The need for tax-efficient structures has magnified with the recent global economic downturn and the increased scrutiny from tax authorities worldwide, says Zoe Kokoni of Eurofast. Companies need to carefully select the jurisdiction they use for implementing such structures as well as implement their structuring with a careful look on substance so as to be able to mitigate risks and taxes.
Cyprus is an established international business and financial centre due to the incentives granted the good infrastructure and its extensive network of Double Tax Treaties (DTT’s). 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 Cyprus functions as a connecting hub for Europe to Central and Eastern European Countries, Asia and the Far East.
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 Special Defence Contribution (SDC).
- Outgoing dividends/royalties/interest paid by the Cyprus Company to the ultimate non-resident beneficial owner is 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 either taxed under CIT at the rate of 12.5% or it could also fall under SDC- in most cases exempt. Where back-to-back loans exist, the 12.5% tax is levied on the interest spread (i.e. 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 etc.
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 the management and control in Cyprus, it is advisable that the following parameters be taken 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 an exercise of generality. Careful planning and sophisticated tax advice is needed in order 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 advisor in this context. Indicatively, the following 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 in order 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.
Different approach and emphasis on different relevant matters is needed for a trading structure and for an IP or intra-group financing structure or a holding structure for example.
However, as a very general comment, there are some common elements of substance usually referred to by most tax advisors that a company needs to have. These are:
- Having a real physical presence in Cyprus, whether owned distinct office or via leasing space in a serviced business centre,
- Having people working in the company’s offices (part-time or full-time)
- Having dedicated telephone, fax, internet lines, a website and email addresses,
- Having at least one bank account opened in a Cypriot Bank, operated by a Cypriot member of the Board of Directors,
- Having at all times proper accounting books in Cyprus, and prepare on-time without delays and submit their annual financial statements,
- Having a company properly capitalized, with any Share Purchase Agreements needed be prepared in Cyprus and in accordance with Cyprus Law,
The above present 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.
Clearly Cypriot Holding and IP Companies offer a competitive advantage in terms of tax planning. Nevertheless, a foremost consideration in order to use these Cyprus 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, local directors common with 500 other companies in Cyprus are starting to become a thing of the past. Now substance is the solution and the way forward.