On the 25th of April 2019, following provisions of the EU Anti-Tax Avoidance Directive of July 2016, the Cyprus law introduced measures against tax avoidance methods that negatively affect the internal markets functioning. These measures are known as Anti-Tax Avoidance Directives – ATAD. In July 2020, the Official Gazette of Cyprus published the law implementing the remaining ATAD I provisions as well as those of the ATAD II. This concluded and ensured that Cyprus law is fully in line with the EU anti-tax avoidance regulatory framework. See below the four directives that were established of the years:
- Interest Limitation Rule (applicable from 01/01/2019):
This directive was introduced with the intention to prevent group companies from providing finance from their subsidiaries in low jurisdiction countries to companies that are based in high jurisdiction countries. As per this rule, any exceeding borrowing costs (EBC) will be deducted in the tax year in which incurred, only up to 30% of the taxable earnings before interest, tax, depreciation and additions (EBITDA). EBC is defined as net interest expense. Losses brought forward are not taken into account when calculating taxable earnings as well as any income that is not taxable. Interest limitation rule is applicable to both related and unrelated companies.
When a company is part of a Cyprus group, then the interest limitation rules will apply on the group as a whole, including permanent establishments in Cyprus. While if a company is not a member of a Cyprus group, then the rules will apply on the company itself.
Law states that any exceeding borrowing costs above €3,000,000 per tax year are not subject to limitation.
There are also exceptions in regards to the interest limitation rule. Exemptions are listed below:
- Standalone companies (companies with no associates, not members of a group, no permanent establishments);
- Financial Undertakings (banks, investment funds, pension funds etc.);
- Loans that were used to fund long-term public infrastructure projects;
- To companies with exceeding borrowing costs below €3,000,000;
There is also a maximum when it comes to the amount that can be claimed. Maximum is the higher of the actual amount of exceeding borrowing costs if below €3,000,000 and 30% of EBITDA.
If a company during its current tax period has unused exceeding borrowing costs and interest capacity that are not deductible, then this can be carried forward for the following five years.
- Controlled Foreign Company (CFC) rule (applicable from 01/01/2019):
Income from subsidiaries or a permanent establishment, that are normally not subject or are exempt from Cyprus tax, may be taxed in Cyprus if conditions of the CFC rule are met. If conditions are met and income arises from non-genuine arrangements, then such income from a low-taxed controlled foreign company is transferred to its controlled parent company. Any tax that has been paid in another country on the income from the controlled foreign company or from the permanent establishment will be credited against the tax payable in Cyprus.
A Cyprus Controlling Entity must recognise to its taxable income, the profits of the CFC, assuming the below conditions are met:
- CFC has profits that have not been distributed to the extent that such profits would have been taxable in Cyprus;
- The arrangements between the Controlling Entity and the CFC are not genuine and have been placed for the purpose of a tax advantage;
- The Controlling Cypriot Entity follows the operations of a significant individual, which operations contribute to the generation of income of the CFC;
The CFC rule does not apply to non-Cyprus tax resident companies if a CFC has either:
- Accounting profits that do not exceed €750,000 and non-trading income which do not exceed €75,000; or
- Accounting profits that do not exceed 10% of its operating costs for the tax year;
- General Anti-Abuse rule:
This rule has been imposed to ensure that when calculating tax liabilities of a company, an arrangement or a series of arrangements that have been performed are that are non-genuine should be ignored. Non-genuine arrangements are defined as any arrangement that takes place that has no economic or commercial purpose.
- Exit Taxation (applicable from 01/01/2020)
When a Cyprus tax resident company or a non-Cyprus tax resident company that holds a permanent establishment in Cyprus moves assets either from their head office to a permanent establishment in another Member State or a third country or vice versa, or moves its tax residence to another Member State or a third country, then this company will in certain cases be subject to exit taxation. If this is the case, then the company will be taxed on the market value of the transferred assets at exit time, less their value for tax purposes. Market value is defined as the amount that unrelated buyers and sellers that engage in a direct transaction are keen to exchange an asset.
There are a few exemptions on specific assets under which Cyprus will not impose exit tax. The exemptions are listed below:
- Assets that are posted as collateral;
- Asset transfers that are done for the purpose of meeting capital requirements or liquidity management, assuming the assets are to revert to Cyprus within a time period of 12 months;
- Outbound transfers from the financing of securities;
In certain circumstances the taxpayer has the option to defer exit tax payment and pay it in instalments over a 5 year period. Such a deferral will be subject to interest.
- Hybrid Mismatches (applicable from 01/01/2020):
A hybrid mismatch arises when there is a difference between tax regimes of two of more jurisdictions. In some cases such the outcome of such a mismatch cannot be acceptable. Such cases are when a double deduction or a deduction without inclusion arises:
Double Deduction: When assessing whether a double deduction is acceptable or denied, we need to identify and distinguish between investor jurisdictions. If the investor's jurisdiction is Cyprus, then the hybridity is neutralised since Cyprus will deny the deduction of any expense, loss or payment. If the investor's jurisdiction is outside Cyprus and Cyprus is the payer's jurisdiction, then the deduction is allowable, assuming that the investor's jurisdiction has denied the deduction. In any event, all deductions remain liable for offsetting against future or current dual-income, whether it arises in current or following period;
Deduction without inclusion: If Cyprus is the payer's jurisdiction, then the hybridity is neutralised by Cyprus denying deduction of payment or deemed payment between head office and a permanent establishment or two or more permanent establishments of the same entity. If the recipient jurisdiction is Cyprus, then the income will be included in its taxable base unless an exemption applies. Exemptions are listed below:
- Payers jurisdiction does not deny deduction;
- Payments are made to a disregarded permanent establishment;
- Payments are made to hybrid entities where the mismatch outcome is due to differences in allocation of payments made to the hybrid entity;
- Payments to entities with one or more permanent establishments where the mismatch outcome is due to differences in allocation of payments;
- If a deemed payment is made between head office and permanent establishment or between two or more permanent establishments, when the mismatch is a result of the payment disregarded under laws of payee jurisdiction;
Purpose of this rule is to ensure that deductions and credits only take place in one jurisdiction and there are no situations in which deductions of a payment are made in one jurisdiction without this income being taxed in the other jurisdiction.
Reverse Hybrid Mismatches (applicable from 01/01/2020):
If one or more associated non-tax resident companies that hold in aggregate either directly or indirectly interest of 50% or more of voting rights in a Cyprus hybrid entity, are located in a jurisdiction or jurisdictions that regard the hybrid entity as a taxable person, the hybrid entity shall be regarded as a Cyprus tax resident and will be taxed on its income under Cyprus tax law. Income will be taxed under income tax and special defence contribution to the extent that income is not otherwise taxed under Cyprus or any other jurisdiction tax laws.
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.