Professional Level Options Module, Paper P6 (CYP)

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1 Answers

2 Professional Level Options Module, Paper P6 (CYP) Advanced Taxation (Cyprus) December 2008 Answers 1 AN accountant Nicosia, Cyprus Date: Finance Director DS SAS France Dear Mr Pastelliere Re: Cyprus operations With reference to our recent meeting in Nicosia, I set out below my response to the issues raised during the meeting. (a) Taxes on income and gains (i) The initial licensing fee invoiced from DS SAS to Cyprus entities will be treated as royalty income paid from Cyprus to a foreign beneficiary as this falls within the definition of Cyprus tax law. As such, this income will be subject to tax in Cyprus under the special mode of 10% withholding tax at source. However, as the double tax treaty between Cyprus and France provides for 0% withholding tax on royalties, no tax will actually be withheld in Cyprus. (ii) As the annual support fee is a fixed amount and has the character of the initial licensing fee (i.e. payment overseas), this will most certainly be treated as royalty income. The tax treatment will be exactly the same as described in (i) above. (iii) If a Cyprus branch (permanent establishment) is formed through which licensing and support fees will be invoiced, such income will be treated as trading income less tax deductible expenses in the hands of the branch and will be taxed in Cyprus at the corporation tax rate of 10%. If a Cyprus subsidiary is formed, the tax treatment will be the same as with a Cyprus branch, but note that as the Cyprus subsidiary is a separate legal entity, the withholdings tax provisions as described in parts (i) and (ii) above will apply. (iv) A Cyprus subsidiary should be used for your intended activities as there are both tax and legal advantages, compared with using a Cyprus branch. With reference to taxation, as stated above, the profits of a Cyprus branch will be taxed in Cyprus at a corporate tax rate of 10%. However, these profits will also be taxed in France at a corporate tax rate of 35% with the Cyprus tax credited against the French corporation tax. If on the other hand a Cyprus tax resident subsidiary is formed, as this is a separate legal entity, its profits will be taxed in Cyprus only at a 10% corporate tax rate. It should be noted in relation to any dividends paid by the Cyprus subsidiary to the French parent company, that although there are no withholding taxes imposed on dividends paid from Cyprus to overseas, such income may be taxable in France in the hands of the French parent company. With reference to the legal aspects of having a subsidiary as compared to a branch, you should note that in the case of a branch, any debts or claims against it will automatically be directed to the French company as it will form part of it. On the other hand a subsidiary, with its own independent management, which will have to be the case if the company is to satisfy the management and control test and be treated as a tax resident in Cyprus, is a separate legal entity from its French parent company and therefore no claims for debts or other liabilities will legally succeed against the parent French company. It therefore follows that considering both the tax and the legal aspects you will be better off with a subsidiary than with a branch. With reference to withholding taxes on the receipt of payments for licensing fees, payments between connected entities within the European Union (EU) are exempt from withholding taxes. Receipts from non-connected entities and non-eu countries may be subject to withholding taxes according to the relevant provision in the respective double tax treaties between Cyprus and each one of the non-eu countries (in both cases i.e. subsidiary or branch). (v) With regards to the method of financing the Cyprus operation (equity or loan), one has to consider the cost of equity as compared with the after tax cost of the loan. If the cost of equity is higher than the after tax cost of the loan, then a loan should be obtained and vice versa. Although this is not a purely tax decision, you should note the following in respect of the Cyprus tax treatment of loan interest: Loan interest will only be allowable if it relates to the acquisition of trading business assets. It does not make a difference for tax purposes whether a branch or a subsidiary is formed, or whether the loan is obtained from a bank either in France or in Cyprus or whether the loan is obtained by DS SAS and re-directed to Cyprus. There are no withholding taxes in Cyprus on interest payments from Cyprus to France whether such interest accrues to a French bank or DS SAS. (vi) The disposal of trading goodwill is a taxable profit for Cyprus corporation tax purposes. Therefore, if either the DS SAS Cyprus branch or the Cyprus subsidiary sells its operations, this gain will be subject to corporation tax at 10% with the taxability of this gain in France being as analysed in part (iv) above. If however the Cyprus subsidiary s shares are sold, no tax will arise in Cyprus, as such gain (on sale of the shares) will be deemed as a capital gain, which will be exempt in Cyprus, as the company will not hold immovable property in Cyprus. Note however that such gain may still be taxed in France and suitable advice must be obtained in France. 15

3 (b) Value added tax (VAT) (i) If your company does not form an establishment in Cyprus, the provision of services through its website will be classed as services provided electronically. In this case, no VAT will be charged if the Cyprus buyer provides a valid Cyprus VAT registration number. In all other cases, DS SAS will have to charge VAT at the standard rate and account for it to the French VAT authorities. In the case of sales of the software on DVDs, the value of the DVD will be treated as a sale of goods and the value of the software as a provision of services. In this case, the reverse charge provisions will apply, and your company will have to register for VAT in Cyprus if the registration limit of 15,600 is exceeded. (ii) A Cyprus branch or subsidiary will have an obligation to register for VAT in Cyprus in respect of local sales and sales to other EU countries. Sales to non-eu countries are outside the scope of Cyprus VAT. Please contact me if you require anything further. Yours sincerely AN accountant 2 MEMORANDUM To: Client partner From: Tax assistant Date: 2 May 2008 Subject: Anna & Ninos Anaxagoras split of interests As requested this memorandum considers various tax implications regarding the above matter: (a) (b) (c) The transfer of shares in a private company holding immovable property is subject to capital gains tax by reference to the increase in value of that property. However, as Yvonne and Anna and Ninos are first degree relatives such a gain will be exempt from capital gains tax. If Anaxagoras Holdings Limited is dissolved, the company will be deemed as disposing of its assets at market value. As such, the following tax implications will arise: The land and buildings in Nicosia and the shops complex in Ireland will be deemed as capital assets, as they have been generating income and any gain on their disposal will be taxable as a capital gain and subject to capital gains tax (CGT) at 20%. However, as the shops are not situated in Cyprus, this gain will be exempt from CGT. With reference to the land in Nicosia, it is not clear from the information provided how the gain will be taxed. It all depends on the intention of the company during the period of ownership. Assuming that it was never the intention to hold it as an investment (e.g. the building permission was obtained with the intention to sell shops/offices), the gain will be treated as a trading profit and subject to corporation tax at 10% Consequently, as a result of the dissolution, the company s deemed distribution may be summarised as follows: 000 Gain on sale of capital assets A Gain on sale of current assets B Less: corporation tax (10% x B) (C) PROFIT ON TRANSFER OF ASSETS D Profit and loss account reserves (all after 2003) 8,100 PROFITS DEEMED AS DISTRIBUTED E Amount E will be subject to special defence contribution (SDC) at 15%, except for that part which relates to Ninos s holding, as Ninos is not a resident of Cyprus. However, Ninos will have to remain a non-resident of Cyprus at least until the end of 2008 (assuming the dissolution is completed within 2008), as if he becomes resident during 2008, the distribution accruing to his shareholding will also be subject to SDC. None of the transactions will be subject to value added tax (VAT), as the Nicosia building was built before 1 May 2004 i.e. before VAT was introduced on buildings, and the Irish shops complex is situated overseas and therefore outside the scope of Cypriot VAT. Land transfer fees on the transfer of the Cyprus immovables will be payable based on their 1907 values as the company will be transferring its assets to its shareholders who are all relatives up to the third degree and to a spouse. The split may be accomplished partly under a scheme of re-organisation (transfer of assets), as the company has three assets of which two are used for one purpose (i.e. to generate rental income) and the third asset is held for development. The reason for this is that one of the pre-requisites of a transfer of assets under a scheme of re-organisation is that the company to be divided must have at least two autonomous branches of activity. 16

4 Another pre-requisite of a transfer of assets under a scheme of re-organisation is that one or more new companies are formed to which assets are transferred from the initial company. The new companies must have the same shareholders as the existing company and also at the same ratio of shareholding. Consequently, assuming one new company is formed, Yvonne must decide at which stage she will transfer her shares to her children (either before or after the split). It must also be noted that in order for the required result to be finally achieved, a free transfer of shares between Anna and Ninos (with no tax consequences as they are relatives up to the third degree) will have to take place. Assuming that Yvonne transfers her shares after the split, a new company with the same shareholding as Anaxagoras Holdings Ltd should be formed, and the land in Nicosia to be developed by Ninos transferred to this new company, as an autonomous branch of the existing company (re: land development). In order to achieve the agreed goals, Anaxagoras Holdings Ltd will then have to transfer the shops complex in Ireland to Anna and Ninos in equal interests (either in their own names or in the name of a company in which they are 50:50 shareholders). This can be done without any tax consequences as the property is situated overseas in terms of capital gains tax in Cyprus. Yvonne and Ninos will afterwards donate their shares in Anaxagoras Holdings Ltd to Anna and simultaneously Anna, Stefos and Yvonne will donate their shares in the new company to Ninos. In this way, no capital gains tax, corporation tax, land transfer fees and mortgage fees will be due on the transfer of the Cyprus situated properties. Note that no capital gains will be taxed in respect of the Irish property, but the gain on its transfer will still be included in accounting profits for deemed distribution purposes. (d) (e) Using a holding company for the purpose of holding shares in one or more trading companies, has the advantage of postponing the payment of the special defence distribution (SDC) on a dividend/deemed distribution by two years, as no SDC is due on the payment of a dividend between companies. A trust on the other hand will not offer this benefit to Stefos and Anna, as trust income is taxed in the same way as its beneficiaries would have been taxed, with the only difference that such taxation is assessed in the name of the trustee. However, in the case of Anaxagoras Holdings Ltd the shares held by Stefos and Anna will need to be donated to the new holding company in which they are also shareholders, as such a transfer (unlike a sale) would be exempt from CGT. However, I would suggest that in order to avoid any future dispute with the Inland Revenue, an advanced tax ruling is obtained beforehand, as the Director of Inland Revenue will have to be certain that the act of introducing a holding company is not a scheme with a view to avoid taxes. As income from the property in Ireland will be taxed there, and personal tax rates are higher than corporate tax rates, the property should be registered in the name of a company. Whether such company is Irish or Cyprus registered will make no difference to the tax treatment of the company as what is important is the tax residency of the company, as determined by the management and control test and not the country of incorporation. As both Anna and Ninos are not resident in Ireland, their company will not be resident in Ireland irrespective of where the company is registered. This in itself is an advantage for their company as if they decide to sell the Irish property, the capital gains on disposal will not be taxed in Ireland as the property belongs to a non-irish resident company and at the same time, it will be exempt from capital gains tax in Cyprus, as the property is not situated in Cyprus. 3 (a) It is imperative that the majority of the board of directors of the Cyprus company CyCo1 are Cyprus residents, as this is one of the requirements of the management and control test (the other two are board meetings taking place in Cyprus and the company s strategic decisions taken in Cyprus). The reason for this is to avoid any possible risk of the Swedish tax authorities treating the company as Swedish tax resident on the basis that the board of directors are Swedish residents. If the company is treated as a Swedish tax resident, its profits will be taxed in Sweden at the applicable Swedish corporation tax rates and the purpose of establishing the new company will be defeated. (b) (c) Transactions between the Swedish company and its other subsidiaries CyCo1 and CyCo2 will have to be at arm s length as these companies are connected persons. Note that no transfer pricing problem will actually arise unless the Director of the Inland Revenue identifies an effort to transfer profits to a low/no tax jurisdiction. Patent royalties paid from Cyprus overseas are taxed in Cyprus under the special mode of taxation at a rate of 10%, deducted at source by the payer. In this case however no tax will be withheld in Cyprus as the payment is made to a connected person within the European Union (EU). 17

5 (d) (e) The VAT treatment of CyCo1 s transactions will be as shown below. Transaction VAT Treatment Sale of goods to EU (not Cyprus) Triangular transaction. Zero-rated to non-eu Export. Zero-rated to Cyprus (CyCo2) Standard rated Purchase of goods from France Intra-community acquisition. Zero-rated Payment of patent royalties Zero-rated, reverse charge provision Dividends paid to Sweden Outside the scope of VAT CyCo1 has no obligation in respect of its Swedish directors, as they are not resident in Cyprus and they do not provide salaried services in Cyprus. CyCo1 will have an obligation to contribute to the Cypriot social security and other funds administered by the social security office, in respect of all its employees in Cyprus as they are all EU citizens providing salaried services in Cyprus. 4 (a) Profits or gains from the sale of shares is exempt both from income tax and capital gains tax unless the company whose shares are traded holds immovable property situated in Cyprus, in which case a capital gain will arise by reference to the capital gain on the indirect disposal of the immovable property by reference to its cost of acquisition and the market value of the property. In the case of Printec Participations Overseas Ltd, the transfer of the shares held in the subsidiaries will not give rise to any chargeable capital gains, except for the gain on the disposal of the Printec Cyprus Ltd shares, as this company holds immovable property situated in Cyprus. The tax implications of the share price stated are twofold. Firstly, the price of the shares of the subsidiaries of Printec Participations Overseas Ltd will determine the stamp duty due on the share purchase agreement; and secondly, the accounting profits of Printec Participations Overseas Ltd for SDC purposes (re: an actual or deemed distribution). As however, the only shareholder of Printec Participations Overseas Ltd is a company resident abroad (Printec S.A), SDC will not be an issue in this case. (b) (c) (d) At the point of eventual liquidation, the company Printec Participations Overseas Ltd will not hold any assets except for cash. The only tax implications (apart from possible capital gains tax as discussed in part (a) above) would therefore be the eventual distribution of this cash as a dividend. Any accumulated accounting profit of the current period and the five accounting periods that precede the current period, will be subject to SDC at 15%. As however, the company s shareholder is a company resident abroad (Printec S.A), SDC will not be imposed. The disposal of shares in not within the scope of VAT and there will be no VAT implications on the transfer of the shares from Printec Participations Overseas to Printec Holdings Ltd. The transfer of the trading activity will be treated as a transfer of a business on a going concern basis. This kind of transaction is exempt from VAT and no VAT implications will therefore arise. Payment of dividends by a Cyprus company are subject to SDC at 15%. As however, one of the company s shareholders holding 90% of the company s shares (H Konstantinou) is not resident in Cyprus, 90% of the dividend payments will be exempt from SDC. However, H Konstantinou will have to declare his dividend income to the Greek tax authorities and this income may be taxed in Greece. The dividends received by Mr Konstantinou s sister in Cyprus will have been subject to SDC, but are exempt from income tax. 5 (a) Tax warehouse A warehouse for customs and excise purposes means any warehouse where goods may be stored without payment of any customs or excise duty or VAT on the importation of goods. Tax warehouses are authorised places where goods subject to excise duty are produced, processed, held, received or despatched under duty suspension arrangements by an authorised warehousekeeper in the course of his business. They include excise warehouses, registered premises distilleries and refineries. They also include fiscal warehouses. (b) When goods are warehoused for customs and excise purposes, payment of any VAT is suspended. Warehoused goods can be moved from one approved warehouse to another or can be exported direct from the warehouse without payment of VAT. VAT only becomes payable when the goods are removed from the warehousing regime and supplied within Cyprus or transferred to another customs regime which does not provide for the suspension of VAT. 18

6 Imported goods which, on arrival in Cyprus, are placed in a customs or customs and excise warehouse are not deemed to be imported for VAT purposes until such time as they are removed from the warehouse into home use, or any customs duties become due. The importer must make an import declaration on the appropriate form but no import VAT is payable and no evidence for input tax is issued. Community goods are those produced or manufactured in the EU or goods received from outside the EU which have been put into free circulation in the EU. The only community goods which are in practice eligible for warehousing are those subject to excise duty (i.e. mineral oils, alcohol and alcoholic beverages and manufactured tobacco) which are received in Cyprus from an excise (tax) warehouse in another EU country. Non-community goods are goods received from outside the EU which have not been put into free circulation in the EU. In the context of acquisitions from other EU countries, such goods arrive in Cyprus from another EU country under external transit (TI) arrangements and may be warehoused in the same way as direct imports. Supplies of goods within warehousing regimes are usually relieved from VAT at the time they take place. VAT becomes due only when the goods are removed from the warehouse to home use and is normally payable together with any suspended duty by the person removing the goods. Similarly, certain services connected with warehoused goods are relieved when originally supplied (through the mechanism of zero-rating), but may be taxed at the standard rate when the goods to which they relate are removed from the regime. (c) (d) Under the fiscal warehousing regime, certain eligible goods can be placed in a notified warehouse and can then be traded by dealers who will not be required to be VAT-registered if that is their only business activity. Supplies of goods and certain services within a fiscal warehouse and supplies of goods intended to be placed in the regime are, subject to conditions, relieved from VAT. With certain exceptions, a charge to VAT arises when eligible goods are removed from the fiscal warehouse regime. The following transactions are relieved from VAT (by being treated as taking place outside Cyprus) if any subsequent supply of the goods in question is made while they are subject to the fiscal warehouse regime. (i) An acquisition of goods from another EU country where, after the acquisition but before any subsequent supply, the acquirer places the goods in a fiscal warehousing regime. The acquirer must, not later than the time of acquisition, prepare and keep a certificate stating that he intends to enter the goods in a fiscal warehouse. (ii) A supply of eligible goods (other than a retail transaction) where, after the supply in question but before any subsequent supply, the buyer places the goods in a fiscal warehousing regime. The buyer must give his supplier, not later than the time of supply, a certificate stating that he intends to enter the goods in a fiscal warehouse. Registration. If transactions falling within (c) (i) or (ii) above are a trader s only Cyprus business activities, the trader will not be required to register for VAT although the trader may apply for voluntary registration. Liability to register for other business activities is not affected by either the value of supplies made in a fiscal warehouse or the value of deemed supplies of related services accounted for by the remover of the goods. It therefore follows that Mr Modinos company will still have an obligation to register for VAT in Cyprus based on sales made to other EU countries. 19

7 Professional Level Options Module, Paper P6 (CYP) Advanced Taxation (Cyprus) December 2008 Marking Scheme Marks 1 (a) (i) Initial licensing fee royalty payment, with explanation 1 0 Subject to withholding tax at 10% 1 0 But 0% based on double tax treaty 1 0 (ii) Annual support fee, royalty income, with explanation 1 0 Tax treatment same as in (i) above 1 0 (iii) If Cyprus branch trading income taxed at 10% 1 0 If Cyprus subsidiary taxed as the branch, but withholding tax provisions apply 1 0 (iv) Suggest Cyprus subsidiary for tax and legal reasons 1 0 Branch profits taxed at 10% but also taxed in France at 35%, 1 0 with Cyprus tax credited against French tax 1 0 Subsidiary profits taxed in Cyprus only, as separate legal entity 1 0 Dividends paid by subsidiary not subject to withholding tax 1 0 But may be taxed in France in the hands of holding company 1 0 If branch formed, debts and claims against branch directed to French company 1 0 If subsidiary with independent management from holding company, no possible liability against French holding company 1 0 Patent payments to connected companies within EU, exempt from withholding taxes 1 0 Receipts from non-eu countries may be subject to withholding taxes per relevant double tax treaties (v) Compare cost of equity with after tax cost of debt * 1 0 Take decision based on which is lowest * 1 0 Loan interest only allowable if for purchase of trading business assets 1 0 No difference if loan from France or Cyprus, or use of subsidiary or branch 1 0 No withholding taxes on payment of interest from Cyprus to France * credit will also be given for alternative answers referring to the issue of the cost of capital employed (vi) Disposal of trading goodwill taxable trading profit 1 0 If operation sold, gain taxable 1 0 If subsidiary s shares sold no tax, with explanation 1 5 Gain may be taxed in France (b) (i) Services provided electronically 1 0 No VAT if purchaser provides valid Cyprus VAT number. 1 0 In other cases charge VAT at the standard VAT rate 1 0 If DVDs sold, treated partly as sale of goods and partly as services. 1 0 Reverse charge provisions, obligation to register if registration limit exceeded (ii) Obligation to register by reference to local sales and EU sales 1 5 Sales to non-eu countries outside the scope of VAT 0 5 Appropriate format and presentation 1 0 Effectiveness of communication

8 Marks 2 (a) Transfer of shares subject to CGT, with explanation 1 0 Yvonne s transfer exempt, with explanation 1 0 (b) Company deemed to dispose of assets 1 0 Land & buildings and shops deemed capital assets subject to 20% CGT, 1 0 But shops exempt as situated overseas 1 0 Land in Nicosia may be either capital or current asset based on intention of use 1 0 Summary of deemed distribution amount 1 0 Amount E subject to SDC, 1 0 But amount accruing to Ninos exempt 1 0 Unless Ninos becomes resident of Cyprus during No VAT on Cyprus buildings, with explanation 1 0 No VAT on Irish shops, with explanation 1 0 Land transfer fees based on 1907 values 1 0 Explanation why (c) Split accomplished partly by reorganisation, with explanation Pre-requisites for reorganisation (2) Same shareholding required 1 0 Free transfer of shares required 1 0 Description of the three stages (3 x 1) Exemption from which taxes (d) Advantage of holding company 1 0 Trust indifferent, with explanation 1 0 Donation of Anaxagoras shares required for exemption from CGT 1 0 Advance ruling advisable, with explanation 5 0 (e) Property registered using a company, with explanation 1 0 Country of incorporation not relevant with reference to management and control Capital gains exempt, with explanation Appropriate format and presentation 1 0 Effective communication

9 Marks 3 (a) Management and control test 1 0 Majority of directors need to be Cyprus resident 1 0 Risk of company being taxed in Sweden 1 0 (b) Identification of connected persons 1 0 Transactions between connected persons at arm s length 1 0 Only a problem if identification of an attempt to shift profits 1 0 (c) Normal treatment of patent royalties 1 0 Explanation why exempt in this case 1 0 (d) Sale of goods Purchase of goods 1 0 Payment of patent royalties 1 0 Dividends (e) No obligation in respect of Swedish directors, with explanation 1 0 Obligation in respect of all Cyprus based staff, with explanation (a) Exemption from corporation tax and CGT, re sales of shares 1 0 Except for Printec Cyprus Ltd, with reasons Share price important for stamp duty 1 0 Also accounting profits re actual/deemed distributions for SDC But no actual SDC issue as shareholder not resident (b) Only issue future deemed distribution 1 0 Subject to SDC but not an issue here 1 0 (c) Transfer of shares outside VAT scope 1 0 Transfer of operations is exempt from VAT, with explanation (d) Dividend payments subject to SDC at 15% 1 0 Dividened paid to H Konstantinou exempt, with explanation 1 0 May be taxed in Greece 0 5 Dividend to sister, subject to SDC but exempt from income tax

10 Marks 5 (a) No VAT or duty on importation of goods 1 0 Authorised places for keeping goods by authorised warehousekeeper 1 0 Premises etc, included 1 0 (b) Payment of VAT suspended 0 5 VAT due when goods are removed from warehousing regime 0 5 Imported goods 1 5 Community goods 1 0 Non-community goods 1 0 Supplies within warehousing (c) Description of fiscal warehousing Acquisition of goods 1 0 Supply of eligible goods (d) No obligation to register on the basis of fiscal warehousing transactions alone 1 0 Obligation to register by reference to sales made to Cyprus and overseas