authorities;
- The company's bank accounts should be managed and controlled in Cyprus. The bank account should have a Cyprus tax resident as a signatory. The bank account statement should show that company's regular expenditure that was done in Cyprus;
- The company's profits should flow to its beneficial owners and go through the company's bank account and not be received on behalf of other parties;
- The Cyprus company should have a logo, a website or any merchandise that can offered complementary to its clients;
- The company should have its team of local professionals. For example the courier companies they work with, the IT company that visits its offices for maintenance etc.;
In addition to the guidelines, that when followed ensures real presence, a company must also take into consideration that it should prove real economic activity and purpose as well.
A transaction to be considered valid, it must have an economic purpose that goes beyond just a decrease of tax liability. Economic purpose is also necessary when using a Cyprus Bank to perform the bank transactions. Banks are requesting full details of each transaction and are requesting a purpose and supporting documents. In order for a company to achieve real economic purpose, it must ensure that it holds assets, has established risks, real functions and has business goals and targets to meet.
Other ways to ensure economic purpose is to transfer intellectual property rights to Cyprus, or set-up a Cyprus International Trust or even consider a Cyprus Stock exchange listing. All three suggestions stated above have their advantages if set-up in Cyprus. It is also important to ensure that the Cyprus Company is constantly being developed and its activity is growing.
Beneficial Ownership of Income:
A holding company in Cyprus should be receiving dividends from its investments and then distributing the profits to its shareholder. The beneficial owner should be the recipient of the company's income and have the right to use the income as they wish and not be contractually obliged to pass on the income to another party. This is the concept of "beneficial ownership of income". If the beneficiary acts as an intermediary, then any benefits of the double tax treaty terms under which the dividend was received, may be denied.
When a company has sufficient substance in Cyprus, this acts as a shield against any foreign tax authorities attempting to challenge the company's tax residence and force tax under their own laws. It may also support transfer pricing challenges and address any anti-avoidance provisions. It is important for companies to be aware of new developments and be prepared for any challenges. No standard approach can be used; each company has its own structure and must be viewed on a case-by-case basis.
Oxford Tax Solutions can provide full support in establishing proper substance in Cyprus and set up headquarters. We offer all services and professional advice to effectively assist you comply with the substance requirements. Please contact us to learn more information regarding our substance solutions.
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.