Tax payable: 19,500 x 0% 0 0 8,500 x 20% 1,700 1,700 8,300/6,078 x 25% 2,075 1,520 5,033 x 30% 1,510 Income tax payable 5,285

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1 Answers

2 Professional Level Options Module, Paper P6 (CYP) Advanced Taxation (Cyprus) December 2016 Answers 1 C&A Design Services/C&A Design Services Ltd (a) Comparative calculations of the overall taxes payable for 2017 under the current partnership structure and on conversion to a limited company Schedule 1: Chris and Andrew s personal tax liability for 2017 under the current partnership structure Chris Andrew Fixed share of profit 24,000 24,000 Share of profit (32,000/2) 16,000 16,000 Rental income 12,000 Total income 52,000 40,000 Less: 20% of gross rents (2,400) Taxable income before social insurance, life premium and pension contributions 49,600 40,000 Less: social insurance contributions and personal life insurance premiums up to 1/6 of taxable income Social insurance contributions (52*780*14 6%) (5,922) (5,922) Personal life insurance premiums Restricted to ((49,600/6) 5,922) (2,345) 0 Taxable income 41,333 34,078 Tax payable: 19,500 x 0% 0 0 8,500 x 20% 1,700 1,700 8,300/6,078 x 25% 2,075 1,520 5,033 x 30% 1,510 Income tax payable 5,285 3,220 Assumption: Chris and Andrew will not apply to pay their self-employed social insurance contributions on their actual income of 40,000, rather than on the minimum provided by the legislation for 2017 of 40,560 ( 780 x 52). Schedule 2: Chris and Andrew s personal tax liability for 2017 as employees under a corporate structure Chris Andrew Salary 24,000 24,000 Rental income 12,000 Total income 36,000 24,000 Less: 20% of gross rents (2,400) Taxable income before social insurance, life premium and pension contributions 33,600 24,000 Less: social insurance contributions and personal life insurance premiums up to 1/6 of taxable income Social insurance contributions (24,000*7 8%) (1,872) (1,872) Personal life insurance premiums no restriction (maximum: 3,728 (33,600/6) 1,872)) (2,600) 0 Taxable income 29,128 22,128 Tax payable: 19,500 x 0% 0 0 8,500/ 2,628 x 20% 1, ,128 x 25% 282 Income tax payable 1,

3 Schedule 3: Corporation tax liability for the company and special defence contribution (SDC) on minimum dividends 2017 C&A Design Services Ltd Accounting profit before salaries and employer s social insurance contributions (32, ,000*2) 80,000 Less: salaries (Chris and Andrew) (48,000) Social insurance contributions employer (48,000*7 8%) (3,744) Other contributions employer (48,000*3 7%) (1,776) Taxable profit 26,480 Corporation tax at 12 5% (3,310) Accounting profits after tax 23,170 Minimum dividend (70%) 16, Chris Andrew Dividend from 2017 profits 8,110 8,109 SDC payable at 17% 1,379 1,379 Assumptions: 1. There is no significant difference in the allowable/disallowable expenses for the purposes of calculating the partnership s taxable profit and the company s taxable profit, except for the treatment of Chris and Andrew s salaries and the associated social insurance contributions. 2. The company will apply for exemption from contributing to the central holiday fund. Schedule 4: Comparison of overall tax liabilities under each structure Chris Andrew Total Partnership: Income tax 5,285 3,220 SDC on rental income ( 12,000 x 75% x 3%) 270 Social insurance contributions (self-employed) 5,922 5,922 Overall tax liabilities as a partnership 11,477 9,142 20,619 Conversion to company: Income tax 1, SDC on rental income 270 Social insurance employees 1,872 1,872 Social insurance employer 1,872 1,872 Other contributions employer SDC on minimum dividends (70%) 1,379 1,379 Total for Chris and Andrew 8,263 6,537 14,800 Corporation tax payable by company 3,310 Overall minimum taxes payable 18,110 Additional SDC payable if 100% of the profits are distributed as dividends (30%*23,170*17%) 1,182 Overall comparable total as a company 19,292 Assumption: Chris and Andrew will want to receive all of the business s after tax profits regardless of the structure, so the company will declare 100% of these after tax profits as dividends and special defence contribution (SDC) will be payable on a 100% actual dividend, not just a 70% deemed dividend. 18

4 (b) Memorandum for tax partner Client: Chris and Andrew Subject: Proposed conversion of C&A Design Services partnership (C&ADS partnership) to a limited liability company C&A Design Services Ltd (C&ADS Ltd) From: Tax assistant Date: 8 December 2016 (i) Overall tax position Effect of different tax structures A partnership is not a taxable entity under Income Tax Law, but only a trading entity, whose taxable profits or losses are allocated to its members (partners) according to their profit sharing ratios. Partners salaries are not deductible in computing the chargeable profit, as these are an allocation of profits on which the partners are liable to income tax. A limited liability company is a separate legal entity and as such is taxable separately from its directors and/or shareholders. If the partnership is converted to a limited liability company, Chris and Andrew will no longer be self-employed but will be considered employees of the new company and only liable to income tax on their salary of 24,000. Taxes payable Chris and Andrew income tax liability If Chris and Andrew remain as partners in the C&ADS partnership, they would each have to file a provisional tax return for 2017 by 31 July 2017, in which they would estimate their overall personal tax liability including the potential share of profit from the partnership. The estimated tax is payable in two instalments, the first with the submission of the provisional return and the second by 31 December of the same year. The balance of any tax underpaid is payable by 30 June of the following year. As employees of C&ADS Ltd, the company, as employer, will deduct the tax due on their salary on a monthly basis and pay this tax over to the tax department on their behalf in the following month. C&ADS Ltd corporation tax liability If the conversion takes place, the company will pay tax at the corporation tax rate of 12 5%. Both the salaries payable to Chris and Andrew and the associated employer s social insurance are tax deductible expenses for the company. The company will have to file a provisional tax return by 31 July 2017, in which it will estimate its tax liability for 2017 and the estimated tax will be paid in two instalments, the first with the submission of the provisional return and the second by 31 December of the same year. The balance of any underpaid tax is payable by 1 August of the following year. Special defence contribution (SDC) on dividends Chris and Andrew or the new company will have an additional tax liability to SDC, either when a dividend is actually paid or under the deemed dividend provisions. According to the SDC provisions, a company is deemed to have distributed to its resident shareholders 70% of its after tax accounting profits at the end of two years from the end of the year to which the profits relate, and must account for special defence contribution at the rate in force. In the case of C&ADS Ltd for the year 2017, this amount will be deemed payable on 31 December SDC is deducted at source by the company and paid over to the Taxation Department by the end of the month following the date of payment/deemed payment (i.e. by 31 January 2020 in the case of the deemed dividend above). In the case of the partnership, 100% of the profits are automatically taxed in the hands of the partners and become part of their personal disposable income. In the case of conversion to a company, 70% of its after tax accounting profits have to be distributed to the shareholders under the deemed distribution rules. In order to make the two scenarios comparable, schedule 4 shows additional SDC payable on the basis that 100% of the company profits are distributed. SDC on the rent receivable by Chris The SDC payable by Chris on the gross rents received for the use of the office building will be the same whether the business is operated as a partnership or is converted to a limited liability company. The SDC is deducted at source on a monthly basis and paid on his behalf to the Taxation Department by the partnership/company by the end of the following month (i.e. by 31 January 2018 in the case of rent for December 2017). Social insurance contributions As partners of a partnership, Chris and Andrew have to pay social insurance contributions as self-employed individuals. The insurable income of a self-employed individual is either the amount as prescribed in accordance with the occupation and place of work or the actual income of the self-employed individual, if lower and an election is made. The contributions are payable quarterly on the tenth of the second month following the end of the quarter, i.e. 10 May for the quarter ended 31 March. 19

5 (ii) If the partnership is converted to a limited liability company, then Chris and Andrew will be employees of the company and both they as employees and their employer, C&ADS Ltd, will pay social insurance contributions. C&ADS Ltd as employer will also pay social cohesion contributions of 2%, redundancy fund contributions of 1 2% and industrial training fund contributions of 0 5%, an additional 3 7% of salary in total. Both the contributions deducted from the employees salaries and the employer s contributions are paid over to the Taxation Department by the employer by the end of the month following the month to which the contributions relate, so by 30 April for the month of March. Value added tax (VAT) implications Transfer of the business as a going concern The conversion of the C&ADS partnership to C&ADS Ltd will be a transfer of a business as a going concern because the partnership is a taxable person, and the partnership business is being transferred to another person (C&ADS Ltd) as a going concern. A transfer of a business as a going concern, where: the whole of the business assets (fixed assets, stocks, goodwill) are transferred or an autonomous part is transferred (e.g. a shop); and the purchaser is already registered or becomes registered and continues the business or similar business; is not treated as a taxable supply of goods or services, but as a change of taxable person. As such, the transfer is outside the scope of VAT, and C&ADS partnership will not need to charge VAT on the transfer of its assets to C&ADS Ltd. This treatment is not an option but depends on the facts in each case. Transfer of VAT rights and obligations The transfer of the rights and obligations in relation to VAT is usually made on the conversion of the business of a sole trader/partnership to a limited company, where the ownership of the business continues in effect to be the same. When the transfer of rights and obligations is approved: the seller must deliver the books and records of the transferred business to the purchaser, except where the Commissioner approves their retention by the seller; and the purchaser will be liable for any VAT due in respect of the period before the transfer of the business, which may come to light after a control visit or otherwise at a later stage. This transfer of rights and obligations will apply on the conversion of the C&ADS partnership to C&ADS Ltd because neither of the exclusions, i.e. where the purchaser is already a registered person or where only part of the business is transferred, are applicable. 2 (a) Tax status and taxes payable in 2017 Income tax Marios moved to Cyprus permanently in September He will therefore be in Cyprus for more than 183 days in 2017, so will be considered a tax resident of Cyprus for income tax purposes and taxed in Cyprus on his worldwide income. Pension from previous employment in Farland The pension relates to his employment in Farland (i.e. outside Cyprus) therefore, Marios can elect for his pension to be taxed separately rather than at normal rates, in which case the first 3,420 will be exempt and the remainder taxed at the rate of 5%. Given the level of Marios s other income, making this election for separate taxation will result in a lower tax liability than adding the pension to his other income and having it taxed at progressive rates. Rental income from Farland Marios will be entitled to the deduction allowed for physical persons of 20% of the gross rents. He will not be able to claim capital allowances on the construction cost of the property because the property is more than 33 years old (Marios bought the house when he was 30 and he is now 67); 33 years is considered to be the life of a commercial or residential building under Cyprus legislation for capital allowances purposes. Even though there is no double tax treaty between Cyprus and Farland, Cyprus will give unilateral relief for tax suffered on the rental income in Farland. However, the relief given cannot exceed the lower of the tax suffered abroad and the tax payable on the same income in Cyprus. The average rate of tax is computed by dividing tax due by the total taxable income at normal rates (the pension income should be excluded as it is taxed separately). This rate is then applied to the gross income from abroad before any tax deductions to determine the Cyprus tax for relief purposes. Salary from part-time employment in Cyprus Marios started the employment immediately on his return to Cyprus in September 2016 and before he became tax resident. Therefore, he is entitled to the deduction of 20% of the remuneration available to a non-resident person taking up employment in Cyprus to a maximum of 8,500. This relief will be available in 2017 and the following two years, i.e. for the three years from 1 January following the commencement of the employment. 20

6 Interest on bank deposits in Farland and Cyprus Interest from bank deposits is exempt from income tax in Cyprus. No relief is available in Cyprus for the tax suffered at source on interest in Farland. Dividends from Farland share portfolio Dividends in the hands of a physical person are exempt from income tax in Cyprus and as a result the 8,000 received from the portfolio of listed shares in Farland is exempt from income tax. No relief is available for the tax deducted at source. Profits on sale of Farland share portfolio Profits from the sales of shares are specifically exempt from income tax or capital gains tax in Cyprus. Capital gains tax may be payable if the relevant company owns immovable property in Cyprus. Special defence contribution (SDC) Marios will not be considered tax resident and domiciled in Cyprus in 2017 for SDC. Although he has a domicile of origin in Cyprus, he has not been Cyprus tax resident for the 20 consecutive tax years before 16 July 2015 (he went to Farland when he was 21, is now 67 and only came to Cyprus for holidays in the intervening period). Therefore, all his income, whether from a Cyprus or Farland source, will be exempt from SDC in This includes the rental income from the Farland house as well as the dividends and interest from both Farland and Cyprus. (b) (c) Tax implications of gifts to Stefanos Dividend payable on Supertrade Ltd shares Stefanos will become tax resident for income tax purposes in 2017 as he will return in February 2017 and does not plan to travel often, which means that he will spend more than 183 days in Cyprus in Stefanos has a Cyprus domicile of origin and has never been non-resident for a period of 20 consecutive years. Therefore, he will be considered tax resident and domiciled for SDC purposes in 2017, and will have to pay SDC at the rate of 17% on the dividend he will receive in 2017 from Supertrade Ltd. Supertrade Ltd will deduct this SDC at source before payment of the dividend. Gift of shares in Smallbuild Ltd Smallbuild Ltd owns immovable property in Cyprus, therefore, although any profit or deemed profit on a transfer or sale of its shares is exempt from income tax, the transfer may give rise to a capital gains tax liability because the transfer of the shares constitutes an indirect transfer of property in Cyprus. However, a gift made from a parent to child, or between husband and wife, or between relations within a third degree of kindred, is exempt from capital gains tax. A grandparent has second degree kindred with his grandchild, so no tax will be payable by Marios on a gift of Smallbuild Ltd shares made to Stefanos. Smallbuild Ltd currently has two shareholders who are both non-resident and non-domiciled in Cyprus for SDC purposes (Marios and John). If the gift of shares is made to Stefanos as intended, from January 2017 the company will have one 50% shareholder who is resident and tax domiciled in Cyprus (Stefanos), and a second 50% shareholder who is neither resident nor tax domiciled (John). Even though Smallbuild Ltd will not distribute any dividends in 2017, as a result of the SDC deemed distribution provisions, it will be deemed to have distributed 70% of its after tax accounting profits within two years from the end of the relevant tax year. The relevant date for the distribution of the 2014 after tax profits is 31 December No SDC is payable on this deemed distribution as, on this date, both the company s shareholders (Marios and John) are non-resident and non-domiciled for SDC purposes. However, if the shares are gifted to Stefanos, on 31 December 2017 (the relevant date for the distribution of the 2015 after tax profit) the company will have one shareholder (Stefanos) who will be considered tax resident and domiciled for SDC purposes. Therefore, Smallbuild Ltd will be deemed to have distributed 14,000 ( 20,000 x 70%) and to pay SDC of 1,190 ( 14,000 x 50% x 17%) even though a dividend will not be paid. There are two ways in which to avoid payment of this SDC: delay making the gift until January 2018, i.e. after the relevant date for the distribution of the 2015 after tax profit, or before making the gift, declare an actual dividend to cover the minimum required by the SDC legislation for both 2014 and 2015, i.e. at a time when Marios and John are shareholders. It would not be necessary to actually pay this dividend, only to credit the shareholders with the amount due but leave it unpaid until Smallbuild Ltd has the cash resources to pay it. Value added tax (VAT) implications of investment in the block of flats As Marios will be purchasing the flats new, he will have to pay VAT at 19% on the purchase price, i.e. 76,000 ( 400,000 x 19%). If Marios rents or in any way uses the flats (or any flat individually) after he has purchased them, this will render the flats used for VAT purposes. Whilst the VAT on the original purchase will not be recoverable, no VAT will have to be charged on any future sale because the sale of used flats is exempt from VAT. If Marios sells any of the flats before they are used, he will have to charge VAT on the sale price. He will need to register for VAT once he has found a buyer (he does not need to register for VAT before then). According to the VAT legislation, registration for VAT is compulsory if, at any time, there are reasonable grounds to believe that the value of taxable supplies (excluding VAT) in the next 30 days will exceed 15,600 (future prospects test). 21

7 He will also be able to recover the VAT he has paid on the purchase of the flat(s) sold, provided the sale takes place within the three-year limit for the recovery of pre-registration VAT on goods. Therefore, if his intention is to sell the flats as new, Marios should make sure that he registers for VAT within this timeframe and claims back the VAT he paid on the purchase. The VAT legislation allows a buyer who is buying a new residence for the purpose of making it their main and permanent residence to apply to the VAT office and obtain approval to pay VAT at 5%. Assuming the flats are likely to be suitable for young couples seeking their first permanent residence, it may be better not to rent them out immediately or use them in any way, so that they remain new and attractive to buyers looking for a new flat as their permanent residence, and who have approval for the 5% rate. Tutorial note: The definition of qualifying person as well as the pre-requisites for the application of the reduced rate of 5% on new residences are excluded topics, therefore candidates were not required to go into detail. 3 Lathos Ltd (a) Corporation tax and SDC payable on corrected profits Corporation tax payable for the years 2013, 2014 and Incorrect taxable profit/(loss) (55,000) 110, ,000 Add back incorrect interest 65,000 15,000 13,000 Deduct correct interest cost (30,000) (31,050) (27,060) Add disallowed interest on saloon car treated as a commercial van (see working) 3,332 2,732 Add back incorrectly claimed capital allowances on saloon car (66,640*100/119*20%) 11,200 11,200 Add back running expenses relating to saloon car 2,500 3,780 Correct taxable profit/(loss) before loss relief (20,000) 110, ,652 Loss carried forward (20,000) 0 Taxable profit 0 90, ,652 Corporation tax at 12 5% 0 11,373 13,582 Working: interest disallowed on saloon car Correct interest cost 31,050 27,060 Total borrowings 621, ,000 Average interest cost 5% 4 1% Cost of saloon car 66,640 66,640 Interest disallowed 3,332 2,732 Special defence contribution (SDC) payable on the 2013, 2014 and 2015 profits Accounting profit/(loss) per accounts (25,000) 100,000 95,000 Add back incorrect interest 65,000 15,000 13,000 Deduct correct interest cost (30,000) (31,050) (27,060) Additional depreciation on VAT element of saloon car (66,640*19/119 over 7 years) (1,520) (1,520) Gross dividend income from Triland portfolio investment company 10,000 Profit on sale of land ( 600, ,165) 282,835 Adjusted accounting profits before tax 10,000 92, ,255 Corporation tax payable (as calculated) 0 (11,373) (13,582) SDC on dividends from Triland (10,000*17%) (1,700) Capital gains tax payable (from working) (25,037) Accounting profits after tax 10,000 79, ,636 Minimum dividend per SDC legislation (70%) 7,000 55, ,545 SDC payable at 17% 1,190 9,444 38,513 Deemed date of payment of dividend 31 December 31 December 31 December

8 Working: capital gains tax on sale of land 2015 Sale proceeds 600,000 Less: indexed cost of purchase (excluding land transfer fees) (300,000*115 16/75 49) (457,650) Less: transfer fees (17,165) Capital gain 125,185 Capital gains tax at 20% 25,037 (b) (1) Dividend from the Triland portfolio investment company Dividend is exempt from corporation tax but chargeable to SDC. The dividend is not exempt because the company in Triland is a portfolio investment company, so more than 50% of its activities (actually 100%) lead to investment income, and no tax is payable by the company in Triland (i.e. the foreign tax burden is substantially lower than the Cyprus tax burden). (2) Sale of the plot of land The plot of land is a capital asset, not a trading asset, so the gain on the sale is subject to capital gains tax not corporation tax. The date of disposal for capital gains tax purposes is the date the contract was signed, i.e. December It is irrelevant that the transfer at the Land Registry has not yet taken place. Lathos Ltd should have declared the sale and paid the capital gains tax due on the transaction within 30 days from the date of disposal (i.e. the signing of the contract). As a result of the delay, interest at the prescribed rate will be imposed on the amount of the tax, from the due date to the date of payment. (c) Land is sold at an undervalue to a related party Capital gains tax As the transaction is between related parties and the sale price is significantly lower than market value, the capital gains section of the Department of Taxation may not accept the declared price and require that the capital gain be calculated using the market value as determined by the internal valuations section of the Department of Taxation. As a result, the capital gains tax payable is likely to be higher than originally calculated. Corporation tax There will be no corporation tax consequences as the transaction is taxable under capital gains tax. Special defence contribution (SDC) The undervalue sale will result in a deemed distribution of a dividend equal to the difference between the market value and the value at which the asset is transferred by Lathos Ltd because: the company has disposed of an asset to a second degree relative of a (physical person) shareholder at a price which is lower than the market value; and the asset was not previously acquired by the company by way of gift from an individual shareholder thereof, or from a relative of a shareholder up to the second degree of kindred, or from their spouse, as Lathos Ltd had acquired the land by purchasing it. 4 Landco Ltd (a) (i) Value added tax (VAT) implications of contract for website services This is a business to business (B2B) supply of services. Therefore, the services are deemed to be supplied where the recipient is located. As Landco Ltd is located in Cyprus, the place of supply of the services will be Cyprus. Even though Landco Ltd is not registered for VAT, it is still deemed to be a taxable person as it will receive the services for the purposes of its business and it can easily provide evidence for this. The supply is therefore a supply which is taxable for VAT purposes in Cyprus in accordance with Cyprus legislation irrespective of where the supplier is located. The location of the supplier affects only the way in which the VAT will be accounted for in Cyprus. Supplier based in Cyprus local supply The supplier will charge VAT at the normal rate of 19%. As Landco Ltd is not VAT registered and will receive this service for the purpose of making exempt supplies (land sales), it will not be able to recover the VAT paid on the services. VAT will therefore form part of the cost of setting up and maintaining the website. 23

9 (ii) (iii) Supplier based in Greece EU supply The supplier in Greece will ask Landco Ltd to provide its VAT registration number in order to determine whether Landco Ltd is VAT registered in another member state. Landco Ltd will not be able to supply such a VAT registration number but it should inform the supplier and provide evidence that the supply is received for business purposes. If this is done, the Greek supplier will not charge VAT on the supply to Landco Ltd, and Landco Ltd will have to account for VAT under the reverse charge provisions of the legislation. Tutorial note: It is possible for Landco Ltd to register for VAT on the basis that it will be making self-supplies of services and obtain a VAT registration number. This registration number can then be provided to the Greek supplier so that no VAT will be charged on his invoices at the outset. Under the reverse charge provisions, Landco Ltd will be deemed to supply the services to itself and therefore will need to register for VAT specifically for this purpose. Based on the terms of the proposed contract, Landco Ltd will have to compulsorily register for VAT because, after the contract is signed, there are grounds to believe that the value of taxable supplies in the next 30 days will exceed the registration threshold of 15,600. Landco Ltd will be deemed to supply the services to itself and charge VAT to itself at 19% and declare this as output tax on its VAT return, but will still not be able to recover this VAT as input tax at is relates wholly to exempt supplies. Supplier based in India non-eu supply The supplier in India has confirmed that no VAT will be charged on the supply in India. According to the Cyprus legislation, the supply is still deemed to take place where the recipient is located, which is Cyprus, so VAT has to be accounted and paid for on the supply in Cyprus. Landco Ltd will therefore have to account for VAT under the reverse charge provisions (as in the case of the supplier based in Greece, above). Conclusion In all three cases, the cost of acquiring the website services will be the same, as VAT will be paid at 19% and this will form part of the cost to Landco Ltd. No supplier has a VAT advantage. In the case of the Cypriot supplier, there will be less administration work for Landco Ltd as it will avoid having to register for VAT and complete and file VAT returns on a quarterly basis in Cyprus. VAT implications of computer server purchase The purchase of the computer server is a supply of goods. Supplier based in the UK EU supply At the time of purchasing the server (three months after the contract for the website services has started), Landco Ltd could be registered for VAT because of the self-supply of the website development and maintenance services (as discussed in (i) above). As the UK is an EU country, Landco Ltd will supply its VAT registration number to the UK supplier and the UK supplier will not charge VAT on the sale. As in the case of the services, Landco Ltd will have to account for VAT on the purchase following the self-supply rules. It will therefore pay VAT at the Cyprus rate of 19% on the cost of buying the server. If Landco Ltd has not already registered for VAT (because the website was developed and maintained by the Cyprus supplier), before it purchases the server from the UK it will need to register as an intending trader on the basis that it will be making taxable self-supplies to itself which exceed the threshold of 15,600 in the next 30 days. Supplier based in China non-eu supply If the computer server is imported from China, a country outside the EU, then VAT will have to be paid at the time of customs clearing the goods in Cyprus, at the Cyprus VAT rate of 19%. In neither case will Landco Ltd be able to recover the VAT due on the import of the computer server because it will be used for the purposes of exempt activities and the VAT will therefore form part of the cost of purchase. Corporation tax treatment of irrecoverable VAT The initial development cost of the website, which is computer software, is a cost of a capital nature, as such the irrecoverable VAT will be capitalised as part of the cost of the initial development and capital allowances claimed at the rate of 33 3% per year. The annual maintenance cost is a cost of a revenue nature, therefore, the irrecoverable VAT will be allowed as an expense against taxable income. The purchase cost of the computer server, which is computer hardware, is also a cost of a capital nature. The irrecoverable VAT will be capitalised as part of the cost of the server on which capital allowances will be claimed at the rate of 20% per year. (b) Supply of consultancy services to Paphos-based company Landco Ltd will be providing a local supply of services which is subject to VAT at the rate of 19%. The tax point at which VAT will have to be charged is the date of issue of the invoice, even though it will be a prepayment for a service which will be provided over the entire year. 24

10 If the contract with the Paphos company is entered into, the first invoice will be issued on 1 January 2017, at which time Landco Ltd will already be VAT registered as a result of the self-supply rules (as discussed in (a), above). However, the provision of taxable services under the contract will result in Landco Ltd becoming partially exempt for VAT purposes as it will now be making both exempt and taxable supplies. Consequently, Landco Ltd will be able to recover part of its input tax as follows: All of the input tax incurred wholly for the purpose of making the taxable supplies can be recovered. None of the input tax incurred wholly for the purpose of making the exempt supplies can be recovered. The remaining non-attributable input tax will be apportioned using the fraction total taxable supplies/total supplies which are recoverable, and the rest is not recoverable. In computing the fraction, certain supplies are ignored and these include self-supplies. Therefore, if Landco Ltd enters into the contract for the supply of the website services with a company based outside Cyprus, the self-supply occurring as a result will not be included in its sales for the purposes of computing the recoverable fraction of input VAT. Input VAT recoverable under the partial exemption method is originally calculated on a quarterly basis but is reworked on an annual basis and any over or under-declaration accounted for. If the amount of input tax wholly or partly attributed to exempt supplies is below the de minimis limit, all such tax is allowed. The limit is an amount not exceeding 171 per month on average and which does not exceed 50% of all the input tax for the period concerned. This tax is known as exempt input tax. As Landco Ltd will only incur small additional costs in supplying the consultancy services to the Paphos company, the application of the apportionment fraction will result in its being able to recover some of the input VAT on its office costs which are currently irrecoverable. 5 Stelios (a) (b) Tax residency position of Grapejuice Ltd (GJ) if Stelios becomes a director The term resident in the Republic when applied to a company means a company whose management and control is exercised in the Republic. There is no definition of management and control but in practice it can be taken to be: where the majority of the directors reside; and where board meetings are held; and where the general policy of the company is formulated. The co-existence of all three criteria is essential. The place where the meetings of the directors are held, although essential, may not always be conclusive. It is the place where real management and control of a company is exercised. This is a question of fact and may be exercised by one person, in which case the place of residency of that individual will be the company s place of residence. There are no clear cut rules each case is decided on its own facts. Where the company s central office is located or where its annual general meetings are held is not a material deciding factor. In the specific case of Stelios and GJ, the following has to be taken into consideration: Stelios will only be one of two directors and therefore there will be no clear majority of directors resident in Wayland or Cyprus. Stelios will spend 15 days every three months in Wayland. As a founding shareholder who assisted in the discovery of GJ s patented method of wine making, it seems that Stelios has been actively involved in the formulation of company policy for some time now. As Stelios will travel extensively to Wayland in his role as a director, it would be advisable to keep records of this travelling and of board meetings held in Wayland, so there can be no doubt as to the place important decisions are made. If this is done, the risk of GJ being considered tax resident in Cyprus is remote. Ideally, GJ should appoint a third director, who is resident in Wayland, so that the majority of the board of directors will reside in Wayland. Tax implications of GJ being tax resident in Cyprus As Wayland does not have a double tax treaty with Cyprus, if GJ is considered tax resident in Cyprus, it will be taxed in accordance with the normal corporation tax rules in Cyprus, irrespective of the fact that it is registered and operates outside Cyprus. Where a Cyprus resident company makes investments abroad, it is liable to corporation tax on the profits made from those investments before the deduction of any foreign taxes paid. As GJ s warehouse and offices are in Wayland, it will be considered to be an overseas permanent establishment (PE) of a Cyprus resident company. The profits of an overseas PE controlled from Cyprus are exempt from tax in Cyprus unless the PE engages directly or indirectly to the extent of more than 50% in activities which lead to investment income and the foreign tax burden is substantially lower than the Cyprus tax burden. GJ is a manufacturing and trading company which does not 25

11 engage in any investment activities, so all its profits will be exempt from income tax in Cyprus. However, GJ will still have to register as a company resident in Cyprus and file a tax return in Cyprus, like any other tax resident company. As a tax resident company, GJ will also be caught by the deemed distribution provisions for the purposes of the special defence contribution (SDC). GJ will be deemed to have distributed a minimum of 70% of its after tax accounting profits in the two years following the tax year in which the profits are generated, and will have to pay SDC at the rate of 17% in respect of any of its individual shareholders who are tax resident in Cyprus. GJ has at least one individual shareholder, Stelios, who is tax resident and domiciled in Cyprus, so SDC will have to be paid even if the minimum required dividend is not distributed. (c) (d) Tax payable by Stelios on his income from GJ Additional income tax payable in Cyprus on director s salary 2017 Net salary from GJ 25,000 Add: tax deducted at source 5,500 Total additional taxable income 30,500 Less: expenses incurred wholly, exclusively and necessarily in earning this income: (4, ,200) (5,200) Additional taxable income 25,300 Additional tax at highest marginal rate of 35% 8,855 Less: relief for tax suffered abroad (maximum of 5,500 and (30,500*35%)) (5,500) Additional income tax payable 3,355 Stelios currently estimates that he will be spending about 60 (4 x 15) days per year in Wayland, so his salary from GJ is taxable in Cyprus as part of his worldwide income. However, there is a provision in Cyprus law whereby remuneration from salaried services rendered outside Cyprus for a total aggregate period in the year of assessment of more than 90 days, to an employer not resident in Cyprus or to a permanent establishment outside Cyprus of an employer resident in Cyprus is exempt from tax. Therefore, Stelios s salary from GJ will become exempt from Cyprus income tax if it is possible for him to increase his total number of days in Wayland to more than 90 days, as it will then fall within the 90-day rule provisions. The Taxation Department may request the submission of supporting evidence including a copy of passport pages or air/sea tickets or boarding passes which show the dates of entry to or exit from Cyprus. Stafili Ltd patent royalties and loan interest payable Both the royalties payable for the exploitation of the patent and the loan interest are expenses of a revenue nature which will be allowed as an expense against Stafili Ltd s taxable profits. As Wayland is not a member of the EU and does not have a double tax treaty with Cyprus, Stafili Ltd will have to deduct withholding tax at the rate of 10% from the royalty payments and pay this tax over to the Taxation Department. No withholding tax is deductible from the interest paid on the loan from GJ by Stafili Ltd. The royalty transaction between GJ and Stafili Ltd is between related parties, so care should be taken that a third party (arm s length) price is agreed. The Taxation Department has the right to amend the values of transactions and raise assessments if it believes that the prices used were not what they would have been if two unrelated parties had entered into the same transaction. Tutorial note: There is no transfer pricing issue in relation to the loan interest as this is to be paid at the market rate. 26

12 Professional Level Options Module, Paper P6 (CYP) Advanced Taxation (Cyprus) December 2016 Marking Scheme Available Maximum 1 (a) Income tax as partners (Schedule 1) Fixed share + share of profit 0 5 Rental income/deduction of 20% only on Chris 1 Social insurance contributions 1 Insurance premium restricted to one-sixth in total 1 Application of tax rates 1 Income tax as employees (Schedule 2) Salary inclusion only 0 5 Social insurance contributions 0 5 Insurance premium no restriction 1 Application of tax rates 0 5 Corporation tax and SDC on dividends (Schedule 3) Employer social insurance contributions 1 Employer other contributions 1 Remaining taxable profit items 0 5 Corporation tax at 12 5% 0 5 Minimum dividend and SDC payable 1 Comparison of liabilities (Schedule 4) SDC on rental income payable by Chris 1 Remaining partnership items 0 5 Company minimum liability items 1 5 Additional SDC on 100% distribution 1 Assumptions 1 mark each (b) (i) Partnership not a taxable person 1 Company a separate legal entity 0 5 Self-employed v employed status of Chris and Andrew 1 If partners, filing of provisional tax return and payment dates 1 5 If employees, deducted at source and paid over by company 1 Corporation tax filing of provisional tax return and payment dates 1 5 SDC on actual/deemed dividend distributions, including timing and payment 2 SDC on rental income deduction and payment 1 Social insurance contributions payable as partners 2 Social insurance contributions payable as employees/employer 1 Other contributions payable by employer 0 5 Payment of contributions, mechanism and timing (ii) Transfer of going concern no VAT chargeable 1 Explanation of reasons 1 5 Not an option based on facts 0 5 Transfer of VAT rights and obligations no effective change of ownership 1 Consequences Professional marks: Presentation/structure of computations/schedules 1 Format and presentation of notes 1 Clarity of explanations and effectiveness of communication

13 Available Maximum 2 (a) Residence status for income tax with explanation 1 Taxed on worldwide income 0 5 Election for separate taxation of pension income with explanation 2 Rental income/20% deduction 0 5 No capital allowances, with explanation 1 Unilateral relief for tax deducted in Farland with explanation 2 Deduction for first employment in Cyprus with explanation 2 Interest on bank deposits and dividends 1 Profit on sale of shares in Farland with explanation 1 Marios not resident for SDC with explanation 1 5 Interest, dividends and Farland rental income exempt from SDC (b) Stefanos resident for SDC with explanation 1 5 SDC on dividend from Supertrade Ltd in Deducted at source by Supertrade Ltd 0 5 Potential capital gains tax liability on transfer of Smallbuild Ltd shares with explanation 1 5 Identification and explanation of gifts to close relatives exemption 2 Gift results in Smallbuild Ltd having a resident shareholder 1 Explanation of resulting deemed distribution issue 1 5 Calculation of potential deemed distribution to Stefanos in Advice re delaying gift until after Advice re early declaration of actual dividend 1 Reference to crediting v actual payment (c) VAT on purchase at 19% as new 1 If rented/used then no VAT on future sale and ability to recover VAT on purchase lost 1 5 If sold new must charge VAT on re-sale 0 5 Need to compulsorily register for VAT with explanation 2 Input VAT only recoverable if purchase within three years before registration 1 Identification of new permanent accommodation residence provision with explanation of potential effect

14 Available Maximum 3 (a) Corporation tax payable Interest correction 0 5 Disallowed element re saloon car 1 5 Capital allowances add back 1 Running expenses adjustment 1 Loss carried forward to Tax at 12 5% 1 Accounting profits adjustment/sdc payable Interest correction (as for CT) 0 5 Additional depreciation on VAT element of car 1 Accounting profit from sale of land 0 5 Gross dividend from Triland 0 5 SDC on dividend 0 5 Deduction of CT/SDC/CGT to arrive at after tax accounting profits for SDC 1 Minimum dividend and SDC payable at 17% 1 5 Capital gains tax payable Indexation on cost excluding transfer fees 1 Deduction of transfer fees 0 5 Tax at 20% (b) Dividend: Exempt from corporation tax 0 5 Not exempt from SDC with explanation 1 5 Sale of land: Capital gains tax not corporation tax 0 5 Date of disposal with explanation 1 Due date for payment of tax 0 5 Reference to interest being payable on late payment (c) Capital gains tax between related parties need for assessment of value 2 No corporation tax 0 5 SDC on difference in values with explanation

15 Available Maximum 4 (a) (i) Recognition of B2B supply 1 Even though Landco Ltd not registered for VAT still B2B 0 5 Place of supply is Cyprus irrespective of supplier 1 Cyprus company local rate 1 No recovery supplies made are exempt 0 5 Greece EU supply reverse charge 1 Mechanism for Greek supplier not to charge 1 Landco Ltd needs to register for VAT with explanation 1 5 Mechanism for charge/payment by Landco Ltd 0 5 India non-eu but still reverse charge 1 Cost the same in all three cases 0 5 But administrative benefits in the case of Cyprus supplier (ii) Supply of goods 0 5 China non-eu VAT paid on importation at 19% 1 Landco Ltd registered for VAT due to self-supply 0 5 UK EU supply reverse charge Cyprus VAT at 19% 1 5 Landco not already registered for VAT: register as intending trader with reason (iii) On software capital element capitalised/capital allowances on total cost at 33 3% 1 On software maintenance part of expenses allowable for corporation tax 1 On server part of capital cost/capital allowances at 20% (b) Services to Paphos company taxable supply 0 5 Identification of tax point 0 5 Landco Ltd will become partially exempt 1 All input tax directly related to taxable supply recoverable and vice versa 1 Non-attributable input tax fraction calculation 1 Fraction calculation ignores self-supplies 0 5 Quarterly recovery with annual adjustment/de minimis 1 5 Will result in partial recoverability of VAT previously lost

16 Available Maximum 5 (a) Managed and controlled from Cyprus 0 5 Criteria (3 x 0 5) 1 5 Co-existence of criteria essential 0 5 General discussion of principles/each case decided on its facts 1 Application of criteria to Stelios and GJ (3 x 0 5) 1 5 Advise keeping travel evidence/documenting the board meetings taking place in Wayland 1 Advise appointing a third director (b) No DDT therefore normal Cyprus domestic law applies 1 Overseas profits subject to corporation tax 0 5 Wayland operations an overseas PE 1 Profits of PE exempt with explanation 1 5 Must still register for tax/file a return 1 SDC deemed distribution provisions will apply (c) Calculation Gross salary taxed in Cyprus including Wayland tax 0 5 Expenses allowed 1 Income tax at 35% rate 0 5 Relief for tax in Wayland 1 Explanation of the 90-days rule 2 Advise Stelios to increase number of days in Wayland and use the 90 days rule (d) Royalties and interest to GJ tax deductible revenue expenses 1 Withholding tax at 10% to be deducted at source on royalties 1 No withholding taxes on interest 1 Related party/transfer pricing issue re royalties