1. Short overview of the Company Tax. Residence of Companies. The substance requirement can be described as follows :

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1 Memorandum on Cyprus Tax Reform 1. Short overview of the Company Tax Residence of Companies For companies, the place of management and control is decisive. This condition for residence was chosen to respect the Cypriot legal tradition, based on British law. The substance requirement can be described as follows : Appointment of at least one director (corporate or individual), but different secretary (corporate of individual) Minimum share capital of CYP Descirption of the activities in the Memorandum and the Articles of Association. Under the new tax legislation, a company is considered to be tax resident of Cyprus when the management and control is exercised in the Republic. Even though there is no specific definition of what management of control is, in practice it is deemed to be situated where the majority of directors reside, the board meetings of the company are held and the majority of significant decisions are taken. Management and control should be exercised in Cyprus for the company to be considered as tax resident of Cyprus and therefore elegible for the benefits provided in the EU Parent- Subsidiary Directive and for those under the Double Tax Treaty network of Cyprus. It is common practice that a service company provides Cyprus resident directors. Tax rates Companies : 10 % Public corporate bodies : 25 % Taxation of dividends Any dividends received from a foreign company are exempt from taxation in Cyprus as long as at least 1 % of the share capital of the foreign company is held by the Cyprus company. The exemption will not apply if the foreign company : 1

2 carries on more than 50 % investment activities which give rise to investment income AND the overseas tax burden on the income is significantly lower than the Cyprus tax burden of the company receiving the dividend (i.e. lower than 5 %) If the dividend emanates from a foreign sub-subsidiary of a Cyprus company, this exemption will be extended and applied if the group (i.e. the foreign company and its foreign subsidiary) does not carry on more than 50 % investment activities. Any dividend not exempted is taxable at the rate of 15 % under the Special Defence Contribution. Taxation of interests General principle : the total of interest income received by an individual and fifty per cent of interest income received by a company is exempt from income tax. Every person resident in the Republic who receives or is credited with interest income, subject ot some exceptions mentioned in the legislation, is liable to Defence Contribution at a rate of ten percent on the gross interest income. In practice, this means that a company can be taxed twice on the receipt of interests : 1st step : withholding tax of 10 % on the gross amount 2nd step : after deduction of all company expenses, the company profit, including half of the profit as a result of interest income, is taxed at the normal rate of 10 % This Special Defence Contribution is not imputable on the company tax. Exception : trading activity Like in other Anglo-Saxon tax regimes, distinction is made between trading and non trading. However, this distinction is made very clear and trading has been rather broadly defined. The principle for trading is that interest accruing from the ordinary carrying on of any business including any interest closely connected with the ordinary carrying on of the business is deemed not to be interest but income from trading activity. In a circular letter Number 2003/8, the commissioner clarified his point of view in that 2

3 The following is considered as interest income accruing from the ordinary carrying on of the business o Interest income of banking businesses. This includes all banking units, cooperatives and businesses having as a primary object the provisions of loans o Interest income of financing businesses offering hire purchase, leasing and other financing arrangements The following is considered as interest income closely connected with the ordinary carrying on of a business o Interest from trade debtors, e.g. businesses engaged in trading of land and buildings or land development as well as businesses involved in trading of motor vehicles or other vehicles or machinery o Interest income of insurance companies o Interest income on commercial bank accounts (current) o Interest income of companies which act as a vehicle for the purpose of financing group companies. An example would be a holding company, a subsidiary company or an associated company which borrows money and subsequently lends this to other group companies. Negative definitions (provided the above is not applicable) o Interest income derived from the provision of loan facilities by a company to third parties o Interest income derived from deposit accounts or bonds In case of doubt, a ruling is possible. Please note that I had the occasion during my visit in Cyprus to meet shortly with the ruling commissioner. Taxation of royalties The gross income arising from intellectual property rights, other exploitation rights, compensations or other similar income arising from sources within the Republic, of an individual who is not resident in Cyprus, is subject to withholding tax at a rate of 10 %. Rights granted for use outside the republic are not subject to any withholding tax. The gross income derived by a non-resident individual in respect of royalties arising from film projection in the Republic is subject to withholding tax at a rate of 5 %. According to my Deloitte colleagues, a possible distinction to be made by trading or non trading as far as intellectual property rights are concerned, is not possible : generally spoken, the management of intellectual property is trading 3

4 and income is not subject to the Special Defense Contribution, which constitutes an important advantage over Ireland. Taxation of capital gains Profits on disposal of securities (defined in the Cyprus Tax Legislation as shares, debentures, government bonds of companies or other legal entities incorporated in Cyprus or abroad) are exempt from taxation in Cyprus. Capital gains tax is payable only if the company whose shares are disposed owns immovable property (land and buildings) situated in Cyprus. The above exemption applies irrespective of the percentage shareholding and irrespective of the time period between the acquisition and disposal of shares of the company. According to our Cyprus colleagues, this extension would also apply to derivatives on all these types of securities (options, swaps, etc;.). Withholdig taxes There is not withholding tax on dividends paid to a non resident. As a result, Cyprus seems a very interesting location for holding companies that in the alternative, would loose partly or wholly the withholding tax. E.g. Belgium does not allow withholding taxes on dividend to be imputed on corporation tax, so that, for a Belgium group, Cyprus will be a favourable location for all portfolio holdings that do not enjoy a full exemption. (portfolio holdings under the P/S threshold in Europe, portfolio holdings outside Europe,aso). As far as income fluxes are concerned, Cyprus has 34 tax treaties and 6 new ones in negociation. Especially countries of the former Sowjet republics have been served, as well as a number of Middle-East countries. Nor Switerzland, nor Luxembourg have a treaty. Belgium has a treaty, moreover, Cyprus does not appear on the Belgian list of tax heavens and Cyprus dividends are, as a result of the recent tax reform, no doubt under the DBI/RDT regime, as all European countries have been accepted. Even after having taken profit from a lower withholding tax on incoming financial income, it remains to be seen in which way it is possible to impute the foreign withholding tax as a credit on company tax. The rules are as follows 1) In case of exempt income, no imputation is possible (e.g. exempted dividends) 2) In case of taxable income, imputation is possible on a case-to-case base. So the tax credit can be given in 4

5 Losses relation with the profit resulting from the specific transaction under withholding tax, and not on a country by country basis nor on a general basis. It must be noted that, the imputation can be realised on an accruals basis and not so much on a cash basis, provided the cash receipt of the income arrives in the same company in a later year. Losses can be carried forward indefinitely Branches On the basis of internal law, profits of branches abroad are exempt from tax, under the same conditions of the dividend exemption. The definition of investment income would be the Cyprus definition of investment income instead of the foreign defintion, in order to apply eventual exemption. Group relief Attaining the 75 % participation threshold, group relief is available in income tax. 2. Possible structures for FSI Holding company Advantages of a Cyprus holding company tax exemption on dividend income no capital gains tax on disposal of securities no capital/net worth taxes no withholding tax on distributions use of treaty network use of European Directives starting from May 1st Requirements minimum 1 % portfolio holding no real substance requirements no minimum holding period no CFC rules Captive finance company Captive investment company Advantages 5

6 only the current income is taxed at 10 % rate, after deduction of expenses, including financing expenses trading status is easy to obtain capital gains are exempt, capital losses do not interfer in the taxable basis no exit withholding tax use of treaty network possible, as well as parent subsididary directive Requirements trading status, an easy one Intellectual property company Advantages taxation at 10 % level trading status anyway no exit withholding tax use of treaty network dividend exemption in Belgium Requirements no special ones 3. Possible structures in general We limit ourselves to a list of possibilities Employment companies Trading and re-invoicing companies Construction and engineering companies Service and consultancy companies Real Estate companies Offshore companies limited by guarantee Offshore partnerships Offshore branches 4. Special regime for shipping companies Ship management companies do continue to enjoy a preferential status, even after the tax reform and the joining of the E.U. Income rising from ship management activities is subject to tax at 4.25 %. A company can elect to pay special tonnage tax if more beneficial. 6