Why set up a holding company?
In essence, holding companies are set up as an effective means of consolidating ownership of operating subsidiaries. Deciding where to set up a holding company is not always a tax driven exercise, but usually, a business entrepreneur will seek the most tax effective means of consolidating ownership of his or her operating subsidiaries. As aptly stated by Lord Tomlin in IRC v Duke of Westminster, “every man is entitled if he can to order his affairs so that the tax attaching under the appropriate Act is less than it otherwise would be”. Indeed, no taxpayer is obliged to pay more tax than he can be compelled to, so a lot of structuring is often resorted to in order to minimize the incidence of taxation. The revenues flowing from such investment are considerable so it is no wonder jurisdiction can offer the best holding regime.
With the introduction of the new Cyprus tax legislation which came into effect on 1 January 2003, Cyprus has dynamically placed itself on the map for the most attractive holding regimes worldwide. The man features of the new regime ore outlined below.
Main Features of the Cyprus Holdings
A. Extraction of Dividends from Subsidiaries
A Cyprus holding company can achieve low or zero withholding tax rates when extracting dividends from underlying subsidiaries by relying either on its double tax treaty network, or on the Parent / Subsidiaries Directive. When there is a choice between these two means (i.e. when the investment is an intra –EU qualifying investment) the Parent / Subsidiary Directive should be preferred as it eliminates the incidence of taxation altogether. Where the investment is outside the EU, or where the conditions of the Parent / Subsidiary Directive are not met, Cyprus can rely on a rich network of double tax treaties, the rates of which, especially as far as Eastern European investments are concerned, are considered particularly advantageous. The treaty network of Cyprus with applicable rates can be found at our article “Doubler Tax Treaties“.
B. Tax Treatment of Incoming Dividends
Dividends received by a Cyprus holding company from a Cyprus subsidiary are exempted from any taxation in Cyprus. Cyprus taxes foreign incoming dividends at a rate 18% but provides for a generous exemption mechanism which is almost always satisfied resulting in the non taxation of the foreign-source dividend income. The exemption mechanism as well as the (challengeable) distinction between local and foreign source dividends will be explained in further detail below.
C. Tax Treatment of Outgoing Dividends
There are no withholding taxes on dividend payments to non residents regardless of the country of residence on the non resident shareholder of the existence or not of a double tax treaty with such country of residence.
D. Tax Treatment of Capital Gains
There is no capital gains tax in Cyprus other than on gains accruing from the disposal of immovable property held in Cyprus or shares in companies the property whereof consist of immovable property held in Cyprus. Moreover, the new legislation specifically exempts from taxation any gains accruing from the disposal of shares, securities and debentures.
E. Thin Capitalisation Rules
There are no debt / equity ratio requirements in the Cyprus tax legislation – a Cyprus company can be capitalized entirely with loans and any arms’ length interest paid to a parent will be fully deductible.
F. Additional Features of the Cyprus Tax Regime
- 12,5% tax on corporate profits;
- No withholding tax on royalties for use outside Cyprus;
- No withholding tax on interest;
- Credit relief available for foreign withholding tax unilaterally;
- Ability to carry forward losses indefinitely;
- Group relief rules available;
- Flexible and tax efficient reorganisation provisions;
- Wide network of double tax treaties;
- Generous permanent establishment provisions in DTT network.
II. Participation Exemption and CFC Legislation
Under the Cyprus tax legislation, dividend income received by a Cyprus resident will not be charged under the income tax law but under the Special Contribution for the Defence Law (SCDL) at 18%. The SCDL implements the Parent / Subsidiary Directive whereby tax-paying companies in the European Union are entitled to receive dividends from “subsidiaries” (a company in which at least 25% of the equity is held by the recipient of the dividend) in other EU countries free of foreign withholding tax and upon receipt must either exempt the dividend income or provide a credit for the underlying tax paid. Cyprus uses the exemption method. Dividends received by a Cyprus resident are taxed at the rate of fifteen per cent (15%), except the following:
- Dividends paid from one Cyprus resident company to another.
- Dividends received from an overseas company by a resident company of Cyprus or a company which is not a resident of Cyprus but has a permanent establishment in Cyprus, holding directly at least one per cent (1%) of the share capital of the overseas company. This exemption does not apply if a) more than fifty per cent (50%) of the paying company’s activities result directly or indirectly in investment income and b) the foreign tax burden on the income of the company paying the dividends is substantially lower than the Cypriot tax burden.
The conjunction “and” implies that both criteria has to be met in conjunction which the 1% holding (which is a constant) for the exemption to not apply. So for example, if a Cyprus company owns more than 1% of a BVI trading company and the BVI company pays a dividend to the Cyprus company then this dividend will be exempt from the 15% tax because although the tax rate of the paying company is substantially lower than the tax burden of the Cyprus company (zero as opposed to ten per cent) it is a trading company so the (a) criterion is met.
The difference in tax treatment between the domestic participation exemption in accordance with which local-source dividends are exempt from taxation and the international participation exemption in accordance with which the foreign-source dividends are exempt only on the satisfaction of certain (albeit easily-satisfied) criteria is a matter of controversy at present in Cyprus, and may be challengeable under the free movement of capital provisions of the EC Treaty.
III. Cyprus Reorganisation Rules
The Cyprus tax legislation has transposed the Merger Directive into the local income tax law and unlike the Directive itself which provides only for cross-border reorganizations with EU member and non EU member states and to reorganizations abroad with tax implications in Cyprus.
In accordance with the legislation, no tax consequences arise in the case of a reorganisation involving a Cyprus holding company.
The Cyprus legislation has introduced a number of tax opportunities for Cyprus holding companies which can receive dividends at mitigated rates of withholding tax based on its double tax treaty network, can exempt the incoming dividend from tax subject to a few simple conditions and can distribute the dividend to its non resident shareholders (whether or not they reside in the EU or in a country with which Cyprus has double tax treaty) free of any withholding tax in Cyprus. Moreover the disposal by a Cyprus company of its underlying shareholding will not attract capital gains tax if immovable property in Cyprus or shares representing immovable property situates in Cyprus are not the subject of such disposal, and the recently introduced reorganization rules offer flexibility and significant tax planning opportunities for restructuring via Cyprus.
A.G.Paphitis & Co. LLC (c)