A year ago, on November 8th 2022, the Croatian Ministry of Finance announced the initialling of an income and capital tax treaty between Croatia and Cyprus, marking a significant step in fostering economic cooperation between the two nations. Following a series of negotiations held in Nicosia from 1st to 3rd November 2022, the groundwork was laid for a comprehensive agreement aimed at addressing tax-related issues. Fast forward to 17th October 2023, during the Economic and Financial Affairs Council (ECOFIN) meeting in Luxembourg, Croatia and Cyprus officially signed the income and capital tax treaty. This pivotal moment not only solidifies their commitment to strengthening bilateral ties but also signifies the replacement of the former Yugoslavia – Cyprus Income and Capital Tax Treaty (1985) in favour of the contemporary agreement aligned with the latest international standards, particularly those recommended by the OECD/G20 Base Erosion and Profit Shifting (BEPS) initiative. This article explores the implications and potential benefits of the newly signed treaty, providing insights into its key provisions and its expected impact on the economic landscape of both Croatia and Cyprus.
On the one hand, this agreement serves as a comprehensive framework to mitigate the impact of double taxation on income and profits. Within its introductory section, the Agreement establishes crucial definitions for terms referenced throughout its provisions. Notably, the definition of “resident” plays a pivotal role in preventing both the double taxation of Croatian residents and the evasion of income and profit taxes. The Agreement includes entities such as pension funds, investment funds, and non-profit associations, designating them as residents and thereby granting them the associated benefits.
On the other hand, it delineates specific provisions within the agreement which grant favourable tax treatment to Croatian construction and similar companies. These entities are exempt from paying profit tax in the Republic of Cyprus if their projects have a duration of less than 12 months. Generally, the taxation of business profits adheres to the principle of the company’s residence country, with exceptions made for the existence of a permanent business unit. Notably, Croatian aviation and shipping companies engaged in international transport between the Republic of Croatia and the Republic of Cyprus can exclusively pay taxes on realized profits in the Republic of Croatia.
Furthermore, the agreement stipulates that profits generated by a company in the Republic of Croatia from the use, maintenance, or rental of containers utilized for transporting goods are taxable solely in the Republic of Croatia. An exception is made if these containers are exclusively employed for transporting goods within the Republic of Cyprus. This nuanced approach to taxation provides clarity and direction, ensuring a fair and equitable distribution of tax responsibilities between the two nations involved.
In the context of dividend taxation, a withholding tax rate of 5% of the gross dividend amount has been established. Similarly, a 5% withholding tax rate applies to interest, except for interest related to the credit sale of industrial, commercial, or scientific equipment, inter-company credit sales, or any bank-approved loans. In such cases, the interest is exclusively taxed in the country where the beneficial owner resides. Copyright fees are also subject to a withholding tax rate of 5% of the gross amount. For Croatian companies engaged in offshore activities in the Republic of Cyprus, there is an opportunity to be exempt from profit tax in Cyprus if their activities there do not exceed a total of 30 days in any twelve-month period beginning or ending in the relevant tax year.
Salaries, wages, and similar income earned by a resident of the Republic of Croatia through non-self-employment related to offshore activities in the Republic of Cyprus may be taxed in Cyprus. However, they are exclusively taxed in Croatia if specific conditions are met.
The agreement incorporates modern anti-abuse provisions to prevent opportunities for non-taxation or reduced taxation through tax evasion or avoidance, including measures against treaty-shopping. The final provisions ensure that Croatian companies in Cyprus enjoy the same status and benefits as local companies. The mutual agreement process allows direct negotiation on any issues of double taxation without involving diplomatic bodies, expediting conflict resolution. The agreement also facilitates the exchange of information between Croatia and Cyprus, serving as a valuable tool in combating tax evasion. With the shared goal of enhancing their economic relationship and cooperation in taxation matters, the Republic of Croatia and the Republic of Cyprus have entered into an Agreement to eliminate double taxation on income and property, with a commitment to preventing non-taxation or reduced taxation through evasion or avoidance, including agreements benefiting third-country residents indirectly.
Last but not the least, the circumstances under which the regulation is applied. This agreement is applicable to individuals who are residents of either or both contracting states. Its scope is determined as income derived from or through an entity or arrangement recognized as fully or partially tax-transparent, as per the tax regulations of any contracting state, and is regarded as the income of a resident of that state. However, this categorization only holds true to the extent that, for tax purposes within that state, the income is acknowledged as the income of a resident of that specific contracting state.
On another note, the scope of the agreement extends to taxes on income and property imposed on behalf of a Contracting State, a political subdivision, or a local authority, irrespective of the method employed for their collection. Income and property taxes encompass all levies on total income and property, or on specific components of income or property. This includes taxes on gains arising from the sale of movable or immovable property and taxes on the overall amount of wages or salaries paid by companies.
The Treaty identifies existing taxes to which its provisions are applicable, notably, in the case of the Republic of Croatia: profit tax, income tax, surtax on income tax, and any other additions imposed on these taxes. In the case of the Republic of Cyprus, the agreement covers income tax, profit tax, a special contribution to the defence of the Republic, and tax on gains from the disposal of property.
Crucially, this agreement also encompasses any taxes that are identical or similar and are introduced after its signing date, either in addition to or as replacements for existing taxes. Both contracting states’ competent authorities are required to inform each other of any significant changes in their tax regulations, ensuring a continuous and collaborative understanding of the evolving tax landscape.
To sum it up, the signing of the income and capital tax treaty between Croatia and Cyprus represents a pivotal milestone in their economic collaboration, underscoring a commitment to modernizing their bilateral taxation framework. The nuanced provisions, ranging from dividend and interest taxation to addressing offshore activities, reflect a strategic effort to create a fair and transparent tax environment. The incorporation of anti-abuse measures and mutual agreement processes further reinforces the integrity of this collaboration. Beyond the immediate implications for businesses and individuals in both nations, the agreement sets a foundation for continued economic growth and cooperation. As the two countries embark on this renewed tax journey, the shared commitment to preventing non-taxation or reduced taxation through evasion or avoidance foretell the sustained strengthening of their economic ties.
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