In March 2013 Cyprus made global headlines as a result of the unprecedented bail-out agreement with the “Troika” (European Commission, European Central Bank and the International Monetary Fund) in an attempt to avoid a disorderly default. In spite of the challenges created by this agreement Cyprus remains a reliable international business and financial centre, continuing to offer access to a favourable tax regime, an extensive list of double tax treaties and a transparent legal system. We would also like to highlight that most of the changes in the legislation do not affect international business and non-resident shareholders of Cypriot Companies. As a matter of fact, many of the changes were designed to make Cyprus a more attractive investment location.
The global economic downturn has increased the need for tax efficient structures maximizing investors’ return. There are many jurisdictions to consider but Cyprus still remains one of the most attractive jurisdictions for this purpose. Cyprus’s fiscal regime offers a range of very attractive tax advantages for structuring business, including one of the lowest corporate tax rates in the European Union.
The low tax rate together with an enviable time zone location and a mature legal, accounting and banking infrastructure, places Cyprus high on the list of preferred jurisdictions for international tax planners.
The fiscal regime of Cyprus offers the following benefits:
- Introduction of the concept of tax resident and non-resident companies
- Introduction of an advance ruling procedure
- Taxation of worldwide income for tax residents and Cyprus sourced income for non-residents
- A uniform corporate tax rate of 12.5%
- Tax-exempt business profits of non-resident companies
- Tax-exempt gains on the trading and disposal of securities
- Tax-exempt dividend income (subject to applicable criteria)
- Tax-neutral group reorganisations
- Tax-relief for group losses
- Tax-credits for foreign tax
- Tax-relief of 80% on intellectual property management company’s profits (owner of IP)
- Full adoption of the EU parent-subsidiary directive, the EU mergers directive, the EU directive on mutual assistance and cooperation and the EU royalty and interest directive
Income tax is imposed on the worldwide income of all resident Cyprus persons (individuals and corporations). Non-resident persons are liable for tax on their Cyprus-sourced income only. A corporation is considered tax resident when its effective management control is exercised in Cyprus. Although there is no concrete definition, it is suggested that ‘effective management control’ is present in the case where the majority of the directors are residents of Cyprus or in the case where the board of directors holds its meetings in Cyprus.
The income tax law provides for a uniform corporate tax rate of 12.5% on the taxable profits of Cyprus tax-resident companies. The sources of income used in calculating taxable income of tax-resident companies under the income tax law include: business profits; interest derived in the ordinary course of business; royalties; rent from property; and any consideration for the trading of goodwill.
The Special Defence Contribution on passive interest income was increased from 15% to 30% and is effective from the 29th of April 2013 onwards.
Tax Treatment of Dividend Income in Cyprus
Dividend income received by a Cyprus Company is exempt from tax under Cyprus law, regardless of whether it is received from another tax-resident company, or from a non-resident company. Similarly, the business profits of a resident Cyprus company derived directly or indirectly from a permanent establishment outside Cyprus are exempt both from the Special Defence Contribution and income tax.
The exemption does not apply if:
- Directly or indirectly more than 50% of the activities of the paying company result in investment income, AND
- The paying company is subject to tax at a rate which is significantly* lower than the Cyprus corporate rate.
*Significantly lower means 50% of the Cyprus tax rate that is, 6.25%
It is important to note that both conditions above must be present for the exemption to be withheld.
A dividend paid by an EU subsidiary is received by the Cyprus holding company without any withholding tax on the basis of the EU parent-subsidiary directive (> 10% shareholding). If the EU parent-subsidiary directive requirements are not met, a double tax treaty still applies. Dividends paid by a non-EU subsidiary which is tax resident in a country that has a double tax treaty with Cyprus will be subject to the provisions of the double tax treaty.
However, although the tax law makes a distinction between treaty and non-treaty countries where withholding tax is deducted on the payment of the dividend to the Cyprus subsidiary, the Cyprus tax authorities will unilaterally give a tax credit equal to the amount of the foreign withholding tax. This reduces, in most cases, the effect of the foreign withholding tax on dividends paid to a Cyprus holding company to zero.
Tax Treatment of Dividend Distribution
Actual dividends paid by a Cyprus resident company to a Cyprus resident company are not subject to any withholding tax, whereas dividends paid to a Cyprus resident individual are subject to a withholding tax of 20%. Still, dividends paid by a Cyprus company to any non-residents of Cyprus (companies and individuals) are not subject to any withholding tax.
At the end of two years from the close of the tax year to which the profits relate a Cyprus company is deemed to have made a distribution of 70% of its profits after tax, in the form of dividends, and must account for a 20% defence contribution thereon. Any amount of actual dividend paid out in the two-year period following the financial year reduces the amount of the deemed distribution. The deemed distribution provisions do not apply to profits that are attributable to direct or indirect non-resident shareholders.
In brief, dividends of a Cyprus company (actual or deemed) attributable to a non-resident of Cyprus are not subject to any withholding tax. This is regardless of the country of residence of the non-resident shareholder or the existence of a double tax treaty with Cyprus.
Tax Treatment of Disposal of Subsidiary
Profits arising from the disposal or trading of securities are not subject to income tax. Securities include shares, debentures, government bonds, founder shares or other shares of legal entities in Cyprus or abroad, as well as options on those shares. This exemption from capital gains and the exemption on the profits from the trading of securities are the main factors behind the rapid development of International Collective Investment Schemes (ICIS) in Cyprus: an ICIS in Cyprus can trade in securities in any stock market without attracting any tax in Cyprus on the profits made.
Taxation Aspects of Group Reorganisation
The Cyprus income tax incorporates the provisions of the EU Merger Directive and extends the benefits of tax-neutral reorganisations to both EU and non-EU members. Furthermore, the provision of the tax is extended not only to cross-border transactions but also to domestic transactions and covers not only capital gains tax, but also stamp duty and VAT.
Under the reorganisation rules assets and liabilities do not give rise to a tax liability on gains or profits of the transferring company. This includes provisions and reserves that are transferred under a reorganisation. In addition, any accumulated losses of a company undergoing reorganisation may be transferred to the new company. If the receiving company has a holding in the transferring company, there is no tax liability on any gains accrued by the receiving company as a result of the cancellation of the holding. Because the reorganisation and share exchange is not subject to tax ? the newly allotted shares have the same value as the shares that were exchanged before the reorganisation.
To sum things up, the provisions of the Cyprus tax laws for the tax neutral group reorganisations are more generous than the requirements of the EU merger directive and Cyprus controlled groups can be restructured effectively with no tax consequences in Cyprus.
Group Loss Relief Provisions
Losses from business operations can be carried forward for five years to be offset against the profits of future years. Group relief, applied only for Cyprus tax-resident companies that are part of the same group, is available to offset the losses of one company against the profits of another. Losses arising from the operation of a permanent establishment abroad can be offset against the profits arising in Cyprus.
Taxation Treatment of Group Transactions
There are no thin capitalisation rules placing any share capital requirements on a Cyprus company. A Cyprus company can be financed fully by loans from its ultimate owner, and any interest payable to its lender, provided it meets the arm’s length principle, would be fully deductible for tax purposes.
Under the income tax law, all interest income on deposits is exempt from income tax. However, interest income on deposits credited or received by a Cyprus tax-resident company or individual is subject to Special Defence Contribution at 30%.
The interest income received in the ordinary course of business, including interest closely connected to the normal trading activity of business, is fully included in the calculation of the taxable profits of a Cyprus tax-resident company. However, this type of interest is exempt from the Special Defence Contribution. This suggests that the effective tax rate on interest received in the ordinary course of business is 12.5%.
The Cyprus Royalty Company Scheme is one of the most advantageous features of Cyprus tax legislation: net profits from royalty receipts of an intellectual property owning (asset) company are subject to an 80% tax relief reducing the effective tax rate payable to 2.5% or less. Also, royalty premiums for use of the intellectual property outside Cyprus are not subject to any withholding tax.
Conclusion: Tax Strategies Increase Returns
In the arena of global competition, companies find it increasingly difficult to create and sustain the growth rate required by their shareholders. Therefore, international tax planning is one of the most effective strategies to increase returns to shareholders. Cyprus offers a sophisticated low tax jurisdiction that, regardless of the events of the spring of 2013, is the jurisdiction of choice for international business-people, multinational corporations and their trusted tax advisors.
The Cyprus holding company scores well on the criteria of what constitutes a tax efficient holding company and, in many cases, surpassing the benefits offered by other similar holding company jurisdictions.