1. Overview of corporate tax work over the last year
Types of corporate tax work
The geographic location of Cyprus and its position as an international finance centre tends to mean that the corporate work undertaken by tax specialists on the island is both complex and varied. It also frequently intersects with personal tax issues since Cyprus is home to many high-net-worth individuals who are significant corporate investors. The COVID-19 pandemic initially led to the deferral of several significant corporate deals; however, some of these are now starting to come to fruition and other avenues for tax specialists have been opened earlier than anticipated as the government seeks to kickstart the economy. Specific areas of activity are the following.
Many corporates based in Cyprus are international or multinational businesses. Cyprus implemented transfer pricing rules in 2017, making transfer pricing a substantial compliance priority for many organisations on the island. They require assistance to introduce practical transfer pricing solutions into their overall global business operations and objectives, to prepare documentation to support their transfer pricing practices and, if necessary, to represent them for the purposes of resolving disputes.
Cyprus is keen to establish itself as a headquartering location and is meeting this with some success. During the past decade, several household names including NCR, Kardex, Amdocs and Bernhard Schulte Shipmanagement have all opted to headquarter on the island and utilise the experience of local tax professionals. Two sectors that have been particularly targeted have been shipping and high-tech. Considerable work is therefore directed towards assisting corporates in navigating the EU-approved shipping tonnage scheme and the EU-approved IP Box regime. Furthermore, corporate migrations have seen a surge with the implementation of the most recent Government Action Plan and the creation of a “Business Facilitation Unit (BFU)”, which acts as a single point of contact for foreign companies. Its purpose is the fast and efficient processing of requests received from foreign companies for the establishment of a company in Cyprus or the expansion of activities of existing companies.
The work in this area has increased substantially for two principal reasons. The first is the desire of the government to promote Cyprus as a regional energy hub – both for hydrocarbon fuels and renewables. The second is a stated aim by the government to accelerate a variety of large capital development projects such as the Larnaca Port development. By their very nature, both of these areas of activity lend themselves to the joint-venture structure. The discovery of natural gas and potential oil deposits in Cyprus' exclusive economic zone has attracted industry giants such as Total, Royal Dutch Shell and ExxonMobil to explore the area and most have established joint-venture vehicles for this purpose. The favoured bidder for the Larnaca development is also a joint-venture company. Professional input is required to structure the most tax-efficient vehicle and to advise on additional tax benefits that may be accessible.
The level of M&A work in Cyprus tends to be high and generally of an international rather than domestic nature. The intervention of the EU in the banking sector post-2013 significantly increased, albeit temporarily, the level of domestic M&A activity. However, the market for domestic transactions involving a Cyprus entity remains much larger in both value and volume. In most deals, the role of the Cypriot law firm is to advise on the Cyprus tax law aspects of the deal as part of a consortia of firms operating under the direction of a main advisor to the client. For example, the merger of FedEx Express International BV and TNT Express Worldwide BV required local professionals to advise on the impacts for two Cyprus subsidiaries. It is noteworthy that the level of activity in the hospitality and tourist sector has shown a definite upturn, which appears to be growth driven by, rather than as a result of, COVID-19-induced financial distress. A notable recent deal for tax advisors is Park Lane Acquisitions and Hyatt Hotels agreeing with Anolia Holdings Ltd to launch the first Hyatt hotel in Cyprus.
Significant deals and themes
Acquisition structure advice: Mediterranean Hospitality Venture Limited (MHV) on its 100% acquisition of Parklane Hotels Limited. This most recent purchase enabled MHV to add internationally branded luxury hotel complex “Parklane, a Luxury Collection Resort & Spa, Limassol”, the only internationally branded luxury resort in Cyprus, to its portfolio of high-end hospitality venues.
Public bids: CPI Property Group SA and Aroundtown SA utilised a Cyprus entity to make a cash offer for all of the share capital of Globalworth Real Estate Investments Limited (a Guernsey incorporated real estate company listed on AIM). Corporate tax advice was required regarding the structuring and implementation of the offer and acquisition of the shares, which was made via the Cyprus entities.
Advanced business structuring: Mintra Holding AS's cross-border acquisition of German-based maritime digital learning and crew competence management specialists Safebridge GmbH and its Cyprus subsidiary Safebridge Limited. Advice was required on structuring the deal to be tax efficient on an ongoing basis.
Greenmont AIFLNP's EUR 15.6 million acquisition of Watium Energia SL. Tax experts were required to provide tax advice throughout the structuring of the deal and the financing of the arrangement through a mix of debt and equity.
2. Key developments affecting corporate tax law and practice
Purely domestic changes
Cyprus supports the European Commission's initiatives to fight Aggressive Tax Planning (ATP), including by adopting the Anti-Tax Avoidance Directive II (ATAD II) and the Directive on Administrative Cooperation Vol. 6 (DAC6). Cyprus reiterates its commitment and willingness to continue cooperation in all appropriate fora for taxation in full respect of the respective competencies under the treaties. In addition to the European and international measures, Cyprus effected two recent key changes aimed at addressing ATP, namely:
- The introduction of withholding tax on dividend, interest, and royalty payments to countries in Annex I of the EU list of non-cooperative jurisdictions on tax matters.
- The introduction of a corporate tax residency test based on incorporation, in addition to the existing “management and control” test.
Corporate tax residency
On 21 December 2021, amendment 193(I)/2021 to the Income Tax Law (ITL) was published in the Official Gazette of the Republic of Cyprus whereby qualification for corporate tax residency will now include an additional test based on the incorporation principle as of 31 December 2022. Any company registered in Cyprus whose management and control are exercised outside Cyprus will therefore still be considered a tax resident unless it can be proved that it is considered a tax resident elsewhere. Prior to the new provision, the locus was on companies having their management and control exercised in Cyprus and not on whether a company was registered in Cyprus.
Withholding taxes to companies resident in a blacklisted country
A withholding tax of 17% will be imposed on corporations that are tax residents of a jurisdiction listed in the EU list of non-cooperative jurisdictions if any of the following conditions are met:
- The company has more than 50% of the voting rights of the Cyprus-resident company issuing the dividend.
- The company owns more than 50% of the capital of the Cyprus-resident company issuing the dividend.
- The company is entitled to receive more than 50% of the profits generated by the Cyprus-resident company.
The above conditions also apply when two or more associated companies that are both included in the EU list of non-cooperative jurisdictions participate directly in the Cyprus-resident company.
A withholding tax of 30% will be imposed on corporations that are tax residents of a jurisdiction listed in the EU list of non-cooperative jurisdictions. Interest payments made by individuals will not be subject to said withholding tax including any interest paid relating to securities listed on a recognised stock exchange.
A withholding tax of 10% will be imposed on corporations that are tax residents of a jurisdiction listed in the EU list of non-cooperative jurisdictions on any income received from the exercise of rights granted for use outside Cyprus.
- Deductions in innovative businesses
Individuals acting as independent investors who incur expenditure either directly or through an investment fund or via an alternative trading platform for venture capital investment in small to medium-sized innovative enterprises will be deducted from taxable income subject to specified conditions in Section 9 A of the ITL.
Contribution for the Defence (SDC)
As from 8 June 2022, SDC for residents is reduced to 3% on the following types of passive interest: saving certificates and bonds issued by the Republic; corporate bonds issued on a recognised stock exchange; as well as bonds and debentures issued by a local authority or government organisation that are listed on a regular stock exchange.
Ultimate beneficial owner registers
On 20 May 2015, the European Council issued Directive (EU) 2015/849, the Fourth Anti-Money Laundering Directive (4th AMLD), wherein EU Member States are to keep a central register of the beneficial or true owners of companies, trusts and other legal arrangements.
On 19 June 2018, the European Council issued Directive (EU) 2018/843, the Fifth Anti-Money Laundering Directive (5th AMLD), which was published in the Official Journal of the European Union. Under the revised provisions, EU Member States are required to launch publicly accessible registers of beneficial ownership of companies, trusts and other legal arrangements.
The 5th AMLD was transposed into Cyprus legislation through an amendment to the Prevention and Suppression of Money Laundering Activities Amendment Law of 2018 (the AML Law). It is expected for all registers to be fully operational by the end of 2022.
Tax measures expected in 2022
In May 2022, further amendments were made to the bills introducing requirements for transfer pricing documentation in Cyprus. The House of Representatives is expected to approve said bills by the end of 2022. The main provisions of the proposed amendments are as follows:
- The definition of “associated company” will require the same person or group to hold a minimum of 25% participation in either the share capital or voting rights of both companies.
- OECD general guidelines on transfer pricing documentation will be adopted.
- A Master File and Local File will need to be created up until the submission of the income tax return of the year in question with said files being submitted upon the request of the tax authorities within 60 days of a request.
- No Local Cyprus File will be required provided that all controlled transactions based on the arm's length principle cumulatively amount to less than EUR 750,000 per tax year.
- Summary information for controlled transactions for each tax year will need to be electronically submitted together with the annual tax return.
- Advance Pricing Agreements will be available.
- Heavy penalties will be introduced for non-compliance.
Notional interest deduction (NID)
Pursuant to Law 116(I) 2015 amending the ITL, resident companies and non-resident companies with a permanent establishment (PE) in Cyprus are entitled to an NID of new equity introduced into them. This is effectively a tax-allowable deduction against taxable profits. The NID is calculated by multiplying the “reference interest rate” by the “new equity” held and used by a company in carrying out its business activities. For the aforesaid purpose, the following definitions apply:
- “reference interest rate” means the 10-year government bond of the country in which the “new equity” is invested, increased by 5%; and
- “new equity” is defined as any share capital (ordinary, preference, redeemable and/or convertible) and/or share premium injected into either: (i) a Cyprus tax-resident company; or (ii) a PE maintained by a non-Cyprus tax-resident entity in Cyprus that is used for the generation of taxable income.
NID is treated as an interest expense and is therefore subject to the same limitation rules. Moreover, it is not available in the case of losses and cannot exceed 80% of the taxable profits of the company (resulting from the introduction of the new equity) calculated before allowing the NID.
European – CJEU cases and EU law developments
CJEU case law
- T-516/18 Luxembourg v Commission and T-525/18 ENGIE, ENGIE Global LNG Holding Sàrl and ENGIE Invest International SA v Commission
In this case, the General Court approved the Commission's approach, which entailed looking at the economic and fiscal reality, rather than adopting a formalistic approach that takes into consideration each of the transactions completed under the intra-group financing structure in question on a separate basis. Additionally, the General Court concluded that it could not be disputed that the ENGIE group was conferred preferential tax treatment in light of the non-application of national provisions relating to abuse of law. It is therefore clear that the test of reality is of utmost importance and that preferential tax treatment can be predominantly ascribed to the non-application of a national measure relating to abuse of law.
EU-level developments and exit taxation
On 3 July 2020, Cyprus fully adopted the provisions of ATAD I and II. Consequently, companies and groups with international activities may find themselves liable to pay an “exit tax”. That is, they may be subject to corporate tax on an amount equal to the market value of the transferred assets at the time of exit, less their value for tax purposes, in any of the following circumstances:
- Transfer of assets to the Head Office or to a PE in another EU Member State or in a third country insofar as Cyprus no longer has the right to tax the transferred assets.
- Transfer of tax residence to another EU Member State or to a third country, except for those assets that remain effectively connected with a PE in Cyprus and for which Cyprus has the right to tax.
- Transfer of the business carried on in Cyprus by a PE in another EU Member State or in a third country insofar as Cyprus no longer has the right to tax the transferred assets due to the transfer.
Hybrid mismatch rules
Companies and groups of companies with international activities should note that on 3 July 2020, Cyprus fully adopted ATAD I and II. Provisions relating to hybrid mismatches came into effect from 1 January 2020. Provisions relating to reverse hybrid mismatches take effect from 1 January 2022. The aim of the provisions is to ensure that tax deductions or credits are only taken in one country and that a deduction is not taken in one country without taxation of the corresponding income in the other country. Cyprus rules follow ATAD minimum standards. They apply to Cyprus registered companies and foreign registered companies with a PE in Cyprus.
ATAD I and II
On 5 April 2019, the House of Representatives approved legislation implementing ATAD in Cyprus with the aim of improving the internal market's ability to deal with cross-border tax avoidance practices.
ATAD contains five legally binding anti-abuse measures, which all Member States must apply. The measures are the following:
- introduction of controlled foreign company (CFC) rules (Action 3);
- the switch-over rule (Action 2);
- introduction of exit taxes;
- interest limitation (Action 4); and
- introduction of the general anti-abuse rule (GAAR) (Action 6).
The provisions relating to interest deductibility rules, CFCs and GAAR, as included in ATAD, entered into force on 1 January 2019. On 3 July 2020, the remaining two amendments for full implementation of ATAD were published in the Official Gazette of the Republic: the first concerns the introduction of an exit tax regime (ATAD I), which applies retroactively from 1 January 2020; and the second is related to hybrid mismatches (ATAD II), which focuses on Action 2 and also applies retroactively from 1 January 2021. The so-called reverse hybrid mismatch rules will apply from 1 January 2022.
Transactions that are not carried out for valid commercial reasons will give rise to tax liability calculated in accordance with the ITL. Cyprus already incorporates within its tax legislation numerous anti-abuse rules. It is expected that relevant Articles within the tax legislation will be introduced to provide greater and specific powers to the Inland Revenue Director to ignore non-genuine arrangements that do not have a valid commercial reason that reflects economic reality. GAAR only applies to corporate transactions.
Thin capitalisation/interest deductibility rules
A limitation on the possibility of deducting exceeding borrowing costs in the tax period in which they are incurred is set at 30% of taxable earnings before interest, taxes, depreciation and amortisation (EBITDA). Taxable EBITDA is defined as the total of net taxable income calculated in accordance with the ITL, increased by the exceeding borrowing costs.
The exceeding borrowing costs restriction does not apply to amounts below EUR 3 million per taxpayer. In addition, the restriction does not apply to companies not forming part of the group and that do not have a related business (participation of at least 25% in the share capital or participating at least 25% in the profits).
The law further excludes financial undertakings from the scope of the interest limitation rules (i.e., credit institutions, investment firms, alternative investment fund managers and management companies of undertakings for collective investment in transferable securities).
An entity, or a PE whose income is not taxable or is exempt in Cyprus, is treated as a CFC where the following two conditions are met:
- in the case of a non-Cypriot tax-resident entity, the Cypriot tax-resident company alone, or together with its associated enterprises, holds a direct or indirect participation of more than 50% in such an entity; and
- the non-resident entity or PE is low-taxed (i.e., the income tax it pays is lower than 50% of the Cypriot corporate income tax that it would have paid by applying the provisions of the ITL).
Cyprus has opted for the ATAD Model B CFC rules since they give EU Member States the ability to “carve out” CFCs via the thresholds provided by ATAD. “Carving out” applies to entities that have: (i) accounting profits of no more than EUR 750,000 and non-trading income of no more than EUR 75,000; or (ii) accounting profits of no more than 10% of operating costs.
Other specific measures transposed into Cyprus law include:
- the amendment of the IP Box regime to follow the nexus approach in response to Action 5;
- elimination of back-to-back reduced margins in response to Actions 8–10;
- amendment as to the taxability of dividends where such are products of a hybrid instrument in response to Action 2;
- ratification of the Multilateral Convention to Implement Tax Treaty Related Measures (MLI) in response to Action 6;
- country-by-country reporting in response to Action 13; and
- the introduction of requirements for transfer pricing documentation in Cyprus in response to Action 13.
It is therefore vital, from a tax planning perspective, that the Cyprus position be examined in terms of its entire structure and its adherence to BEPS and ATAD.
On 22 January 2020, the instrument of ratification of the MLI, together with the positions of Cyprus and an explanatory statement, were published in the Official Gazette of the Republic.
The MLI is designed to allow countries to swiftly incorporate new tax treaty provisions into their existing bilateral tax treaties (in line with measures arising from the G20/OECD BEPS Project). The MLI does not operate in the same manner as an existing treaty protocol amendment – rather, it “complements” existing treaties and is to be read in conjunction with the treaty at hand. While the MLI provides flexibility on each state's sovereign right over the adoption of the MLI positions, some elements contained therein (inter alia, the provisions on the prevention of treaty abuse and dispute resolution) are considered G20/OECD “minimum standards” for those jurisdictions participating in the BEPS initiative.
Cyprus approved the minimum Actions as prescribed by the MLI – Action 6 (Purpose of Covered Tax Agreement), Action 7 (Treaty Abuse) and Action 14 (Making Dispute Resolution Mechanisms More Effective).
The publication of the above completes the domestic procedures by Cyprus for entry into force of the MLI, with deposit of the MLI having taken place on 23 January 2020. The entry into force will follow Article 34 of the MLI, i.e., “the first day of the month following the three months following the deposit”, being 1 May 2020. For provisions relating to withholding taxes, the earliest entry into effect will be 1 January 2021 (provided that the other contracting jurisdiction has also submitted its instrument of ratification with the OECD prior to, or during, 2020). For provisions relating to other taxes, the earliest entry into effect will be 1 November 2021 (provided that the other contracting jurisdiction also submitted its instrument of ratification with the OECD prior to, or during, January 2020).
COVID tax implications
The Cyprus Tax Department issued a circular on 27 October 2020 clarifying the provisions of the ITL (Article 2) on “tax residence” and “permanent establishment” amidst COVID-19 as well as an additional circular on 25 January 2021 extending the validity of the previous circular for as long as the restrictions continue to apply globally.
Creating an unintended PE
Cyprus is dealing with the unusual travel problems caused by COVID-19 by adopting the OECD's “stopping the clock” approach to the extent that the current circumstances should not create any changes in the definition of a PE. Cyprus appreciates the exceptional circumstances producing the result that activities are being conducted in a jurisdiction where, without the restrictions imposed by governments, they would not normally occur, such as, for example, working or concluding contracts remotely or on construction sites.
Creating a forced change of residency for legal entities
Cyprus embraces the OECD's approach that the inability of the decision makers to travel should not affect the application of the Article 4 tiebreaker rule for the purposes of determining a company's place of residence. Non-Cyprus tax-resident companies would not be deemed to acquire tax residence in Cyprus merely because their staff, directors, representatives, or employees under a service contract are stranded in Cyprus solely because of the current restrictions.
By the same token, the failure of a director to travel to Cyprus to attend a board meeting, when such a failure is due to the restrictions, will not affect the company's tax residence in Cyprus. It is worth noting that pursuant to certain amendments to the Cyprus companies laws, a director can be present at a meeting via teleconference. Meetings can be organised and considered duly held through the use of electronic fora to also include general meetings.
COVID-related carve-outs are applicable as long as the global restrictions remain in force.
The standard rate of VAT is 19%. Reduced rates of 5% and 9% apply to certain supplies. COVID-19 vaccines and diagnostic tests are 0% rated.
Mandatory disclosure rules update
On 18 March 2021, the Parliament approved the draft bill of the Law of Administrative Cooperation in the Field of Taxation (Law 205(I)/2012) implementing DAC6. This said bill was fully enacted into local Cyprus law on 31 March 2021.
DAC6 requires EU-based intermediaries or taxpayers to disclose certain cross-border arrangements that were implemented on or after 25 June 2018 to their local tax authority, who must then share the information with the tax authorities of all other EU Member States.
On 26 February 2021, the Cyprus Tax Authority, in response to difficulties arising from COVID-19, issued a Directive wherein it was announced that there would be no imposition of administrative fines for overdue submission of DAC6 information that should have been submitted until 30 June 2021. This date was further extended until 30 September 2021 via an announcement made on 3 June 2021 in the following cases:
- reportable cross-border arrangements that were made between 25 June 2018 and 30 June 2020 and had to be submitted by 28 February 2021;
- reportable cross-border arrangements that were made between 1 July 2020 and 31 December 2020 and had to be submitted by 31 January 2021;
- reportable cross-border arrangements made between 1 January 2021 and 31 August 2021 that had to be submitted within 30 days from the date they were made available for implementation, or were ready for implementation, or the first step in the implementation has been made, whichever occurred first; and
- reportable cross-border arrangements for which secondary intermediaries provided aid, assistance or advice between 1 January 2021 and 31 August 2021 and had to submit information within 30 days beginning on the day after they provided aid, assistance or advice.
3. Tax climate in Cyprus
Cyprus-resident companies must be set up in a manner that satisfies international tax compliance and acceptance. The international legal framework has taken a sharp stance in safeguarding the substance of companies, specifically through the EU Parent/Subsidiary Directive, which allows for the refusal of benefits for arrangements that are considered “non-genuine” and that have been put into place solely for purposes of obtaining a tax advantage. In addition, the ATAD series, BEPS Action 5 on harmful tax practices, the MLI as well as the new Article 29 contained within the OECD Model Double Tax Treaty (referring to the Principal Purpose Test and Limitation of Benefits) reinforce the need for proper substance. Cyprus follows all of the aforesaid EU and international standards by having them embedded into its national legislation.
IP Box regime
Special allowances and incentives are granted for intellectual property rights in Cyprus.
Taxable profits from intellectual property would consist of:
- Less expenses linked with revenue generation.
- Less capital allowances on the cost of the intellectual property.
- Less NID on the value of any intellectual property injected into the Cyprus company in exchange for equity in the Cyprus company.
- Less 80% deduction under the nexus approach.
The effective corporate tax rate of a successfully implemented Cyprus intellectual property owner may, under certain conditions (full enjoyment of deductions listed above), reduce the effective corporate rate up to 2.5%.
As a general note, Cyprus currently applies the “modified nexus” approach in line with Action 5 of the BEPS Action Plan. Such a regime is subject to stricter substance requirements (the “nexus” approach); notably, the hiring of new employees or relocation of employees in Cyprus and the conducting of research and development in Cyprus.
In particular, under the new regime, which applies on qualifying assets developed after 1 July 2016, qualifying profits and qualifying expenditure are taken into account in arriving at the effective tax rate that will be subject to taxation in Cyprus, and this applies mainly in relation to software and patents.
In other words, the tax relief is not fixed or pre-determined as per the previous regime.
This matter is governed by the Merchant Shipping (Fees and Taxing Provisions) Law of 2010 as amended by Law 39(I)/2020 (together, the Tonnage Tax Law). As a result of this amendment, the tonnage tax system of Cyprus has been extended until 31 December 2029, giving effect to the Decision of the European Commission dated 16 December 2019 to prolong such system and to approve it as being in line with the relevant EU policy and community guidelines on state aid to maritime transport. The Tonnage Tax Law gives qualifying Cyprus-resident shipping and ship management companies the option to be taxed on the basis of the tonnage of the vessels they operate, simplifying and reducing the tax burden. It widens the range of exempt gains to include profits on the disposal of vessels, interest earned on funds and dividends paid directly or indirectly from shipping-related profits, in addition to profits from shipping operations.
Film and audio-visual production industry
In September 2017, the government approved an initiative to encourage the development of the film and audio-visual production industry in Cyprus by means of grants, tax incentives and other assistance.
Law 139(I) of 2018, which took effect on 11 December 2018, amends the ITL to provide tax exemption of income from production of films and audio-visual media in accordance with the government's programme.
The amending law adds a new sub-paragraph to Article 8 of the ITL providing up to 50% exemption from tax of income derived from the production of films, series and other relevant audio-visual programmes as described in the government programme. The deduction is limited to 35% of the eligible costs approved by the competent authority implementing the programme. Any restriction on the exemption resulting from the limitation to 35% of costs can be recovered over the next five years. No exemption is available if the taxpayer has received a grant under the programme.
In addition, small enterprises as defined in Article 17 of Regulation (EU) 651/2014 may claim an annual deduction of 20% of the cost of cinematographic infrastructure and technological equipment providing it is used in Cyprus for at least five years. Medium-sized enterprises may claim an annual deduction of 10% of such costs.
The film industry incentives have been approved by the Council of Ministers and will end on 31 December 2023.
4. Industry sector focus
Please see the “Tax climate in Cyprus” section above.
5. The year ahead
Tax residency-related considerations
COVID-19 has tested the strength of the global economy and health system as well as fully demonstrating the need of businesses to invest in modern working practices, IT infrastructure, and human resource management due to staff still having to work remotely through various electronic fora.
COVID-19 has produced some “novel” issues for tax authorities looking to apply standard tax treaties to non-standard situations. This has led the OECD Secretariat as well as competent authorities around the globe to issue initial guidance on an emergency basis on tax residency-related matters, among others.
The imposition of emergency measures by governments around the globe, such as travel restrictions, has created an array of complications that will need constant review and refinement.
There has also been the introduction of a corporate tax residency test based on incorporation, in addition to the existing “management and control” test as explained above.
Considerations related to substance and “beneficial ownership of income”
Further to the discussion in the “Tax climate in Cyprus” section above, during the last few years, many foreign taxpayers have not been automatically granted treaty benefits unless there is evidence that the recipient is the actual beneficial owner of the income. Tax authorities around the world are becoming stricter and more sophisticated and proper tax planning is therefore required for safeguarding the taxpayer's interest. With the MLI now firmly in place, it is vital that existing structures be consolidated to ascertain proper commercial reasoning as well as appropriate levels of substance.
Moreover, the European Commission published a draft Directive on 22 December 2021, known as the Anti-Tax Avoidance Directive III (the Directive), aimed at preventing the use of shell companies for tax evasion and avoidance in the EU. The Directive proposes the introduction of a “minimum substance test” and reporting requirements to identify shell companies, which could have serious consequences for investment structures that do not perform “actual economic activity”.
The Directive is intended to come into effect from 1 January 2024, including the aim for adoption by the end of 2023 and implementation by the Member States by mid-2023. As the Directive is still under review, there could be potential amendments. If an entity is regarded as a “shell” company under the Directive and is unable to rebut that presumption, the entity will not be allowed to claim the tax benefits available from tax treaties and EU directives. It is also noted that the information and data reported by the affected entity should be covered by an automatic exchange of information between Member States and could potentially result in tax audits.
The Directive sets out a list of substance-related features that determine whether an entity is regarded as a shell entity applicable to all EU Member State resident entities, regardless of legal form. The Directive also sets out certain undertakings that do not require any entity to demonstrate minimum substance, placing the entity out of scope of the Directive.
Transfer pricing-related considerations
On 24 January 2022, the Cyprus Tax Department published a new “Frequently Asked Questions” (FAQs) section on its website on transfer pricing. The FAQs relate to Interpretative Circular 3 issued on 30 June 2017 (the Back-to-Back Circular). The Back-to-Back Circular applies to Cyprus tax-resident companies and PEs of foreign companies conducting intra-group back-to-back financing transactions and sets out requirements for the transfer pricing analysis of such transactions. The answers to the FAQs are applicable to all transactions that fall within the scope of the Back-to-Back Circular and relate to loan agreements concluded as at the date of the issue of the FAQs (i.e., 24 January 2022), as well as to those loan agreements that were concluded prior to that date and have not been examined by the Tax Department by that date.
Please see the “Mandatory disclosure rules update” section above.
Reform of the Cypriot taxation system
The Ministry of Finance has initiated discussions for a revamp of the Cypriot taxation system in an effort to modernise it and encourage foreign investment as Cyprus seeks to rebrand itself as a tech island. It is also likely that the reform will incorporate issues of green taxation.
Tech hub/headquartering-related incentives
Cyprus is positioning itself as a tech hub, and the IP Box regime, along with the application of the NID as well as various tax and employment incentives at an employer and individual level, is expected to prompt foreign investment and domiciliation services.
A bill was approved in May 2022 by the Council of Ministers, and has been introduced before the Parliament for enactment into law. The bill introduces a new Business Attraction Programme, with the aim to establish Cyprus as a primary investment hub and destination for entrepreneurs and businesses. The new programme's scope also extends to attracting both foreign employees and Cypriot high-profile individuals who have been living abroad for a certain number of years. The bill incentivises the management of foreign businesses to migrate to Cyprus (headquartering), or to move some of their business activities to Cyprus, thereby leading to the island's direct and indirect economic growth and an increase in revenue income. The government intends for the programme to become one of the most competitive programmes in the EU. The attraction of the programme is evidenced by the enormous interest already being shown in it, especially from FinTech companies, several of which have chosen Cyprus as the destination to relocate their headquarters to in recent years. The bill has already been submitted to the Parliament for its enactment into law.
The new bill also provides for a 50% tax deduction for individuals becoming tax-resident and taking up employment in Cyprus. The new bill seeks to reduce the income threshold of EUR 100,000 to EUR 55,000 and extend the current 10-year eligibility period to 17 years.
The Ministry of Finance, in its statement, also announced that the new programme is relevant to another upcoming bill from the Ministry of Interior. This bill will seek to promote the rights of professionals' spouses to relocate to Cyprus while also granting them access to the employment market. The Ministry of Interior's new bill also seeks to create a one-stop shop to facilitate implementation of the programme.
The technology sector is embraced in Cyprus through various existing and new legal policies. Apart from the existing IP Box regime, the new Trademarks Law has recently been enacted and a Cyprus Digital Nomad Visa Scheme has also been put in place. Cyprus tax compliance and tax reform also underpin many of the actions undertaken. The government, while expressing and delivering on its promise and intent to attract and provide benefits to enterprises and foreign investment concerned with digitalisation and the development of modern technology and processes, is also committed to promoting a fair, fully transparent, internationally compliant and pro-business tax regime.
The test of “reality” as well as the increasing importance of transparency and substance are expected to lead to business restructurings or enhancement of the level of the substance of all companies within a specific group and not only at a local level. Substance is also important in the context of exchange of information and transfer pricing, among others. All cross-border transactions will be screened pursuant to EU (i.e., ATAD I and II) and international regulations.
Lastly, digital taxation as well as other tax reforms that are on the EU and G20 agenda may play a very important role in the establishment and future operations of multinational enterprises.
It was first published in GLI – Corporate Tax 2022.
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.