Answers
Professional Level Options Module, Paper P6 (CYP) Advanced Taxation (Cyprus) June 2015 Answers 1 Le Romstan Resort Ltd MEMORANDUM To: Max, chief financial officer of Le Romstan Resort Ltd (LRR) From: A. N. Adviser Date: 10 November 2014 Re: Various tax matters Following our meeting today, we are happy to submit our thoughts on the concerns you have raised. We would be happy to discuss anything further. (i) (ii) (iii) Disclosure of tax issues to the tax authorities Although there is a chance that the tax authorities may not discover a particular matter, we would never advocate a course of action which involved concealing errors from the tax authorities. As a taxpayer you have an obligation, both ethically and responsibly, to put any tax issues which you have encountered in front of the tax authorities. Even though this will result in the definite imposition of tax along with interest and penalties, it will reinforce to the tax authorities the notion that you are a responsible taxpayer. In addition, the tax authorities have the right at any time to investigate the previous six tax years, increased to 12 tax years if there is a suspicion of fraud. By disclosing the tax issues which may have arisen recently, the case for fraud will be made remote. Also, the interest payable now will be less than that which would be imposed, if the tax authorities, acting within their allowable timeframe, discover the matter some years later. Mandatory service charge PAYE LRR has a legal obligation, under the tax legislation, to withhold income tax from all of the remuneration which the hotel pays to its employees, through the Pay-As-You-Earn (PAYE) system. This obligation also extends to the amounts paid to the employees on the income they receive which is derived from the 10% mandatory service charge, given that the employees entitlement to this income is a result of their employment with the hotel. As such, you should calculate every month the income tax which arises on the additional emoluments from the allocation of the mandatory service charge as per the units of each employee, and pay this to the tax authorities through the PAYE system. Failure to do this could result in the tax authorities assessing such tax on the hotel business, and imposing penalties and interest for late payment. Given that we are currently in the 2014 tax year, the income tax returns of the employees for the 2013 tax year, as well as earlier years, should already have been submitted. If the employees have already paid the relevant tax for these previous years through self-assessment, the only tax remaining will be that relating to 2014. Any tax which has already been paid by the employees through self-assessment for prior years should not be assessed on LRR simply because it was not deducted at source through the PAYE system. If, however, the employees have not paid the required tax through the self-assessment system, LRR will have an obligation to pay this tax. As such, you should first ascertain whether the employees have paid their taxes correctly on their total emoluments, including the additional income relating to their units, for at least the last six tax years. Second, you should review the tax liability which arises in 2014 from the mandatory service charge income and arrange for this tax to be paid through the PAYE system during the remaining two months of this tax year s PAYE payments. The matter should also be discussed with the employees, so as to ensure they will not have any issues given that this will affect their disposable income for the upcoming two months. Mandatory service charge VAT The mandatory service charge is in respect of a service provided by the hotel to its customers. In the VAT legislation, a service is defined as anything which is not a good, so given that it is mandatory, and forms an integral part of any supply which takes place in the hotel, the service charge will be subject to VAT at the same rate as that attributed to the main transaction. As such, the mandatory service charge on the sale of products or treatments from the beauty therapy salon will be subject to VAT at the standard rate, which is currently 19%, and that on the restaurant bills, for example, will be subject to VAT at the reduced rate of VAT, currently 9%, which applies to restaurant and catering services. Given that the gross amount of the charge is 10%, the VAT element should be extrapolated from within this sum and paid to the VAT authorities. Only the net amount should be attributed to the employees as remuneration, as per the allocation method described by you during our meeting. Therefore, the past amounts paid to the employees will have been overstated given that the relevant VAT had not been deducted and you will need to decide whether to claim this back from the employees. Once the VAT amount has been calculated, a request should be placed with the Department of Taxation (DoT) to correct the omission for the last six years. A request for a correction is mandatory given that the period for which the correction is requested is greater than three years, and the amount of the correction will exceed 1,708. If the request for a correction is granted by the tax authorities, the VAT amount will be payable, but without the imposition of interest or penalties. 17
Given that this was not an act of fraud by LRR, the assessment would cover the last six years, although it is not clear that the tax authorities will accept this, and may attempt to assess the last 12 years. If the tax authorities do not accept that this was the result of a genuine error on behalf of LRR, they may impose penalties and interest. (iv) (v) (vi) Tender process for lease of the shops Camilla is the daughter of one of the shareholders of LRR. As such, she is a related party of LRR and any transactions between LRR and Camilla should be undertaken on arm s length terms. It is clear from the tenders submitted that Camilla s offer (the lowest of the three) was not at the market rate. As the two independent offers were for 10,000 and 9,000 per month respectively, the market rate could be estimated to be somewhere between these two around 9,500. Given that her tender offer was for only 5,000 per month, it appears as if Camilla won the tender as a result of her relationship with one of the shareholders, as it is otherwise not in LRR s interests to award the tender to the one offering the lowest price. Consequently, you should either re-negotiate the agreement with Camilla, or an adjustment should be made to LRR s taxable profits for a notional rental income of 4,500 per month, to bring the amount up to the market value. Given that this income is notional, no special defence contribution (SDC) will apply. If no action is taken, the DoT will impose an additional notional rental income on LRR. SDC on the lease payment As the lease payments are subject to SDC and the tenant (Camilla) is an individual, Camilla should make the lease payments to LRR gross. LRR must calculate and pay the SDC to the tax office by 30 June for the lease payments received during the first six months of a tax year, and by 31 December for those received during the last six months. The gross lease income received would amount to 15,000, on which SDC amounts to 338 ( 15,000 x 75% x 3%). So LRR s net rental income per quarter will be 14,662 ( 15,000 338). Tax implications of the loans and corporate guarantee (1) Loan to Camilla As stated above, Camilla is a related party of LRR. As such, if Camilla is a debtor in the books of LRR, a deemed benefit will arise every month, which constitutes taxable income for her. The value of the benefit is by law 9% of the monthly debit balance, reduced by any interest charged to her by LRR. As such, if the 5% interest charge continues, Camilla will have an additional 4% per annum benefit on the 200,000 debit balance. If the loan terms are amended so as to make it interest free, Camilla will have a deemed benefit equal to 9% per annum of the monthly balance. LRR will need to pay the tax on behalf of Camilla through the PAYE system, and will thus be required to register Camilla for this purpose. Given that the provision of loans is not in LRR s normal course of business, if interest is charged on the loan, the interest accrued will be fully exempt from corporation tax, but will be subject to SDC at a rate of 30%. (2) Loan to Costas Costas is neither an officer, nor a shareholder of LRR, nor a relation of these, so he and LRR are not related parties. As such, the loan received by Costas will not create a benefit (as in the case of Camilla) nor will there be any other tax issues for him. For LRR, the tax treatment of the interest accrued on the loan made to Costas will be the same as that on the loan from Camilla, i.e. it will be fully exempt from corporation tax, but subject to SDC. (3) Guarantee to Elvira The board agreed to provide the corporate guarantee to the developer for Elvira s property, because of Elvira s importance to your marketing department. As such, the benefit of receiving this corporate guarantee can be linked directly with her employment, and so would constitute a benefit in kind, which is taxable for Elvira. Given that the corporate guarantee does not cost LRR anything, it is debateable as to whether the value of the benefit is therefore nil, or whether it should be equal to what the bank would have charged, being 1 5% on 100,000 per year. However, as Elvira is not a related party, no arm s length principles apply, and so, in this case, the value of the benefit should be the cost to LRR of providing the corporate guarantee, which is nil. If the guarantee needs to be used, resulting in a cost of 100,000 to LRR, then that amount will constitute a benefit in kind, taxable on Elvira. (vii) VAT on the sale of products from the beauty therapy salon With regards to the VAT treatment of the sale of products from the beauty therapy salon, the place of supply for the sale of goods where no transport exists is where the goods are located at the time the supply takes place. Therefore, for all the products sold by the beauty therapy salon which the customers take away with them, Cyprus VAT should be charged at the standard rate, i.e. 19%. The place of supply for the sale of goods where transport exists is deemed to be the place where the goods are located at the time when the transport to the customer begins. Once again, this will be Cyprus. However, there is a difference in the treatment depending on whether the goods are shipped to another EU country or to a country outside the EU. 18
In the case of goods shipped to another EU country, given that the customer is a consumer (i.e. the transaction is business-to-consumer or B2C), this constitutes distance selling and Cyprus VAT should be charged on the invoice. However, the beauty therapy salon will need to monitor the total sales made to each EU country to which transport is made, as each EU country has its own registration threshold for distance selling. If this threshold is surpassed in any one calendar year, LRR (as the foreign supplier) is obligated to register for VAT in that country and to charge VAT at the local rate on any B2C sales made where transport ends in that country. For goods which are shipped outside the EU, the place of supply is Cyprus, but the sale will be zero rated as such sales constitute exports. As such, no Cyprus VAT should be charged on the invoice. 2 Rikos and Kostis (a) (b) (c) (d) Partnerships are transparent for tax purposes. As such, the taxable profits or losses of Karios Bros Movers (KBM) will, given that they are equal partners, be attributed equally to Rikos and Kostis, and included in their taxable income. The transportation of furniture within Cyprus constitutes a domestic transportation of goods service. Both the transportation for Degas SA (Degas) and for OOO Kandinsky (Kandinsky) will be business-to-business (B2B) transactions, given that, in each case, the transport is effected on behalf of the furniture supplier. With regards to the transportation effected on behalf of Degas, the place of supply of the domestic transportation following the basic B2B rule would be where the customer is based. Degas is VAT registered in France, and thus, the invoice to Degas should not include Cyprus VAT as the place of supply would be France and Degas will need to apply the reverse charge mechanism. The place of supply for the transportation made on behalf of Kandinsky is different from that of Degas, because Cyprus applies the use and enjoyment provisions to the domestic transportation of goods services. Under the basic B2B rule, the place of supply would be outside the EU, i.e. Russia, where Kandinsky belongs. But because Russia is outside the EU, the use and enjoyment provisions will apply, resulting in the place of supply reverting back to Cyprus, where the transportation effectively takes place, or is used and enjoyed. As such, KBM should charge Cyprus VAT, at the standard rate of 19%, on its invoice to Kandinsky. Rikos Taxable income on the sale of KBM s business to Sorolla SA Income arising from the sale of the tradename Sale proceeds 390,000 Less 80% statutory deduction (312,000) 78,000 Income arising from the sale of the three vans Original cost of vans 450,000 Capital allowances claimed (assumption 1) 20% x 4 years (360,000) Written down value 90,000 Sales proceeds 100,000 Balancing charge 10,000 Income arising from the sale of the office furniture Original cost of furniture 30,000 Capital allowances claimed (assumptions 1 and 2) 20% x 2 years (12,000) Written down value 18,000 Sales proceeds 10,000 Balancing allowance (8,000) Taxable income from sale 80,000 Taxable income attributable to Rikos (50%) 40,000 Assumptions: (1) A full charge was claimed in the year of purchase and none in the year of sale. (2) Accelerated allowances were claimed at 20% given that the purchase was made in 2012. Following the purchase of the KBM business, Sorolla SA (Sorolla) will employ Rikos on a full-time basis to run its office in Cyprus. The Cyprus office will constitute a fixed place of business, through which the business of Sorolla is wholly carried on i.e. Sorolla will have a permanent establishment (PE) in Cyprus. As such, any income attributed to the Cyprus office, mainly being the transportation which Rikos would undertake within Cyprus, will be considered as Cyprus source income and tax will be payable in Cyprus on the taxable profits at 12 5%. The 19
PE should be registered with the Cyprus Department of Taxation and submit an annual tax return. Any payments made by the PE to Sorolla will not attract any tax in Cyprus. (e) (f) It appears that Rikos will remain in Cyprus for more than 183 days in any tax year following the sale of the KBM business. Therefore, he will remain a Cyprus tax resident, and be taxed in Cyprus on his world-wide income. However, if Rikos is outside Cyprus for more than 90 days in the tax year, undertaking work for a foreign employer, i.e. Sorolla EU Transport SA, then the income attributable to those days will be exempt from Cyprus income tax (the 90-day rule). The exemption would most probably be calculated on a pro-rata basis, based on the number of days worked outside Cyprus. Kostis Capital gain on the disposal of the Limassol apartment Tutorial note: In order to ascertain the capital gains tax from the sale of the Limassol apartment, its base value should be calculated, given that it was acquired through an exchange in which rollover relief was claimed. Base cost of apartment following rollover relief Sale proceeds December 2008 300,000 Less indexed cost of 1 January 1980 value 40,000 x (111 43/34 96) (127,494) 172,506 Rollover relief 350,000 (300,000 + 50,000) 127,494 = 222,506 restricted to 172,506 Readjusted value of apartment for future disposal 350,000 172,506 177,494 Capital gain on disposal of the apartment Sale proceeds June 2014 420,000 Less indexed cost December 2008 177,494 (as above) x (118 03/110 04) (190,382) Less land transfer fees (21,166) 208,452 Less life-time exemption Residential dwelling exemption 85,430 less general exemption used (17,086) (68,344) Less loss brought forward (23,500) Capital gain 116,608 3 Marina (a) Corporation tax The consolidated profits of Cyprus Fashion Ltd (CFL) for 2013 show net profits before tax of 120,000, but this includes the profits of CFL s foreign branch in the UK, of 180,000, which are specifically exempt from Cyprus taxation. After removing the UK branch profits, the Cyprus operations made a tax allowable loss of 60,000, which will be carried forward and set off against the first available future profits. Special defence contribution In addition, given that Marina, the 100% shareholder of CFL is a Cyprus tax resident, the 2013 consolidated profits of 120,000 will be subject to the deemed distribution rules, whereby at least 70% of the after-tax accounting profits should be distributed within two years of the end of the tax year, i.e. by 31 December 2015. If no distribution occurs, then a deemed distribution of the same amount will arise, on which special defence contribution (SDC) at 17% will be imposed, i.e. 120,000 36,000 (the tax paid in the UK) x 70% x 17% = 9,996. Any actual dividend paid before 31 December 2015 will reduce the amount of the deemed dividend. (b) (i) Christos will come to Cyprus for a period of two weeks to cover the fashion festival as a self-employed professional photographer. He will therefore not be a Cyprus tax resident. The income he will receive for this work constitutes Cyprus source income and will be taxed through the special mode of taxation for professionals coming to Cyprus to undertake specific work. As such, Christos will be subject to income tax at the flat rate of 10% on his gross emoluments. CFL should withhold this income tax at source and remit it to the Department of Taxation (DoT) by the end of the month following the month in which it is withheld, together with a statement explaining how the income arose and showing how the tax was calculated. (ii) Christos is providing a service to CFL for the purposes of its business. As such, it is a business-to-business (B2B) service and the place of supply is where the recipient of the service is located, i.e. in Cyprus. CFL should apply the reverse charge mechanism to the value of the invoice, at the value added tax (VAT) standard rate of 19%. Given that the service received directly relates to CFL s taxable supplies, all of the input VAT can be claimed on the application of the reverse charge. 20
(c) (d) (e) (f) The gross amount of the royalty paid to Christos, a tax resident in Ildoria, is derived from sources within the Republic. As such, as per the Cyprus income tax legislation, withholding tax of 10% can be imposed on such income. This 10% rate will be the rate applied, regardless of the right provided under the double tax treaty to withhold tax at 15%. Therefore, CFL should withhold an amount of 1,000 ( 10,000 x 10%) from the royalty payment and remit this to the DoT in the month following the month in which it is withheld. Christos will declare the royalty income in Ildoria, which will impose a 20% flat rate of tax. From this, as per the terms of the double tax treaty, double tax relief will be given using the credit method. Therefore, the Ildorian tax payable will also be 1,000, i.e. 20% x 10,000 = 2,000 Ildorian tax less relief of 1,000 for the tax withheld in Cyprus. Christos will thus receive net income of 8,000 ( 10,000 1,000 1,000). If Gabs Gabs Ltd (GGL) sells the activities of its Cyprus branch to Themis Stok Leo plc (TSL), the branch will have gross income of 2,700,000, being the income from the sale. Part of the gross income will be allocated against the equipment, including the printing machines, which will result in a need for the branch to produce balancing statements. The final amount of net income, following any balancing adjustments, will be taxed at the corporation tax rate of 12 5%. There will then be further tax to pay in Ildoria, as it imposes a 20% tax rate on all types of income, but a credit for the Cyprus tax will be given against this Ildorian tax, as per the terms of the double tax treaty. If Gabs Gabs Ltd sells the activities of the branch to Themis Stok Leo plc, this will constitute a sale of a going concern, which is outside the scope of value added tax (VAT). As such, no VAT would arise on such a sale. The deemed dividend distribution rules will not apply to GGL, as GGL is not a Cyprus tax resident company. If Marina remains a Cyprus tax resident at the times when the distributions are made over the three years following the sale, the dividends will attract SDC at 17%. Dividend income is specifically exempt from income tax in Cyprus. Marina would receive the dividend gross from GGL, given that Ildoria does not impose any withholding tax on dividend payments. She would then need to pay the relevant SDC through self-assessment as follows: for any dividends received in the first six months of the tax year, payment should be made by 30 June of that year, and for any dividends received during the second part of the tax year by 31 December of that year. 4 Evgenia (a) Two companies are considered to be part of a tax group for group loss relief purposes where: one company is a 75% subsidiary of the other, either directly or indirectly, or both companies are directly or indirectly 75% held by a third company; the companies are Cyprus tax resident companies; and the companies have been part of the tax group for the entire tax year, except in the case of a company incorporated by its parent during the tax year. As such, Evgenia Electronics Holdings Ltd (EEH) is in a tax group with Barcyprus Holdings Ltd (BCH) (75% direct holding) and Darsales International Ltd (DSI) (75% indirect holding), as they are all Cyprus tax resident companies and have been part of the group for the entire tax year. EEH is not in a tax group with Farproduction Cyprus Ltd (FPC), given that EEH s indirect holding in FPC is only 56 25% (75% x 100% x 75%), which is less than 75%. BCH, DSI and FPC also fulfil all the necessary criteria and so will form a separate tax group. (b) (i) Special defence contribution (SDC) payable by FPC 31 December 2014 In 2012 FPC made after-tax accounting profits of 135,000. As FPC will not declare a dividend within two years, it will be subject to the deemed distribution rules on 31 December 2014, and be liable to pay SDC on the deemed distribution to the extent that its shares are beneficially held by Cyprus tax resident persons (individuals or companies). Polar Electrics Inc (PE), a non-cyprus tax resident, is the beneficial owner of 18 75% (75% x 25%) of FPC. The remaining 81 25% of beneficial ownership is held by Cyprus tax resident persons. Therefore, on 31 December 2014, FPC will be deemed to have distributed 94,500 ( 135,000 x 70%) and be liable to pay SDC on that deemed distribution of 13,053 ( 94,500 x 81 25% x 17%). This amount will be debited to the relevant shareholders accounts as follows: Evgenia 4,016 ( 13,053 x 25%/81 25%); and DSI 9,037 ( 13,053 x 56 25%/81 25%). 31 December 2015 On 31 December 2015, FPC is expected to declare an actual dividend equal to 70% of its after-tax profits, i.e. of 94,500. Of this amount, 23,625 ( 94,500 x 25%) will be payable to Evgenia, on which, as Evgenia is a Cyprus tax resident, SDC of 4,016 ( 23,625 x 17%) is attributable. However, as SDC has already been deducted through the deemed distribution rules, and debited to Evgenia s shareholder account, no further SDC will be withheld on the dividend payable on 31 December 2015. Evgenia will thus receive net dividends of 19,609 ( 23,625 4,016), with regards to her 25% direct holding in FPC. 21
(ii) The remaining actual dividend, equivalent to 70,875 ( 94,500 x 75%), is payable to DSI, of which 25% is beneficially owned by PE, a non-cyprus tax resident person. Again, because of the SDC previously withheld under the deemed distribution rules, no further SDC will be withheld from the dividends declared by FPC to DSI on 31 December 2015, and DSI will receive a net dividend of 61,838 ( 70,875 9,037). The SDC of 9,037 paid on the deemed distribution on 31 December 2014 (as discussed above) will also be attributable to the future dividends declared further up the group structure, in respect of the element of any dividend finally payable to Evgenia. As such, these dividends will not be subject to any further SDC. 31 December 2017 The remaining 30% of the after-tax profit of 40,500 ( 135,000 x 30%) is expected to be distributed on 31 December 2017. 25% of this, i.e. 10,125, will be attributable to Evgenia from which SDC at 17% should be withheld at source. Evgenia will thus receive a net dividend of 8,404 ( 10,125 x 83%). No SDC will be applicable to the remaining 75% of the dividend attributable to DSI of 30,375. This is because even though four years have passed from the year in which the profits arose, the exemption for dividends between Cyprus tax resident companies still applies, given that the dividend is received directly from the profits which gave rise to those dividends and not indirectly. FPC is the company which made the profits from which the dividend was declared, and it is FPC which is declaring the dividend (directly) to DSI. Note: Even if the above were not the case, 25% of the dividend is beneficially owned by non-cyprus tax resident persons, i.e. PE, and so would not attract any SDC. SDC payable by DSI DSI will receive gross dividends from FPC on 31 December 2015 of 70,875. DSI will immediately, on the same date, distribute this entire amount to BCH. No SDC applies to this distribution, because it is derived directly from a dividend on which SDC has already been imposed (as in (i) above). On 31 December 2017, DSI will receive a further dividend from FPC, relating to the remaining after-tax profits of 2012, of 30,375. Again, DSI will immediately, on the same date, distribute this entire amount to BCH. 25% of the amount, i.e. 7,594 ( 30,375 x 25%), is attributable beneficially to PE, which is a non-cyprus tax resident, and as such, no SDC applies. However, SDC will apply to the remaining amount of 22,781 ( 30,375 x 75%), because BCH is receiving dividends indirectly, for which four years have passed, from the end of the year in which the profits which gave rise to the dividend were made (being in 2012). Therefore, DSI should withhold and pay SDC at the rate of 17% to the Department of Taxation 3,873 ( 22,781 x 17%). (c) (d) When applying a reorganisation scheme, the following tax exemptions apply: corporation tax (including no balancing statements); special defence contribution; capital gains tax on the transfer of chargeable assets; stamp duty; land transfer fees on the transfer of any immovable property; and mortgage fees on the transfer of any mortgages between companies. Any FOUR only required In order to eliminate the minority shareholdings which exist below the level of EEH, PE and Evgenia should use a reorganisation scheme involving a share for share exchange, as this will avoid a charge to taxation. This is because BCH owns immovable property in Cyprus if such a reorganisation scheme is not used, a charge to capital gains tax would arise. With regards to PE s 25% minority holding in BCH, EEH should issue shares to PE in exchange for PE s 25% minority holding in BCH. With regards to the 25% minority shareholding which Evgenia has in FPC, the same principle applies, but the scheme will have to be repeated at each level in order to arrive at the desired result. Therefore, Evgenia should exchange her shares in FPC with shares in DSI, resulting in DSI owning 100% of FPC and Evgenia becoming a minority shareholder in DSI. This would be followed by another share-for-share exchange between BCH and Evgenia for the shares in DSI, and finally, by an exchange of shares between EEH and Evgenia for her shares in BCH. The exact percentage of holding exchanged at each level would depend on the comparative values of the capital of the two companies at the time of the exchange. Tutorial note: The reorganisation could have been carried out in a bottom-up approach instead of a top-down approach as above. The result would be the same and full marks were awarded in both instances. 22
5 Ramsy (a) The following badges of trade are used to analyse transactions to determine whether or not they are capital or trading in nature: 1. The subject matter of the transaction: This badge of trade looks at the type of asset which is being sold. In this case, the company, Gordon Ltd (Gordon), acquired land which was divided into building plots on which five houses were constructed. Gordon is now negotiating to sell these five houses. Of the five houses, two have been kept by the company to generate income, which is a characteristic of a capital transaction. The fact that they have been used for short-term rental as holiday accommodation is not significant, as the houses would over time be expected to appreciate in value, which would represent capital appreciation. However, three of the five houses are held as trading inventory which clearly signals a trade. It could thus be argued that the overall project of the five houses was a trading one. 2. The length of ownership: Gordon has held the land for several years, which is indicative of a capital transaction. A short period of ownership would indicate trading. However, during this time, work was undertaken on the land (see 4 below). The houses were finished five years ago and have continued to be held by Gordon during this time. A five-year period of ownership is not an indication of a trade, however, three of the houses are being held as available for resale. As a result, this badge of trade is not a strong indicator of one type of transaction over the other. 3. Frequency of similar transactions: Gordon has never carried out any similar transactions. If the selling of property was undertaken frequently, this would be an indication of a trade. The fact that this will be the first sale which Gordon has made does not give weight to trading. Under the circumstances, this is not a badge of trade which is particularly helpful in deciding whether the transactions are of a trading or a capital nature, especially given the importance of certain other badges of trade in the current situation. 4. Supplementary work: Supplementary work undertaken on an asset to make it more marketable and enhance its value is a strong indication of a trade. In the context of the current scenario, the land was purchased and was then divided into building plots, following which houses were constructed on the building plots. As such, there was significant supplementary work undertaken, which is a strong indication of a trade. 5. Circumstances responsible for sale: Gordon has found an investor to purchase all five houses. Following a five-year period during which three of the houses, which were held as being available-for-sale, were not sold, Gordon will sell all five houses at a profit and reinvest the funds in a similar project. There are no special circumstances to justify a capital transaction, whereas the circumstances do appear to justify a trading one. 6. Motive: Where one of the main motivations in a transaction is the desire to make a profit, this is a clear indication of a trade. From the outset, it can be argued that a profit motive existed and influenced Ramsy s actions. For example, the fact that Gordon submitted an application to divide the land into building plots in the year of purchase is a strong indication of an adventure in the nature of trade. In addition, the fact that Ramsy is proceeding with the sale of the houses, and is happy to do so given that this will result in a good profit, is also a strong indication of a trade. 7. Method of financing the acquisition of the asset: If a loan is used to purchase the property, this is an indication of trade, especially if the loan is repaid following the sale. In this case, although the purchase of the land and its subsequent division into building plots was financed by a loan from Ginger Ltd (Ginger), which is an indication of trading, the construction of the houses was financed by equity, which is an indication of a capital transaction. There are thus mixed indications from the method of financing, rendering this badge as not a particularly strong indicator for either case. 8. Knowledge of the owner: There is nothing to suggest that Ramsy, who is Gordon s sole director, has any knowledge of trading in land, given that his other company, of which he is also the sole director, trades in electrical goods, which cannot be seen as being a similar activity. Ramsy incorporated Gordon to try something different and, given that this is Gordon s first project, it can be assumed that Ramsy has little knowledge in trading in immovable property. 9. Method of acquisition: Certain forms of acquisition, such as through gift or inheritance, preclude the trading nature of the transaction as they indicate a lack of profit motive. In the present case, the land was purchased and will subsequently be sold. This can be taken as an indication of trading. 10. What happens with the sale proceeds: The use of the sale proceeds can sometimes be used to determine the intention behind whether a transaction is of a trading or of a capital nature. In the present case, the sale proceeds are to be reinvested to undertake a similar project, a clear indication of a transaction of a trading nature. Overall conclusion: There are several strong indicators that the transaction will be considered as an adventure in the nature of trade. The subject matter of the transaction combined with the supplementary work and method of acquisition, i.e. the purchase of land, following by its division into building plots, construction of the houses and holding of three of these as available-for-sale prior to the subsequent sale of all the houses (albeit after five years) indicates trading. The part use of debt to finance the project also reinforces this argument. When the profit motive is factored in, as well as the fact that the sale proceeds will be used to undertake a similar project, an adventure in the nature of trade is a strong conclusion. Tutorial note: There is no clear right or wrong overall answer as, in practice, a variety of possibilities exist, including for the Department of Taxation to accept that the profit on the sale of three of the houses will be taxed under corporation tax and the other two under capital gains tax. The purpose of the question was to allow candidates to display their understanding of each badge of trade. What is important is the intuitive explanation of each badge of trade, as applied to the scenario, and the resulting reasonable conclusion. 23
(b) The immovable property tax for the 2009 tax year would have been applied on the 1 January 1980 value of all the property which Gordon held on 1 January 2009. This would be the 1 January 1980 value of the five building plots held by the company. During 2009, five houses were constructed on the land, and these were completed at the start of 2010. This means that on 1 January 2010, Gordon held five building plots with five houses under construction. As such, the 2010 immovable property tax would be based on the 2009 value, with the addition of the 1 January 1980 value of the construction costs, which had been incurred up until 1 January 2010. Gordon should have estimated the value of the construction and submitted a declaration showing this value as an addition to the 2009 value of property which had been declared. 24
Professional Level Options Module, Paper P6 (CYP) Advanced Taxation (Cyprus) June 2015 Marking Scheme 1 Le Romstan Resort Ltd Available Maximum (i) Explanation that there is an ethical obligation to disclose any errors 1 Explanation that disclosing now: will make the case for fraud remote 0 5 If no fraud, tax authorities can only go back six years rather than 12 years 1 is likely to result in the imposition of less interest 0 5 3 3 (ii) (iii) (iv) Explanation that LRR has an obligation to deduct tax through PAYE on all employee emoluments, including the mandatory service charge, every month 1 Failure to do so will result in interest and penalties for late payment 1 Explanation that only 2014 is affected, given the previous years tax returns should have been submitted and the relevant tax paid 1 5 Advice to ascertain whether employees have correctly paid tax for previous tax years and the effect of not doing so for LRR 1 Advice to correct PAYE for 2014 during remaining months 1 Need to discuss the matter with the employees 0 5 6 5 Explanation that the service charge is consideration for a service, subject to VAT at the rate attributable to the main transaction 1 5 Explanation that the VAT element should be extrapolated from the charge and only the net amount attributed to employees as remuneration 1 5 Explanation that a request for a correction should be made to the tax authorities for the last six years, including that there will be no interest or penalties if this is accepted 1 5 Discussion of the potential consequences if the tax authorities do not accept as a genuine error 1 5 5 5 Explanation that Camilla is a related party and thus the lease terms should be at arm s length 1 Estimate of the market rate 0 5 Explanation of the possible courses of action and consequences 1 5 Explanation that no SDC applies to notional rental income 0 5 3 5 3 (v) Explanation of how SDC is payable 1 5 Calculations 1 2 5 2 (vi) Loan to Camilla Explanation that as Camilla is a related party, the debit balance creates a deemed benefit 1 Explanation of the value of the deemed benefit if a 5% rate is applied and if the loan is provided interest free 1 Explanation that LRR will need to pay Camilla s tax through PAYE 0 5 Explanation of the taxation on the interest income for LRR 1 Loan to Costas Explanation that no benefit arises on Costas 1 Explanation of the taxation on the interest income for LRR 0 5 Guarantee to Elvira Explanation that the guarantee provided to Elvira is as a result of her employment 1 Explanation that a benefit in kind (BIK) arises 0 5 Discussion of the value of the BIK re the guarantee 1 5 Explanation of the BIK if the guarantee needs to be used 0 5 8 5 7 25
Available Maximum (vii) Explanation of the place of supply for sales of goods without transport, concluding that Cyprus VAT should be charged 1 5 Explanation of the place of supply for sales of goods with transport 1 Explanation of the VAT treatment for a customer situated within the EU, including the possible obligation to register in the other EU country under the distance selling rules 2 5 Explanation of the VAT treatment of exports 1 6 6 Format and presentation of the memorandum 2 Effectiveness of communication 2 4 4 35 2 Rikos and Kostis (a) Correct explanation of how a partnership is taxed 2 2 (b) Explanation that transport is a B2B domestic transportation of goods service 1 Explanation of the VAT treatment of the service to Degas SA 1 5 Explanation of the VAT treatment of the service to OOO Kandinsky 2 5 5 5 (c) Calculation of the taxable income on the sale of the tradename 1 5 Calculation of the taxable income from the sale of the vans, including assumption 2 Calculation of the taxable loss from the sale of the office furniture, including assumption 2 Calculation of taxable income attributable to Rikos 0 5 6 6 (d) Explanation of why a PE exists 1 5 Explanation that Cyprus tax will be payable on Cyprus source income 1 5 Consequent Cypriot registration and filing requirements 1 4 4 (e) Explanation that Rikos is Cyprus tax resident 1 Explanation of the effect of the 90-day rule 2 3 3 (f) Calculation of base cost 2 5 Calculation of the capital gain on the sale of the apartment 3 5 5 5 25 26
3 Marina Available Maximum (a) Explanation that foreign branch profits are exempt from corporation tax 1 Explanation that CFL has a tax loss for 2013 which will be carried forward 1 Explanation of the effect of the deemed distribution rules, with calculations 2 4 4 (b) (i) Explanation that Christos is not a Cyprus tax resident person 0 5 Explanation that the income is Cyprus source income, subject to tax at the 10% flat rate 1 Explanation of CFL s obligation to withhold and remit the tax 1 5 3 3 (ii) Explanation that it is a B2B service and the place of supply rule 1 Explanation of reverse charge with a right of deduction 1 2 2 (c) Explanation that Cyprus withholding tax at 10% will apply 1 5 Explanation of the Ildorian tax position, including the tax credit per the double tax treaty 1 Statement of net income received by Christos 0 5 3 3 (d) Explanation of the taxation on the sale of the branch business 3 3 (e) Explanation of going concern being outside the scope of VAT 1 1 (f) Explanation that the deemed distribution rules will not apply 1 Explanation that Marina will be taxed under SDC not income tax 1 5 Explanation of no withholding tax 0 5 Explanation of how Marina would pay the SDC 1 4 4 20 27
4 Evgenia Available Maximum (a) Definition of a tax loss group 1 5 Explanation that EEH, BCH and DSI form one tax group 0 5 Explanation why FPC is not in a tax group with EEH 0 5 Explanation that BCH, DSI and FPC form a second tax group 1 3 5 3 (b) (i) 31 December 2014 Explanation that the deemed distribution rules apply 0 5 Explanation that PE s holding is not subject to SDC 1 Calculation of the deemed distribution, SDC payable and the allocations to shareholder accounts 1 5 31 December 2015 Explanation of the SDC treatment of the dividend to Evgenia, with calculation of the dividend amount 1 Explanation of the SDC treatment of the dividend to DSI, with calculation of the dividend amount 1 Explanation why no SDC is payable on future dividends paid from this DSI amount 1 31 December 2017 Calculation of the SDC payable on the dividend to Evgenia 0 5 Explanation of the SDC treatment of the dividend to DSI 2 8 5 8 (ii) Explanation of the SDC treatment of the 31 December 2015 dividend amount payable to BCH 1 Explanation of the SDC treatment of the 31 December 2017 dividend amount attributable to PE 0 5 Explanation of the SDC treatment of the remaining 31 December 2017 dividend to BCH, with calculations 1 5 3 3 (c) (d) List of taxes exempted FOUR only required, 0 5 marks each, maximum 2 2 Explanation of the use of a share-for-share exchange reorganisation scheme given that BCH holds Cyprus immovable property 2 Explanation of the scheme for PE s holding in BCH 0 5 Explanation of the scheme for Evgenia s holding in FPC 1 5 4 4 20 5 Ramsy (a) Correct identification of the badges of trade (0 5 marks each) 5 Explanation and application of each badge of trade to the scenario in the question (1 mark each) 10 Well argued overall conclusion based on the analysis of the badges of trade 2 17 16 (b) Explanation of the immovable property tax for 2009 1 Explanation of the immovable property tax for 2010 2 Explanation of the need to estimate and submit a valuation of the construction 1 4 4 20 28