TAX ASPECTS

he combination of low tax with the existence of an impressive and ever expanding network of Double Taxation Treaties (DTT) with tens of countries has proven to be a tremendous tool for international tax planning for any tax professional.  With regard to any form of investment towards Eastern European countries especially, Cyprus has unquestionably positioned itself as the world’s primary “business hub”.  

Cyprus has wisely managed to differentiate from “tax havens” and establish itself internationally as one of the most important “low tax jurisdictions”.  It has therefore managed to escape the suspicions and control of the tax authorities of other countries.  The only tax for an International business entity ranges between 0 - 10% only  

Cyprus may be used by organizations with international operations to mitigate taxation in various ways. Firstly, it can eliminate or minimize withholding taxes thanks to the zero or low withholding rates contained in the treaties. Secondly, it can be used to eliminate or substantially reduce taxation in the country of origin of the organization by combining the beneficial provisions of its treaties with domestic law. Thirdly, even in the absence of a DTT with a specific country, it can still be utilized in conjunction with other jurisdictions to lead to tax minimization.

Cyprus treaties are analyzed in our leaflet “Double Tax Treaties between Cyprus and …”.

The treaties with Eastern Europe are extremely beneficial. They all provide for zero or substantially low tax-withholding rates for dividends, interest and royalties. Royalties are very broadly defined this allowing for important tax planning. Permanent establishment in these countries can be avoided by careful planning. Capital gains from the sale of immovable property situated in Eastern Europe can be extracted and repatriated to the investors’ country of origin free of any foreign tax. Similar structures can also be designed from DTT Cyprus has signed with other countries.

Some of the DTT eliminate double taxation using the tax exemption method while others use the tax credits method. Some of the latter also contain tax sparing credits provisions.

For specific tax structures and more details please ask for our leaflet “Specific Tax uses for IBCs”.

Aspects of Cyprus Tax

and non-taxable entities

A company is considered to be a tax resident of Cyprus if it is “managed and controlled” in Cyprus. Although no definition of management and control is provided in the tax law itself, this is generally accepted as being the place where board decisions are taken and where the directors reside. Consequently, for a company to be managed and controlled in Cyprus we would expect to see resident directors and regular board meetings being held in Cyprus.

A company that is incorporated in a foreign country is considered to be tax resident in Cyprus if managed and controlled in Cyprus. Similarly, it is possible to incorporate companies in Cyprus that are non-resident for Cyprus tax purposes. Non-resident companies i.e. entities not managed and controlled in Cyprus are not subject to taxation in Cyprus unless they have a permanent establishment in the island. Where they have such an establishment, they are taxed only on that income that arises from the activities of that establishment. Such companies cannot

take advantage of the Cyprus network of double tax treaties and are therefore used mainly for trading activities where treaty benefits are not required. The reputation of Cyprus as a top quality financial centre with highly developed banking, legal and accountancy professions gives a non-resident Cyprus company a clear advantage

over known offshore jurisdictions which are often viewed with suspicion or mistrust.

Taxation of resident companies

Resident companies are subject to Cyprus corporation tax at the rate of 10%. This is the lowest corporate tax rate in the EU. Dividends, interest, royalties and profits realised for sale of securities are subject to special tax treatment as detailed below

Taxation of transactions in shares and other securities

Profits realised from the sale of securities are exempt from tax. “Securities” are defined as meaning shares, bonds, debentures, founders' shares and securities of companies or other legal persons and options thereon.

The definition of security does not embrace all financial instruments. The Cyprus Tax Authorities have not issued a definitive list of all the financial instruments that they consider to fall under this definition but it is generally considered that promissory notes and currency contracts are not considered as securities. Profits realised on dealing in these instruments are not exempt and are subject to corporation tax.

Taxation of dividends

Dividends received by a Cyprus resident company are generally exempt from taxation in Cyprus if they are received from a foreign entity in which the Cyprus entity owns more than 1 % of its share capital.    

The exemption does not apply where the foreign entity receives more than 50% of its income from investment activities, and the foreign tax burden of the company paying the dividend is substantially lower than that of the Cyprus resident company "Substantially lower" has been interpreted as meaning less than 5% The Cyprus Tax Authorities have acknowledged that foreign tax burden does not cover only the tax paid by the company paying the dividend but includes also the tax paid by lower level subsidiaries. In practice, therefore, dividends received from subsidiaries or associates are rarely taxed. Where dividends do not satisfy the requirements for exemption from taxation or where the holding constitutes less than 1% of the paying company’s share capital, then they are subject to defence tax at the rate of 15%. However, any tax withheld at source is allowed as a deduction from this tax even if it is made from a country  that does not have a double tax treaty with Cyprus.

EU Parent-Subsidiary Directive

Cyprus holding companies take benefit of the EU Parent-Subsidiary Directive. Dividends paid between associated enterprises that are both situated in the EU are made without any withholding taxes. A company is defined an associate of another, if that other company holds at least 20% of its share capital. This percentage will fall to 15% in January 2007 and 10% in January 2009.

Taxation of interest income

The taxation of interest income depends on whether it is derived in the ordinary course of business or it is closely related with that business. In such cases, the interest income earned is included in the calculation of taxable income under corporation tax and taxed at 10%. Interest earned by banks, financial companies, hire purchase companies or leasing companies is considered to arise from the ordinary course of business. Interest earned as detailed below is considered to be closely related to that business and is also subject to corporation tax

a) businesses such as car dealers, property developers that sell their products on extended payment terms and charge interest on their trade debtors

b) interest on current account balances at banks

c) interest earned by companies which act as a vehicle through which a group finances the operations of companies within it.

No formal definition of "group" has been provided but it is generally considered that a group comprises any relationship where the companies are ultimately controlled by one entity. Consequently, two entities that are owned by a physical person without a common holding company are not considered a group In all other cases, where the interest is considered to arise outside the ordinary course of business then only half of that is treated as income for corporation tax purposes but the gross interest received is also subject to defence tax at the rate of 10%. Thus the effective tax burden on such interest is 15%. Interest on deposit accounts and interest earned on loans granted to third parties are treated in this way. A credit is provided against the defence tax payable for any taxes withheld at source, irrespective of whether a double treaty exists or not.

EU Interest and Royalty Directive

The EU Interest and Royalty Directive came into effect on 1 January 2005 and provides that interest and royalty payments arising in one EU member state are exempt from any taxes imposed on those payments in that state, whether by deduction at source or by assessment, provided that the beneficial owner of the interest is a company in another EU member state. For the directive to apply the companies must be associated. One company is defined as an associate of another, if that other company holds at least 20% of its share capital. This percentage will fall to 15% in January 2007 and 10% in January 2009. The company receiving the interest or royalty payment must not be acting as a trustee, agent or intermediary. It should be receiving the income for its own benefit. The interest or royalty must be on an arm’s length basis. The directive will not apply to what is considered to be "in excess of an arm’s length amount".

The low tax regime of Cyprus makes it the ideal route through which non-EU residents can extract profits from their EU operations. Interest and royalties are allowed as an expense in the EU payer reducing its tax base and is taxed at low rates, often nearly zero in Cyprus.

Greece, Czech Republic, Slovakia, Poland, Portugal, Spain, Latvia and Lithuania have been granted a transitional period in which to apply the directive, as the economic effect of immediate compliance would be onerous. They can charge a maximum withholding tax of 10% up to 2007 and 5% until 2011. However, the Cyprus network of double taxation treaties includes Greece, Czech Republic, Slovakia and Poland.

The overall tax burden on interest and royalties remitted to Cyprus from these countries is not affected by the transitional provisions as Cyprus grants a tax credit for the taxes withheld by these countries.

Taxation of royalties

Royalties received by a non-resident from sources within Cyprus are liable to 10% withholding tax. However, if a Cyprus company is granted the right to use a patent, trademark or innovation outside Cyprus, then there is no withholding tax and the Cyprus company is taxed at the corporate tax rate on the profit margin that it realises on the use of the right.

 Treatment of tax losses

Taxable losses incurred during a tax year which cannot be set-off against other income of the same tax year are carried forward indefinitely and set-off against future profits. This provision is applicable for losses arising from the year 1997 onwards. Taxable losses cannot be carried forward if there is a change in the ownership of the company and a significant change in the nature of business within three years from the year in which the loss arose.

 Group relief

The taxable losses of any company may be set-off against the taxable profits of another company in the same group provided that the two companies are members of the same group for the whole year and are both tax residents of Cyprus. For the purpose of group relief, a company is deemed to be a member of the same tax group if (a) it is 75% subsidiary of another company, or (b) both are 75% subsidiaries of a third company

 Personal Income Tax

Income tax is imposed on every tax resident of Cyprus on his or her worldwide income. Non-tax residents of Cyprus are only taxed on their income accrued or derived from sources in Cyprus. Tax resident is any person, irrespective of nationality, who spends more than 183 days in aggregate in Cyprus in any year of assessment.ax rates

Chargeable income Tax rate Accumulated tax

 0 – 10.000 - -        0%

10.001 – 15.000   20%

15.001 – 20.000   25%

over 20.000         30%

Foreign pension is taxed at the rate of 5%. An annual exemption of Cν2.000 is allowed. The following types of income are exempt from taxation

Type of income Exemption limit

 Interest income - The whole amount

Dividend income - The whole amount

Remuneration from salaried services in Cyprus by an individual who was not resident of Cyprus immediately before the commencement of his employment in Cyprus - 20% of income with a maximum amount of Cν5.000 annually for three years

Remuneration from salaried services rendered outside Cyprus for a period of more than 90 days in any year of assessment - The whole amount

Profits of a permanent establishment abroad The whole amount(under certainconditions)

C. Costa & Associates partners will be happy to provide more details about our services