Key provisions from the Cyprus and Kazakhstan tax treaty explained
Costas Savva and Niki Antoniou of Taxand Cyprus discuss the most important provisions from the Cyprus and Kazakhstan DTT, effective January 1 2021.
The Republic of Cyprus and the Government of Kazakhstan signed a double tax treaty (DTT) on May 15 2019. The DTT is effective from January 1 2021 and includes a combination of provisions of the OECD and UN Model Tax Conventions. The most important provisions agreed between the two states are discussed below.
Article 5 of the DTT contains a definition of permanent establishment (PE) which is used to determine the threshold for the business profits in the country of source. The PE wording is mostly in alignment with the OECD Model, except for the ‘service PE’ provisions, that is based on the 2011 UN Model.
According to the provisions of the DTT a ‘service PE’ arises where services, including consultancy services, are furnished in one contracting state by a resident of the other contracting state through employees or other personnel engaged by the resident for such purpose, but only where activities of that nature continue (for the same or a connected project) within the country for a period or periods aggregating more than 183 days within any 12-month period.
The UN Model adopts the sourcing approach, which means that the sourcing countries are entitled to tax only the income that arises in their territory and for this reason has been designed in such a way in order to provide the tax authorities of the Contracting State a broader jurisdiction to tax. Therefore, with the inclusion of the ’service PE’, the scope of the PE concept is expanded, providing an additional reason to impose the obligation for the contracting states to pay income tax.
Another important provision of Article 5 is found in paragraph 6 and deals with the commissioner arrangements that follow the 2017 OECD Model. It is made clear that a PE shall be deemed to arise where a person is acting in a contracting state on behalf of an enterprise and, in doing so, habitually concludes contracts or habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without any material modification.
As a result of this provision, the contracting states make clear their intention to tax in respect of any activity of a person acting for it. According to the OECD commentaries, persons whose activities may create a PE for the enterprise are persons, whether or not employees of the enterprise, who act on behalf of the enterprise and are not doing so in the course of carrying on a business as an independent agent falling under paragraph 7.
Articles 10–12: Passive income
The dividends income under Article 10, the interest income under Article 11 and the royalty income under Article 12 of the DTT provide that such incomes are taxed in the place where the beneficial owner of the income is tax resident.
According to the OECD Model commentaries, the beneficial owner is the person who has the right to use and enjoy the property unconstrained by a contractual or legal obligation to pass it to another person. Therefore, the commentaries clarify that an agent or nominee is not treated as the beneficial owner of the income.
Article 10(2) of the treaty provides that provided that there is such a provision in the domestic law of the source country, withholding taxes shall be imposed at a maximum rate of 5% if the beneficial owner of the income is a company that holds directly at least 10% of the capital of the company paying the dividends. In all other cases, a withholding tax of 15% is imposed.
Withholding taxes are also imposed at a maximum rate of 10% provided that the recipient of the income is the actual beneficial owner of the income according to Articles 11(2) and Article 12(2), which deal with interest income and royalty income, respectively.
Further, paragraph 6 of Article 10: Dividend provides a provision that is not included in the OECD Model nor in the UN Model and deals with the branch profit taxation. As explained in paragraph 6, the DTT does not prevent a contracting state from imposing a special tax on the company's profits attributable to a PE in that contracting state. However, it is clarified that any additional tax so charged shall not exceed 5% of the amount of such profits, in addition to the tax which would be chargeable in the profits of a company which is resident of the contracting state.
Regarding the latest provision explained above, it could be argued that the said provision comes in contrary to the non-discrimination provision illustrated in Article 24(3) of the DTT, and therefore it could be argued that the provision does not have applicability. Article 10 states that the taxation of the PE shall not be less favourably levied in the state concerned than the taxation levied on enterprises of that state carrying on the same activities.
Article 13: Capital gains income
For the capital gains, Cyprus retains the exclusive taxing rights on disposal of shares made by Cyprus tax residents. However, according to the DTT, gains derived by a resident of a contracting state from the alienation of shares or comparable interests in the capital of a company deriving from more than 50% of their value directly or indirectly from immovable property situated in the other contracting state may be taxed in the other contracting state.
Article 29: Entitlement to benefits
In response to the BEPS Action 6, the PPT has been introduced as a mechanism in order to attack treaty shopping arrangements.
According to the PPT found in Article 29 it is made clear that no benefit would be granted to the taxpayer under this agreement “if it is reasonable to conclude that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit unless the taxpayer establishes that granting that benefit was in accordance with the object and purpose of the tax treaty”.
Consequently, the tax authorities are now entitled to disallow the application of treaty benefits, such as withholding tax. Therefore, in order for the test to be established it is necessary to be able to indicate the business purposes behind the arrangement or transaction in relation to which tax treaty benefits are applied, and to examine whether the tax authorities could successfully argue that obtaining treaty benefits was one of the purposes behind an arrangement or transaction.
The combination of the provisions found in both the OECD and UN models will strengthen the relationship between the two countries significantly. The DTT is undoubtedly a big step forward for Cyprus since this DTT will assist Cyprus to lift its position as an attractive place of investment for various investors from Kazakhstan.
Partner, Taxand Cyprus
Lawyer, Taxand Cyprus