Back in 2019, Cyprus partially adopted the Anti-Tax Avoidance Directive (EU 2016/1164) or ATAD I. On 3 July 2020, the Official Gazette published the law implementing the remaining ATAD I provisions on exit taxation, as well as those of the Hybrid Mismatches Directive (EU 2017/952) or ATAD II. With that, Cypriot national law is now fully in line with the EU anti-tax avoidance regulatory framework.
The new rules regarding exit taxation, hybrid mismatches, and tax residency mismatches apply retroactively as of 1 January 2020. The only exceptions are the provisions concerning reverse hybrid mismatches, which will enter into effect as of 1 January 2022.
Cyprus Corporate Taxpayer
The amended Income Tax Law defines a Cypriot corporate taxpayer as:
- A Cyprus tax-resident company; or
- A permanent establishment in Cyprus of a non-Cyprus tax-resident company
Exit Taxation Rules
As per the Income Tax Law, Cypriot corporate taxpayers are subject to taxation equal to:
(1) The market value of the transferred assets
(2) At the time of exit of the assets
(3) Less their value for tax purposes
in any of the circumstances listed below:
- When a Cyprus tax-resident company transfers assets from its Cypriot head office to its permanent establishment elsewhere in the EU or a third country, to the extent that Cyprus may no longer tax the assets in question as a result of the transfer.
- When a permanent establishment in Cyprus of a non-Cyprus tax-resident company transfers assets either to its head office or to another permanent establishment elsewhere in the EU or to a third country, to the extent that Cyprus may no longer tax the assets in question as a result of the transfer.
- When a Cyprus tax-resident company relocates its tax residence elsewhere in the EU or to a third country, with the exception of any assets that retain an effective connection with a permanent establishment in Cyprus.
- When the permanent Cypriot establishment of a non-Cyprus tax-resident company relocates the business it carries out to another EU member state or to a third country, to the extent that Cyprus may no longer tax the assets in question as a result of the transfer.
If a company or a permanent establishment that is tax resident in another EU member state transfers its residence, assets, or business to Cyprus, the starting value for tax purposes of the transferred residence, assets, or business shall amount to the value accepted by the member state in question, unless it does not reflect the market value.
Market value equals the amount for which:
(1) Consenting and unrelated buyers and sellers
(2) That engage in a direct transaction
(3) Are willing to exchange an asset or settle mutual obligations.
Cyprus shall impose no exit taxes on:
- Assets posted as collateral;
- Outbound transfers arising from the financing of securities; and
- Asset transfers carried out for the purposes of meeting prudential capital requirements or liquidity management, where such assets are due to revert to Cyprus within twelve months.
Deferral of Exit Tax Payments
The Assessment and Collection of Taxes Law allows exit tax payments to be paid in installments over a five-year period. That applies to intra-EU transfers as well as to transfers within the European Economic Area (EEA), where there is a mutual understanding for tax recovery.
However, such deferrals are subject to interest and, where appropriate, require the provision of guarantees to leverage non-recovery risks. What's more, a deferral may be discontinued immediately if the relevant requirements of the Income Tax Law are not met.
What Are Hybrid Mismatches?
Hybrid mismatches are caused by the differences in the tax regimes of two or more jurisdictions. While hybrid mismatches may seem quite natural, they are, in fact, considered abusive by the EU.
For a hybrid arrangement to qualify as unlawful, it needs to result in a mismatch outcome, namely:
- A double deduction (DD); or
- A deduction without inclusion (DWI).
The purpose of the new hybrid mismatch rules is to neutralize DD and DWI outcomes.
The Anti-Tax Avoidance Directive addresses structured arrangements that were deliberately designed to result in a mismatch outcome or where that outcome is priced into the terms of the arrangement. The arrangements can be between:
- Associated enterprises
- A taxpayer and an associated enterprise
- A head office and its permanent establishment
- Two or more permanent establishments of the same company
The only exception is where the taxpayer or the associated enterprise in question could not reasonably have been expected to be aware of the hybrid mismatch and did not share in the value of the ensuing tax benefit.
What Happens If a Hybrid Mismatch Is Identified?
In the event of a hybrid mismatch, Cyprus shall deny any deduction arising from the mismatch. However, if Cyprus is the recipient of a hybrid mismatch payment, Cyprus shall neutralize the hybridity by taxing the payment accordingly.
Under the new provisions, Cyprus shall assess hybrid mismatches on Cyprus tax-resident companies and the permanent Cypriot establishments of non-resident companies in the following arrangements:
- A payment under a financial instrument produces a DWI outcome, the payment is not included in the income within a reasonable period, and the mismatch outcome is due to differences in the characterization of the financial instrument or the payment.
- A payment to a hybrid entity results in a DWI to the income, and the mismatch outcome is due to differences in the allocation of payments to the hybrid entity under the jurisdiction of establishment or registration and the jurisdiction of any person with participation in the entity.
- A payment to an entity that has one or more permanent establishments results in a DWI, and that mismatch outcome is due to differences in the allocation of payments between the head office and the permanent establishment or between two or more permanent establishments of the same entity, as per the jurisdictions where the entity operates.
- A payment results in a DWI due to a payment to a disregarded permanent establishment.
- A payment by a hybrid entity results in a DWI, and that mismatch is due to the fact that the payee jurisdiction disregards the payment.
- A deemed payment between the head office and a permanent establishment or between two or more permanent establishments results in a DWI, and that mismatch is due to the fact that the payment is disregarded under the payee jurisdiction.
- A double deduction takes place.
In the event of payments made by hybrid entities or permanent establishments, the payer jurisdiction is the one where the entities or establishments in question are established or situated.
How do the new rules allow Cyprus to neutralize double deduction? By denying the deduction of any payment, expense, or loss in Cyprus where Cyprus is the investor jurisdiction.
Where Cyprus is the payer rather than the investor jurisdiction, it will allow the deduction, but only if the investor jurisdiction itself has neutralized the deduction. In any event, all deductions remain liable for offsetting against any current or future dual-inclusion income, whether it arises in the current or subsequent tax period.
Deduction Without Inclusion
Where Cyprus is the payer jurisdiction, it shall neutralize DWI due to hybridity by denying the deduction of any payments or deemed payments between:
- A permanent establishment and a head office; or
- Two or more permanent establishments of the same entity.
If Cyprus is the recipient jurisdiction, it will include the income in its taxable base, in so far as no exemptions apply.
The ATAD provisions establish several exemptions that apply in the event that:
- Cyprus is the recipient jurisdiction; and
- The payer jurisdiction does not deny the deduction, such as when the source is in a third country.
- In such situations, Cyprus will not add to the tax computation of the recipient taxpayer the income arising from the following payments:
- Payments to hybrid entities where the mismatch outcome is due to differences in the allocation of payments made to the hybrid entity in question;
- Payments to entities with one or more permanent establishments where the mismatch outcome is due to differences in the allocation of payments;
- Payments to a disregarded permanent establishment; and
- In the event of a deemed payment between the head office and a permanent establishment or between two or more permanent establishments, where the mismatch outcome is due to the fact that the payment is disregarded under the payee jurisdiction.
In addition, as per a transitional provision in force until 31 December 2022, certain hybrid mismatches resulting from interest payments under a financial instrument to an associated enterprise under the Notional Interest Deduction (NID) rule will not raise hybridity issues.
Imported mismatches likewise fall within the scope of the ATAD hybrid rules. More specifically, the deductions for any payments shall be denied in so far as:
(1) Such payments directly or indirectly fund deductible expenditure
(2) That gives rise to a hybrid mismatch
(3) Through a transaction between associated enterprises or as part of a structured arrangement
(4) Unless one of the jurisdictions involved has made an equivalent adjustment regarding such hybrid mismatches.
Disregarded Permanent Establishment Income
A disregarded permanent establishment is:
(1) Any arrangement
(2) Treated as giving rise to a permanent establishment under the law of the jurisdiction of the head office
(3) But not under the law of the other jurisdiction.
In so far as a hybrid mismatch involves disregarded permanent establishment income which is not taxable in Cyprus, the Cyprus taxpayer is required to include that income to its taxable base. Under different circumstances, Cyprus would have attributed that income to the permanent establishment.
The only exception to this rule is where such income is exempt from tax under a double taxation treaty between Cyprus and a third country.
A hybrid transfer is any arrangement to transfer a financial instrument, where the underlying return is treated for tax purposes to be derived by more than one party to the arrangement at the same time.
In so far as the parties to an arrangement set up a hybrid transfer to produce withholding tax relief for two or more of the parties, Cyprus shall reduce the relief it grants in proportion to the net taxable income in the country.
Tax Residency Mismatches
The ATAD rules also seek to eliminate tax residency mismatches. These occur when:
- Expenses; or
are deductible in multiple jurisdictions as a result of the taxpayer being tax resident in all of them.
If such deductions from the taxable base of the taxpayer are allowed in both Cyprus and the other jurisdiction or jurisdictions, Cyprus shall deny that deduction in so far as the other jurisdictions provide for it to be set off against non-dual inclusion income.
Even so, Cyprus shall not grant the deduction where:
(1) All jurisdictions involved are EU member states; and
(2) There is a double tax treaty between Cyprus and the member state concerned, which stipulates that the taxpayer is not a Cypriot tax resident.
Reverse Hybrid Mismatches
A reverse hybrid entity is one that is treated as transparent in its jurisdiction of establishment or incorporation but is considered as taxable in the investor jurisdiction. A typical example would be a partnership where income is deemed to flow through to the partners.
It is possible for reverse hybrid entities to also give rise to a DWI. Their income may be exempt in the jurisdiction of establishment as well as in that of the investor. That is because the entity is not transparent, and there is no flow-through approach.
In so far as the income of a reverse hybrid entity is not otherwise taxed in Cyprus or elsewhere, that entity shall be deemed a Cypriot taxpayer and shall be taxed accordingly, subject to conditions. However, this provision does not apply to collective investment vehicles that meet certain requirements.
The New Anti-Tax Avoidance Rules and Your Business
So, what does the new anti-tax avoidance law mean for you and your business? In order to find out, make sure to contact us today and book a consultation with our legal and financial experts.
We cannot stress enough how critical that is. The provisions are not only highly complex but also retroactive and already in almost full force. That is why you want to get up to speed with the new regime as quickly as possible.
This way, you will be able to make informed decisions about your business and investment portfolio going forward. Perhaps more importantly, we will also make sure that you avoid any unpleasant surprises and potential regulatory pitfalls.
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.