Is it justifiable that Cyprus has been considered by European authorities of acting as a tax haven? All the below actions taken by the Cyprus Authorities, which have been adopted into the Cyprus law, should be considered before this question is answered.
Cyprus has incorporated into its tax legislation the automatic exchange of information with all European tax authorities and it has also adopted and incorporated into legislation the relevant OECD guideline, known as Common Reporting Standard, through which automatic exchange of information is extended to all contracting parties.
Further, Cyprus has adopted all of the European Tax Directives (ATAD).
The Anti-Tax Avoidance Directive (ATAD), is effectively the action taken by the Council in response to the recommendations of the Base Erosion and Profit Shifting (BEPS) Action Plan of the OECD. The main objective of the ATAD is to ensure that tax is paid where the profits and value are generated.
On the 5 April 2019, the Cyprus House of Representatives adopted the law implementing the provisions of the ATAD. The measures which were incorporated being:
- Controlled Foreign Company (CFC) rules
- Interest limitation rule
- General anti-abuse rule
The provisions of the law apply retrospectively, as of 1 January 2019.
Controlled Foreign Company (CFC) rules
An appealing tax planning tool is to shift profits from companies based in high-tax jurisdictions to their subsidiaries based in low-tax jurisdictions. The aim of the CFC rule is to combat this deferral and to tax such income in the jurisdiction in which the parent company is tax resident.
Member States are allowed to choose between two options. The first option is generally applicable to predefined passive income of a CFC (option A) while the second option is applicable to income arising from “nongenuine arrangements” put in place essentially to obtain a tax advantage (option B). Cyprus has selected option B. The CFC rules apply to both Cypriot tax resident companies and non-Cypriot tax resident companies which have a permanent establishment (PE) in Cyprus.
Cyprus considers a CFC as a company which is tax resident outside of Cyprus and is controlled by a company or companies’ tax resident in Cyprus. A CFC is a low taxed non-Cyprus tax resident company in which,
- A Cypriot resident company, either by itself or together with its associated enterprises, holds an interest either directly or indirectly of more than 50% in a non-Cypriot tax residency company.
- Where by the actual corporate tax paid on the profits of the foreign entity or foreign PE is lower than 50% of the tax that would have been imposed, if such profits were subject to tax in Cyprus in accordance with the provisions of the Cyprus Income Tax Law.
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 is not more than €75 000; or
- Accounting profits that do not exceed 10% of its operating costs for the tax year.
The non-distributed income of a CFC which is the result of non-genuine arrangements is added to the taxable income of the Cyprus tax resident controlling company.
It is clarified that non-distributed income is the income that has not been distributed within the year in question.
There should be no CFC charge if there are no significant people functions in Cyprus that are instrumental in generating the income of the CFC. A Transfer Pricing Study will be required in this respect.
It is possible for the Cypriot controlling entity to claim credit for any overseas tax imposed on the CFC profits which are included in its tax base. The Law does not limit the credit to the tax imposed in the jurisdiction of the CFC.
Interest limitation rule
Another common and appealing tax planning tool is for companies based in low tax jurisdictions to provide financing to related companies based in high tax jurisdictions. The interest expense at the level of the borrowing entities could effectively reduce the overall tax liability.
In order to avoid this before mentioned practice, the interest limitation rule was introduced which restricts exceeding borrowing costs deductible in the tax period in which it is incurred to 30% of the tax payers EBITDA (earnings before interest, tax, depreciation and amortization), subject to a threshold of €3,000,000. For the purpose of calculating a company’s EBITDA, any income that is not taxable and any tax losses brought forward are not taken into consideration.
Exceeding borrowing costs refer to net interest expense, being mainly interest income less interest expense on all forms of debt, including other costs similar to interest and expenses incurred in connection with the raising of finance.
Standalone entities (not part of a consolidated group) and financial undertakings (such as credit institutions and investment firms) are excluded from the limitation rule. Moreover, grandfathering has been provided for loans concluded before 17 June 2016. Finally where the Cyprus resident company is part of a consolidated group for financial reporting purposes, the taxpayer may fully deduct its Exceeding borrowing cost, provided that the ratio of its equity over its total assets is equal to (or no more than 2% lower) than the equivalent group ratio.
Any unused exceeding borrowing costs and interest capacity which cannot be deducted in the current tax period, may be carried forward for the next five years.
The interest limitation rule is applicable to financing with both related and non-related parties.
General Anti-Abuse Rule (GAAR)
The Cyprus Income Tax Law provides that for the purpose of calculating the corporate tax liability, any arrangement or series of arrangements should be ignored if they have been put in place with the main purpose of obtaining a tax advantage that defeats the purpose of the applicable tax law and which are not genuine and do not display any economic substance, always having regard to all relevant facts and circumstances. Where such arrangements are disregarded, the tax liability will be calculated in accordance with the provisions of the Income Tax Law. This is aimed at all non-genuine transactions performed whether domestically or cross-border.
Following the partial adoption of the EU Anti-Tax Avoidance Directive in 2019, on 19 June 2020, the Cyprus Parliament voted into law the remaining provisions of the ATAD.
The anti-tax avoidance measures that have further been incorporated into law are the following:
- Exit taxation rules
- Hybrid mismatch rules
The provisions of the law apply retrospectively, as of 1 January 2020.
Exit taxation rules are designed to prevent taxpayers from avoiding tax by transferring their activities or assets out of the country in which the specific activities or assets had gained their value in. Based on these rules, Cyprus will have the right to tax, subject to the provisions of the Cypriot Income Tax Law any unrealized gain created in Cyprus at the time a taxpayer transfers its activities, or assets out of Cyprus. The value of the gain should be based on the arm’s length principles.
A taxpayer will 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.
Under certain circumstances, a taxpayer has the right to pay the exit taxation in instalments over a period of five years and any existing tax deductions or exemptions regarding corporation tax rules will continue to be applicable.
Hybrid mismatches occur due to the different tax treatments of a payment of a financial instrument from one jurisdiction to another. Hybrid mismatches usually have the following tax effect, being a double deduction in both jurisdictions or a deduction in one jurisdiction without being taxed in the other.
The objective of the hybrid mismatch rules is to neutralize the tax effects of hybrid mismatch arrangements. So in order to avoid any double deduction, when the receiver of such is a Cyprus tax resident, the deduction will not be accepted in Cyprus and when the payer of such is a Cyprus tax resident and where the deduction is not denied by the foreign jurisdiction then the deduction will be denied in Cyprus.
The hybrid mismatch rules deal with the following types of arrangements:
- A payment from a financial instrument were the mismatch is attributed to the difference in characterization of the financial instrument or the payment and when the payment is not included in the jurisdiction of the payee within a reasonable time frame.
- A payment to a hybrid entity were the mismatch results from differences in the allocation of payments made to the hybrid entity;
- A payment to an entity with one or more PEs were a mismatch results from differences in the allocation of payments;
- A payment to a disregarded PE;
- A payment by a hybrid entity whereby the mismatch results from the fact that the payment is disregarded under the laws of the payee jurisdiction;
- Situations with double deduction outcomes.
The Directive provides for the following two measures to correct and to neutralize the effects of hybrid mismatch arrangements:
- The primary rule, whereby if there is a deduction on the income on the level of the recipient, the payer will be denied a deduction on the payment; and
- The secondary rule, whereby if the payment is deductible at the level of the payer, the income will be included at the level of the recipient.
The law provides the following measures regarding the treatment of hybrid mismatch outcomes:
To the extent that a hybrid mismatch results in a double deduction, the deduction will be denied in Cyprus under the primary rule, if Cyprus is the receiver jurisdiction. Where Cyprus is the payer jurisdiction, the deduction will be denied in Cyprus if it is not denied by the investor jurisdiction.
The UK’s exit from the EU changes the world balance within both political and economic systems.
International companies seem to have initiated a relocation of financial resources and employees to other EU countries.
Those businesses trading mainly with the EU countries are subject to the greatest risk and expected to suffer the most. Those companies that trade with companies outside the EU bear less risk, though it exists too. A car dealership may serve a good example: cars produced in the UK may contain parts produced in the EU and vice versa. In turn, this will mean an increase in prices of end products and services, which will definitely influence the entire supply chain. This is one of the reasons why some UK based companies are moving to the EU.
Further, the UK may adopt a decision to stop complying with the rules and regulations of the EU. The country may decide on an individual basis what is of benefit to its economy and vice versa. The British authorities are expected to maintain existing EU rules and regulations, however this cannot be guaranteed.
With respect to taxes it should be mentioned that an increase in existing taxes and/or introduction of new taxes is a possible scenario in the future. In particular, with respect to VAT as the UK currently operates in accordance with the European standard, it is uncertain whether the country will preserve it or implement its own new standard.
Some UK citizens have already applied for second passports in other European countries and also in Cyprus.
It seems that Brexit may also benefit the Cyprus shipping sector as there are numerous shipping companies that have set up subsidiaries in Cyprus and transferred part of their business so as to enjoy the benefits provided.
In addition, Cyprus has recently attracted a number of investment fund managers from the United Kingdom.
There are many undeniable advantages which make Cyprus an excellent destination to relocate from the UK and to avoid any possible negative implications of Brexit.
- At the moment in the UK uncertainty prevails and different possible scenarios for the future. On the other hand in Cyprus due to all the above implementations it can be considered as a possible reliable jurisdiction that offers the stability of its financial, law and political system, reliable legislative and regulatory framework, providing a wide range of possibilities for efficient tax planning.
- Tax legislation in Cyprus is simple and predictable, provides for one of the lowest taxes rates in Europe.
- The country has a stable, growing economy and easy access to countries of the European Union, Africa, Middle East and Asia.
- Cyprus enjoys the privilege of being a member of the European Union and is subject to the EU legal framework, which guarantees uniformity and a coherent approach to all regulated relationships within the EU.
- The legal and judicial systems of Cyprus and the UK are quite identical due to history and the close relationships between the countries. For instance, corporate rules are mainly adopted from English company law and the legislative system in Cyprus is based on English common law.
- The other advantages offered by Cyprus are the favourable climate, multicultural population, high standards of living, safety and good ecological situation and fairly low living expenses, which make the country not only a good place for doing business but also a decent place for a comfortable life.
Just because Cyprus has one of the lowest tax rates in the EU does not make it a Tax Haven by default and although there are still many changes which need to take place, it is without a doubt that Cyprus is moving in the right direction.
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