Companies need to carefully select the jurisdiction they use for implementing such structures as well as implement their structuring with a careful look at substance so they can mitigate risks and taxes.
Cyprus is an established international business and financial centre because of incentives, good infrastructure and its extensive network of double tax treaties (DTTs). Its EU membership and compliance with EU and OECD standards, in line with its most favourable tax regime and transparent legal system, places Cyprus amongst the most favourable holding and IP company jurisdictions.
Cyprus is also a vehicle for investment for many countries such as Russia, Poland, Ukraine, the Balkans, India and China. It could easily be said that the country functions as a connecting hub for Europe to Central and Eastern European countries, and Asia.
Advantages of Cyprus holding and IP companies
- The provisions of the EU Parent – Subsidiary Directive, as well as the Interest and Royalties Directive, have full application in Cyprus, resulting in the elimination of withholding tax obstacles.
- Dividend income received by a company which is a tax resident of Cyprus is exempt from corporation tax (CIT) and in most cases is also exempt from the Special Defence Contribution (SDC).
- Outgoing dividends/royalties/interest paid by the Cyprus Company to the ultimate non-resident beneficial owner are exempt from any withholding taxes irrespective of the existence of any DTTs and irrespective of the applicability of the EU Parent – Subsidiary Directive.
- Interest income is taxed under CIT at the rate 12.5% in the majority of cases. Where back-to-back loans exist, the 12.5% tax is levied on the interest spread (that is on the difference between interest payable and receivable).
- A non-offshore jurisdiction that offers a flat tax rate of 12.5% only on 20% of the royalty income from IP rights or profits from the sale of the IP, resulting to an effective rate of 2.5%.
- Cyprus provides unilaterally for a tax credit in the absence of a DTT, for any withholding taxes levied at source in the other country.
- Profits from the sale of titles are generally exempt from taxation in Cyprus. The definition of titles includes ordinary shares, founder's shares, preference shares, bonds and debentures, units in collective investment schemes, options and futures.
Management and control and the substance consideration
The tax residency of a company is determined by the principles of management and control. In the absence of a formal definition regarding the establishment of management and control in Cyprus, companies should take these parameters into account:
- the majority of the directors of the company are residents in Cyprus,
- important company decisions are taken in Cyprus by the local directors,
- the headquarters of the company are maintained in Cyprus,
- the company has an economic substance in Cyprus
Economic substance has become an extremely important issue. More and more countries are looking deeper into the substance over form doctrine. It is a rather dangerous exercise to try to codify what actions need to be taken by any company to enhance its substance. It simply cannot be as an exercise of generality. Careful planning and sophisticated tax advice is needed to determine the extent of enhancing the substance of a company. A number of important considerations and factors must be taken into account by an experienced tax adviser in this context. Indicatively, these should be considered:
- the nature and operation of the company and that of the group the company belongs to.
- the business strategy of the group.
- the legal and management structure of the group as a whole.
- the country where the group's head office is located. This is important to understand the approach and the tax requirements of the tax authorities of the head office.
- the country in which the investment is taking place.
A different approach and emphasis on different relevant matters is needed for a trading structure, an IP or intra-group financing structure or a holding structure, for example.
However, as a general comment, there are some common elements of substance usually referred to by most tax advisers that a company needs to have. These are:
- a real physical presence in Cyprus, whether an owned distinct office or via leasing space in a serviced business centre;
- people working in the company's offices (part-time or full-time);
- dedicated telephone, fax, internet lines, a website and email addresses; and
- at least one bank account opened in a Cypriot bank, operated by a Cypriot member of the board of directors;
- at all times, proper accounting books in Cyprus, prepared on-time without delays and submitted with their annual financial statements;
- a properly capitalised company, with any share purchase agreements prepared in Cyprus and in accordance with Cyprus law.
These are only general guidelines since enhancing substance is a rather tailor-made, case by case exercise. As a final point one should also keep in mind that Cyprus has its own similar rules as well. The tax authorities may very well disregard a transaction or a company based on substance over form or because a transaction is not within the arms-length principle. However, the source country tax authorities will naturally be more concerned in this respect.
Substance in the future
Clearly, Cypriot holding and IP companies offer a competitive advantage for tax planning. Nevertheless, a foremost consideration in using these holding companies is substance. It seems that the days where a brass-plate inexpensive company bought off-the-shelf in Cyprus, with a standard registered office and local directors common with 500 other companies in Cyprus are starting to become a thing of the past. Substance is the solution and the way forward.
Zoe Kokoni is director in the international business services division at Eurofast Taxand. With more than 20 years of experience in taxation issues, she is the head of the domestic tax department of the firm. Zoe has specialised for many years in estate duty and internal tax legislation and its applicability for a great number of years. Her extensive wealth of experience concerning advanced domestic taxation matters has enabled Zoe to provide the firm with strong administrative heritage incentives.
She is a regular participant and speaker in various international and local conferences concerning tax related matters.
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