Recent Changes in the Cyprus Laws and changes in International tax structures

Transcription

1 Recent Changes in the Cyprus Laws and changes in International tax structures In July 2015 a package of amendments were submitted into Cyprus Parliament and have been voted into law. A second pack is expected to be voted. Here we will analyse some of the changes that have been come into force and how they can be used to improve international tax structures. ksa.pre@ksa.com.cy tel: fax: Spatharikou, 4004 Mesa Geitonia, Limassol, Cyprus 1

2 Contents Changes in the Income Tax Laws Notional Interest Deduction for New Equity Capital Expected changes 50% exemption to high earners Changes in the SDC Laws Introducing the non domicile principle Beneficial Ownership Issues and Practical Solutions Examples of tax structures Changes to the Capital Gains Tax Law Substance Requirements Exemption from Capital Gains Tax 2

3 Changes in the Income Tax Laws -Notional Interest Notional interest Deduction on New Equity Cyprus introduces provisions to allow notional deduction of interest (NID) in cases were funds are introduced to the company in the form of equity instead of interest bearing or interest free loans. Deemed interest deduction will be allowed on new equity funds introduced into a Cyprus tax resident company and which funds are used for the operations of the company. The deemed interest will be calculated on the basis of a reference interest rate, which is equal to the yield on the 10 year government bond of the country where the new funds are invested, plus 3% or the Cyprus government bond yield (currently around 5%) plus 3%, whichever is higher. New equity refers to any equity funds introduced into the business after 1 January 2015 and includes both share capital and share premium to the extent that it has been actually paid. New equity may be contributed in cash or in assets in kind. In the case of assets in kind the amount of new equity may not exceed the market value of the asset, as agreed with the tax authorities. The notional interest to be deducted cannot exceed 80% of the taxable income of the company for the year before the deduction of the notional interest expense. The deductibility of the interest expense depends on whether the funds for which the interest is paid have been used to finance taxable operations of the company. Notional interest antiavoidance In order to tackle possible abuse of the NID, the commissioner may not authorize the granting of any allowances under the provision of this section, if he considers that actions or transactions have taken place without substantial economic or commercial purpose, or that new capital for which a claim for allowances were derived from capital existed prior to 1 st January, 2015 and which are presented as new capital through actions or transactions with related parties with the main purpose of the granting of the allowance provided for in this section. The Notional Interest Deduction can be used to eliminate the Beneficial Ownership Issues with back to back loan that are currently widely used as discussed under the Beneficial Ownership section below. Changes in the Special Defence Contribution (SDC) Laws -non domiciled Defence tax is payable only by individuals who are considered to be tax residents of Cyprus (as defined in the income tax laws), which effectively means an individual who spends at least 184 days in Cyprus every tax year. SDC tax is payable on dividends (17%), interest (30%) and rental income (3% on 75% of the income), earned by a Cyprus tax resident individual from sources within Cyprus and outside Cyprus. The law has been amended so that individuals who are not considered to be domiciled in Cyprus are no longer subject to SDC on dividends, interest and rents, even if they are considered as tax residents of Cyprus. The effective date of the amendment to the SDC Law is 16 July An individual can be considered as domiciled in Cyprus either (i) by domicile of origin or (ii) by domicile of choice, as defined by the Wills and Succession Law of Cyprus. 3

4 For the purposes of determining liability to SDC tax an individual has a domicile in Cyprus if he or she has a domicile of origin in Cyprus as defined in the Wills and Succession Law, unless he or she has acquired and maintains a domicile of choice outside Cyprus and was not a tax resident of Cyprus for any period of at least 20 consecutive years prior to the year of assessment, or unless he or she was non resident for purposes of the Income Tax Law for any of the immediately preceding 20 tax years. In any case, an individual will be deemed to be domiciled in Cyprus if he or she has been a tax resident for 17 or more of the 20 tax years immediately preceding the year of assessment. The amendment includes an anti-avoidance provision restricting its application in cases where domiciled individuals transfer assets to related non domiciled persons in order to take advantages of the changes. Changes in the capital gains tax laws Any immovable property bought from 16 July 2015 until the 31st of December 2016 will be exempt from any future capital gains tax. This means that anyone buying real estate property within this period will not have to paying any capital gains tax if he or she sells the property at any time in the future. This covers both land and buildings. Expected tax changes 50% exemption from salaries paid to highly paid individuals Under current law, if a person has income from employment in Cyprus which commenced after 1 st January 2012, and was not tax resident of Cyprus during the previous tax year, then the 50% of this income is exempt from taxation for a period of five years provided the income from employment in Cyprus exceeds euros per annum. The period of five years will now be extended to ten years and will cover also employees which started after 1 January 2012, before the new law came into effect. Thus, an employee who came to Cyprus in 2013 and who would have been entitled to this benefit until the year 2018, will now be entitled to the benefit until the year For new employments, an individual will be entitled to this benefit only if he was not tax resident of Cyprus for any three out of the last five tax years prior to the commencement of his employment in Cyprus and provided that he was not tax resident Cyprus the previous tax year. The exemption is granted in any year in which his income from employment exceeds euros per annum, irrespective of whether the income drops below euros in any particular year, provided that when the employment started, the income exceeded euros and provided the Tax Commissioner is satisfied that the increase/decrease in the annual income is not made for the purpose of obtaining this tax benefit. Beneficial Ownership Issues and Practical Solutions Double Tax Treaty benefits are given to companies or individuals who are tax residents of a contracting state, provided that the tax residents are the beneficial owners of the income. Beneficial ownership issues: Financing structures In case of the back to back loans, the tax authorities of the source country may deny DTT benefits since effectively all income is passed to a non-tax resident of the other contracting state. The introduction of the Notional Interest Deduction on equity can be used to eliminate the beneficial ownership issues by converting loan payables to equity. 4

5 Example A: A back to back structure were a BVI company provides a loan to Cyprus company and then the Cyprus company finances the operation of a Ukrainian company. Comments: Based on the DTT between Cyprus and Ukraine the tax authorities of Ukraine may claim that the Beneficial Owner of the interest income is the BVI company and not the Cyprus company and therefore apply 15% withholding tax instead of 2% WHT provided in the DTT. How the structure can be improved using the NID Rule: Option A: The BVI company contributes the funds as equity to the Cyprus company (or converting existing loans to equity) and the Cyprus company finances the operation o a Ukrainian company Comments: The Cyprus company can deduct a notional interest expense an amount equal to the 10year government bond yield of Ukraine plus 3%. This can reduce the taxable profit (before NID) by a maximum of 80%. Therefore, the effective tax rate based on this structure is 2.5%. This will create higher tax charge compare to the 0.35% profit margin however it eliminates the risk of Beneficial Ownership because the Cyprus company, who receives the interest income has no obligation to pass this income (under loan or any other agreement) to the BVI company. The income can be passed to the BVI company as a dividend which will not create Beneficial Ownership issues. 5

6 Option B: Two tier structure The BVI company provides a loan to the CypCo1 who contributes the funds as equity to CypCo2. The CypCo2 provides a loan to Ukrainian operating company Comment: Under the above structure the interest income of CypCo2 will be distributed to CyprCo1 as a dividend and not as an interest reducing Beneficial Ownership issues. CypCo1 will have a taxable loss equal to the interest expense of the BVI company. The taxable profits of CyCo2 from the interest income will by offset by the tax losses of CyCo1 under the group relief, with a margin to be left to be taxed in Cyprus. Beneficial Ownership issues: Holding Structures There are no significant Beneficial Ownership issues for holding companies since it is difficult for the tax authorities to prove that the recipient of the dividend is not the Beneficial owner of the income. The recipient has usually no obligation to pass such income to its shareholders since the declaration of dividends depends on Board resolution of the company. It is recommended however, not to pass all or almost all of the amount of dividends received to the shareholders. Therefore, existing holding structures can be still used. 6

7 Substance requirements Substance determines the company s tax residency Statutory substance is proved by paying its taxes, filing its tax returns, preparing audited financial statements and meeting all its statutory obligations. Physical substance is statutory substance including an office, telephone facilities, employees and properly qualified directors, Economic substance which is more on day to day activities, which is a similar concept to effective management. A lack of substance may be an indication that double tax treaty and or EU directives are being abused. Indications of substance -Who are the directors, what is their business background, how much time can they allocate to the business of the company -How do directors take decisions -Operate bank accounts from Cyprus -Maintain fully fledged offices with real people and real decision making and hire highly qualified local personnel or relocate senior executive people to Cyprus -Carry out the accounting functions in Cyprus -Actively participate in the local business community/ organisations. Substance of holding companies An indication of substance requirements for a holding company may be the following: -Statutory Substance (board of directors) is a must. Depending on the activities of the company you may need to add a physical substance. -For example a holding company just holds only one investment and the only decision is to declare the dividend once a year, the minimum physical substance is required. If a holding company buys and sells regularly investments and declares dividends regularly, then more physical substance is required and sometimes economic substance as well. -The directors need to be in a position to run the company at their own free will and not be directed by the shareholders, of course having regard to the interests of the owners of the business. The directors need to prove that they are in a position and have the adequate knowledge to accept and or reject complicated sales and purchase agreements The setting up of a company for the purpose of holding a single subsidiary could be considered as treaty shopping. If the holding company holds more than one investment and performs other functions / activities, and there are business reasons for setting up the company, this would be advantageous in defending claims by the tax authorities for treaty shopping. Substance for financing companies An indication of substance requirements for a financing company may be the following -Statutory Substance (board of directors) is a must. Depending of the activities of the company you may need to add a physical substance. -For example, in the case of financing company just having only one loan and the only decision is to assess the liquidity of the company once a year, the minimum physical substance is required. Similar considerations are also for a licensing company. On the other hand, if a financing company provides loans regularly to affiliates and receives interest more often, the more physical substance is required and sometimes economic substance as well. Similar consideration are also for a licensing company. 7

8 Contact: Elias Kyriakides Director Neophytos Savvides Director George Panayiotides Senior Manager Address: KSA 5 Spatharikou, 4004 Mesa Geitonia, Limassol, Cyprus P.O Box 56245, 3305 Limassol, Cyprus Tel.: Fax: