The Cyprus Tax Authorities, issued an Explanatory Circular (Circular 25) on the 3rd of September 2018, clarifying the tax treatment of Non-Refundable Capital Contribution from Cyprus Tax Resident Companies to Non-Tax Resident Companies.This Circular explains how debit or credit balances created from Non-Refundable Capital Contribution will be treated by the Cyprus Tax Resident Companies provided that certain criteria will be met and therefore, Article 33 (related party transactions) will not be applicable for such cases.
B. Non-Refundable Capital Contribution
A Cyprus Tax Resident Company may fund a Cyprus Non-Tax Resident Company, of which it is a shareholder, either through equity or debt (such as by way of issue allotment of shares, granting of loans, and/or provision of Non-Refundable Capital Contribution).
For the avoidance of doubt note that non-Refundable Capital Contribution is a funding through which the shareholder of a Company contributes (as part of the share capital of that Company) funds for future capital increase, however no shares are issued in exchange at the time of the contribution.
C. Tax Treatment of Non-Refundable Capital Contribution
The Explanatory Circular 25 issued by the Cyprus Tax Authorities on 3 September 2018 explains the tax treatment of non-refundable capital contributions to Non-Tax Resident Companies by Cyprus Tax Resident Companies.
In accordance with the Circular, Article 33 of the Income Tax Law N.118 (I)/2002 (related party transactions), does not apply to debit or credit balances created by non-refundable capital contributions to Non-Tax Resident Companies, provided that all of the following criteria are satisfied, and relevant supporting documents evidencing that such criteria have been met are provided accordingly:
- The contributor has no legal right to request repayment of the contribution;
- Repayment of the contribution is only possible if this is made by the reduction of capital or through dissolution or liquidation of the recipient, in accordance with the laws of the jurisdiction governing the recipient, or if the taxpayer produces satisfactory evidence that the relevant laws of such jurisdiction does not require a formal reduction of capital;
- Repayment takes place not earlier than two years from the end of the tax year in which the capital contribution was made;
- The contributor has a direct participation 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.
Non-refundable capital contributions that meet all the above criteria, are deemed to be part of the assets of a Company that are not being used in the business for the purposes of articles 9 and 11 of the Income Tax Law. Non-refundable capital contributions meeting the requirements above are not eligible for any tax relief in Cyprus, and are subject to disallowance of direct and apportioned expenses, particularly for what concerns the deduction from taxable income of costs of investment in innovative enterprises and the notional interest deduction. Furthermore, no deduction is allowed on the costs of financing non-refundable capital contributions.
The Circular applies retroactively with effect from 1 January 2017 for all the Non-Refundable Capital Contributions for Non-Tax Resident Companies in existence as at that date and those created thereafter. In addition, any existing advance tax rulings covering, exclusively or partly, non-refundable capital contributions, which are not in line with the provisions of the Circular become void for what concerns their provisions on this topic.
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