Answers
Professional Level Options Module, Paper P6 (CYP) Advanced Taxation (Cyprus) June 2017 Answers 1 Memorandum To: Tax partner From: Tax assistant Date: 31 August 2016 Client: Anna Protos, Protos Properties and Investments Ltd (PPI) (i) (ii) (iii) (iv) Net monthly rental payable by Vita Supermarkets Ltd As Vita Supermarkets Ltd is a company, in accordance with special defence contribution (SDC) legislation it has to deduct the SDC payable on the rental payments at source. The amount of SDC is deducted from each payment of rent and is 3% on the gross rent reduced by 25%. In the case of PPI, rent is payable on a monthly basis, therefore Vita Supermarkets Ltd will deduct 90 ( 4,000 x 75% x 3%) from each month s rental, and pay the net amount of 3,910 to PPI. Anna should check the bank statements of PPI that this is the amount received every month. The SDC deducted should be paid by Vita Supermarkets Ltd to the Taxation Department by the end of the month following the month in which it was deducted. Vita Supermarkets Ltd must provide PPI with two six-monthly certificates of the SDC deducted each year, i.e. one for the period January to June and one for the period July to December. Tax implications of immediately withdrawing all available cash from PPI The provision of a loan or other financial facilities, except for balances arising from business transactions, provided by a company to a director or shareholder or spouse thereof or relatives thereof up to the second degree of kindred, is deemed to be a benefit on the recipient. The value of the deemed benefit is calculated each month on the outstanding balance of the financing facility (debit balance) at 9% per annum. The tax on the deemed benefit must be accounted for each month under the Regulations for the Deduction of Tax on Emoluments (PAYE). If Anna withdraws the money from PPI s bank account, this will be considered to be a loan to a shareholder or director, therefore she will be deemed to have a benefit in kind of 6,300 per year ( 70,000 x 9%). However, as Anna does not have any other income, no tax will be payable on this benefit. It is irrelevant that she will use part of this facility to repay the personal loan made to her father to invest in the shares of PPI. Cash flow forecast including taxes payable Schedule D shows a summary cash flow forecast for 2017. When referring to this schedule, the following should be noted: PPI will have to pay corporation tax for 2017 of 5,031 (per Schedule A). It has been assumed that the total tax will be paid by provisional tax declaration during 2017, i.e. 50% by 31 July 2017 and 50% by 31 December 2017. Depreciation has been added back, and the capital allowances available on the shop have been computed per the tax legislation, in Schedule B. As the building in question consists of a shop, it will be classified as a commercial building for the purpose of capital allowances. The legislation prescribes that the period of use of such a building is 33 years and, in the event that such a building is sold or transferred in any way, the new owner has the right to claim capital allowances for the remainder of the period of use on the original cost of construction of the building, excluding the cost of land. Where the building is bought from a developer, the cost of construction can include his profit on the initial sale of the building and a proportion of the land transfer fees which the developer incurred. The minimum deemed dividend distribution provisions of the SDC legislation require PPI to distribute at least 70% of its 2015 after tax accounting profits by 31 December 2017. Assuming that relief for PPI s 2014 loss is claimed in 2015, the minimum dividend which should be distributed has been computed in Schedule C as 20,037, which will result in net dividend income for Anna which is higher than the loan instalments for the year of 13,200. If the whole of this minimum dividend is distributed to Anna on 1 January 2017, then she will have net income from PPI of 3,431 available in her hands and PPI will have surplus cash for the year after payment of taxes and the dividend to Anna of 17,657. Tutorial note: It is equally acceptable to assume that PPI will only pay a net dividend of 13,200 in January 2017 and pay the balance required as per the SDC deemed distribution provisions in December 2017, in which case the SDC deducted at source will be payable to the Taxation Department by the end of January 2018. Market value of building for transfer purposes Anna is a related party to PPI, therefore, irrespective of what Anna declares as the sale price, the Taxation Department will assess whether the price declared is the price which PPI would have been willing to sell to a third party. There are two methods of valuation which can be used, the comparative method and the development method. 15
Comparative method The property to be valued is compared with the prices obtained for other similar properties in the same area and at the same date. This is the safer method because it is based on facts and on minimal assumptions, but it requires the maintenance of records and plans and other information. This method has been used by the Inland Revenue in many of its decisions. Property valuations performed by the Land and Surveys Department for all properties in Cyprus for 2013 are now available on the internet and can be easily obtained and compared. The Taxation Department uses this information regularly. Development method/residual method This is a theoretical method based on many assumptions and is used where there are no comparatives available. Under this method it is assumed that the property will be developed, e.g. if the value of the finished buildings is assumed to be 800,000, the cost to construct them 500,000, and the profit of the developer is 70,000, then the estimated value of the land will be 230,000 ( 800,000 less 570,000). The Inland Revenue only uses this method in certain cases. In Anna s case, the valuation will definitely be affected by the fact that the property is rented and so has a regular stream of income. SDC implications Whenever a company disposes of an asset (immovable or movable) to a (physical person) shareholder or to a relative of such shareholder up to the second degree of kindred or spouse, by way of gift or at a price which is lower than the market value, the difference between the market value and the value at which the asset is transferred will be deemed to be a distribution of a dividend. The exception to this provision, in respect of an asset which has been acquired by a company by way of gift from an individual shareholder thereof or from a relative of that individual up to the second degree of kindred or from his spouse, will not apply in Anna s case because PPI acquired the building from a third party, the furniture sales company. Schedule A Corporation tax due for 2017 Accounting profit (same as 2015) 34,460 Add: Immovable property tax 1,260 Company annual registration fee 350 Depreciation 9,345 10,955 45,415 Less: Capital allowances (Schedule B) (5,165) Taxable profit for year 40,250 Corporation tax payable at 12.5% 5,031 Schedule B Capital allowances on building Total income for developer 750,000 Less: Cost of land (210,000) Less: Construction cost (450,000) Profit on project 90,000 Profit relating to construction cost (450,000/660,000 x 90,000) 61,363 Total construction cost (excluding the cost of land) with related profit 511,363 Cost per unit eligible for capital allowances (511,363/3) 170,454 Capital allowances for PPI per year (170,454/33) 5,165 16
Schedule C Minimum dividend payable by December 2017 out of 2015 profits for SDC deemed distribution purposes Accounting profit for 2015 34,460 Less: Corporation tax for 2015 (Corporation tax for 2017 as computed in Schedule A, adjusted for saving from 2014 loss brought forward (5,031 (2,200 x 12.5%)) (4,756) Less: SDC deducted at source (90 x 12) (1,080) Accounting profits after tax for deemed distribution purposes 28,624 Minimum dividend payable (70% x 28,624) 20,037 SDC at 17% thereon 3,406 Net dividend in the hands of Anna 16,631 Loan instalments (12 x 1,100) 13,200 Excess over loan instalments 3,431 Schedule D Summary cash flow projection for 2017 Cash inflows Rental income ((12 x 4,000) 1,080) 46,920 Total inflows 46,920 Cash outflows Total expenses excluding depreciation (13,540 9,345) 4,195 Corporation tax for 2017 (Schedule A) 5,031 Net dividend payment from 2015 profits (Schedule C) 16,631 SDC on net dividend payment (Schedule C) 3,406 Total outflows 29,263 Surplus 17,657 2 Paula (a) (b) Residence of a company The term resident in Cyprus when applied to a company means a company whose management and control is exercised in Cyprus. 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 the real management and control of a company is exercised which may sometimes, in fact, 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. But where the company s central office is located or where the annual general meetings are held is not a material deciding factor, neither is the country of incorporation. The tax implications of each option for depositing the money Option 1 Personal deposit with a local bank Paula is tax resident and domiciled in Cyprus and therefore will be taxed on her worldwide income in Cyprus. However, interest on deposit accounts received by any taxable person (individual or company) is exempt from income tax in Cyprus but taxable under the provisions of the special defence contribution (SDC) legislation. The bank will deduct 30% SDC at source every time it makes a payment of interest; this deduction will be shown as a transaction on the deposit account. The bank will pay the SDC to the Taxation Department by the end of the month following the month of deduction. The bank is not required by law to give to Paula a certificate of SDC deducted but Paula can request the bank to provide such a certificate if required. Option 2 Personal deposit with a bank in Farland As in Option 1 above, the interest income will be taxable in Cyprus under the SDC legislation at the rate of 30%. It is irrelevant that the interest is paid by an overseas bank. Paula will have to make an SDC declaration twice a year for the interest income she receives from abroad without deduction of Cyprus SDC at source one covering the period January to June, and the second for the period July to December. The declarations must be filed and the tax paid within one month from the end of the relevant six-month period. 17
Even though there is no double tax treaty between Cyprus and Farland, Cyprus will grant double tax relief on a unilateral basis under the credit method. The Cyprus tax law provides specifically that the foreign tax in a foreign country on income arising in that country will be credited against the Cyprus tax on the same income. The amount of the credit must not exceed the amount of Cyprus tax payable on the foreign income, where this is computed in accordance with the provisions of the Cyprus law and charged to tax at a rate ascertained by dividing by the amount of the total income, the tax chargeable on the total income of the person entitled to the foreign income. The foreign income is inclusive of any foreign tax suffered. As a result, Paula will be allowed to deduct the whole of the 10% tax suffered in Farland as this is less than the SDC rate of 30%. Option 3 Deposit in the name of Tokos Ltd with a Cyprus bank Tokos Ltd is a Cyprus tax resident company because its sole director, Paula, is a Cyprus tax resident. The interest income is exempt from corporation tax, but SDC will be deducted at source at 30% from the interest income received by Tokos Ltd, in the same way as for Paula in Option 1. The interest income, however, will be part of the after-tax accounting profits of Tokos Ltd for SDC deemed dividend distribution purposes, because Paula, who owns 100% of the shares, is tax resident for SDC purposes. For SDC purposes, companies are deemed to have distributed 70% of their accounting profits after corporation tax at the end of the two years from the end of the year to which the profits relate. This deemed distribution is reduced by any actual dividends paid. Based on the information provided, the gross interest for one year on the deposit will be about 150,000 ( 5 million x 3%), so SDC of 45,000 ( 150,000 x 30%) will be deducted at source. This will mean that Tokos Ltd s after-tax accounting profits will be higher by 105,000, and (assuming that the company is not loss making) Tokos Ltd will be required to pay an additional minimum dividend of 73,500 ( 105,000 x 70%) and SDC on this dividend of 12,495 ( 73,500 x 17%). According to the Cyprus legislation, the SDC on the dividend should be deducted at source by Tokos Ltd and paid to the Taxation Department by the end of the month following the month in which it is deducted. Option 4 Deposit in the name of Tokos Ltd with a bank in Farland As in the case of Option 2, Tokos Ltd will have to file a declaration to pay the SDC due on the interest income and be eligible for double tax relief on the 10% tax paid in Farland against the SDC payable. As in the case of Option 3, the interest will be exempt from corporation tax but will form part of Tokos Ltd s taxable profits for SDC deemed dividend distribution purposes. Option 5 Deposit made by Tokos Overseas with a bank in Cyprus As Paula will be the only director of Tokos Overseas, the company will be Cyprus tax resident, therefore the tax implications will be the same as for Tokos Ltd in Option 3, i.e. the Cyprus based bank will deduct SDC at 30% at source and the interest income will be caught by the SDC deemed dividend provisions. Option 6 Deposit made by Tokos Overseas with a bank in Farland As Tokos Overseas will be Cyprus tax resident, the tax implications will be the same as for Tokos Ltd in Option 4. Option 7 Tokos Overseas not considered to be a tax resident of Cyprus If the sole director of Tokos Overseas is a non-cyprus resident and that director exercises management and control over the activities of the company, without the involvement of Paula, then Tokos Overseas will be a non-cyprus tax resident company, so outside the scope of Cyprus tax. In this case, no SDC will be payable on the interest income received from the Cyprus bank by Tokos Overseas, nor will the SDC deemed dividend distribution provisions apply to the company. However, as Paula is a tax resident of Cyprus, any dividend she receives from Tokos Overseas, although exempt from income tax, will be subject to SDC at the rate of 17%. As in Option 2, Paula will have to declare any dividend income she receives by means of SDC declarations every six months. (c) Loan by Tokos Overseas to Pare-Fere Ltd Pare-Fere Ltd and Tokos Overseas will be considered to be related companies, because they are 100% owned by husband and wife, Robert and Paula. It does not matter that Paula is not a shareholder, director or employee of her husband s company, or vice versa. For income tax purposes, transactions between related parties should be made on an arm s length basis. As the company had previously defaulted on a bank loan, it would be reasonable for a new lender to ask for a higher interest rate, as it would be taking on a higher risk. It can probably be argued that the increased interest rate of 8% reflects the arm s length rate, given these circumstances. As Tokos Overseas is not Cyprus tax resident and so not subject to tax in Cyprus, Pare-Fere Ltd can pay the interest due to it without deduction of any SDC at source, and treat the interest expense for tax purposes in the same way as it did the interest on the local bank loan. A more in-depth investigation of the facts of the loan transaction between Tokos Overseas and Pare-Fere Ltd may raise questions about the tax residency status of Tokos Overseas. It could be argued that, even though Tokos Overseas has a non-resident director, the decision to grant the loan was made by Paula and that, as a matter of fact, the management and control of the company is exercised by Paula. If this is held to be the case, Tokos Overseas will be considered Cyprus tax resident, because Paula is resident in Cyprus, with all the tax implications outlined above for Options 5 and 6. 18
3 K-Parts Ltd (a) (b) (c) (d) Sale of special engine to Mr A The supply of the engine is a local supply of goods which is not exempt from value added tax (VAT). There is no provision in the legislation for a reduced or zero rate for local supplies of engines, therefore VAT should be charged at the rate of 19%. The basic tax point for goods is the date on which the goods are supplied or the customer collects them or the date the goods are made available to the customer. An invoice should be issued within 14 days from the basic tax point. A company can apply for an extension of the 14-day period if this is required by the nature of its business. A tax point occurs if an invoice is issued or payment is received wholly or partly before the date of the basic tax point, in which case this earlier date takes precedence over the basic tax point, and VAT should be accounted for on this date. For the sale of the engine, a tax point occurred when the prepayment was received. The prepayment is deemed to be inclusive of VAT, so the VAT due is 399 ( 2,500 x 19/119). K-Parts Ltd should include this amount on the VAT return covering the quarter in which the prepayment was received. The basic tax point will be triggered when the engine is actually supplied to Mr A, and an invoice should then be raised for the whole sales amount within 14 days. The invoice will show total VAT of 1,900 but, as 399 has already been accounted for on the prepayment in a previous VAT quarter, the net amount of 1,501 will be included in the quarterly VAT return relevant to the date of the invoice (provided it was issued within 14 days of the supply). The final settlement of the amount due by Mr A three months after delivery is simply the settlement of a debt and will not have any VAT implications. Supply of gearbox to B Ltd The supply of the gearbox is a supply of goods, taxable at the standard rate of VAT of 19%. According to the VAT legislation, VAT is chargeable on the supply of goods made in the Republic. A supply of goods is made in the Republic only if the goods are in Cyprus at the time of supply. In this case, the goods are not in Cyprus at the time of supply and will never come to Cyprus. The transaction is therefore outside the scope of Cyprus VAT, and K-Parts Ltd should not charge VAT on the transaction. The fact that the goods will be invoiced to a local customer (B Ltd) is irrelevant. Mail order sales K-Parts should obtain sufficient details from customers so as to be able to identify whether they are within the European Union (EU) and, if so, whether they are purchasing the parts for private or business use. Customers can then be separated into the following categories for VAT purposes: Mail order to non-eu customers business and non-business The sale and dispatch of goods to customers outside the EU is an export, irrespective of the purpose for which the parts are purchased and, as a result, is zero rated for VAT. Evidence of dispatch should be kept by K-Parts. Mail order to EU-VAT registered business customers The sale of goods to customers within the EU is an intra-community sale and is zero rated provided the customer is registered for VAT in their own member state. K-Parts Ltd should obtain the VAT details of its EU business customers, and check the system available on the internet for the verification of VAT numbers of businesses in the EU. K-Parts Ltd should record the customer s VAT number on the invoice, and classify the sale as an intra-community sale. Again evidence of dispatch should be kept. Mail order to EU non-business customers and non-vat registered business customers The sale of goods by mail order to EU non-business customers and to EU business customers who are not VAT registered (or who fail to provide a valid VAT number) is subject to Cyprus VAT at the standard rate of 19%. K-Parts Ltd should also monitor the sales made to each EU country on an annual basis as, if the distance sales threshold of that EU country is exceeded, K-Parts Ltd should register for VAT in that country and charge VAT at that country s local rate. As some countries in the EU have a VAT rate lower than Cyprus, such local registration may be beneficial to non-vat registered customers in those countries as the total cost of the goods to them will be lower. Consultancy services from Paul Where taxable persons who are established in Cyprus receive services from overseas, the place of supply for VAT is where the recipient of the services is established. The recipient is required to account for VAT in respect of these services in Cyprus, under the reverse charge procedure. No tax need be accounted for on such services which are zero rated or exempt. The services provided by Paul are neither exempt nor zero rated, therefore K-Parts Ltd must account for VAT on the services using the reverse charge method. K-Parts Ltd will treat Paul s invoice as both the sale and purchase of a service at the same time, and account for both output VAT and input VAT in Cyprus on the invoice. For example, if Paul raises an invoice for 5,000, K-Parts Ltd will increase its input VAT by 950 and, at the same time, increase its output VAT by 950, resulting in a net VAT effect of 0 in the relevant VAT quarter. Paul s services relate to the inspection of used parts and machines 19
K-Parts Ltd might wish to purchase for resale, so are in connection with the taxable supply of parts, in which case all the input VAT will be recoverable. Tutorial note: A business which is not registered for VAT and receives services from abroad to a level that they exceed the Cyprus registration threshold of 15,600 will have to register for VAT as it is deemed to be making taxable supplies to itself. Paul supplies the services of a professional but he is not supplying these services in Cyprus. Therefore, no withholding tax should be deducted at source by K-Parts Ltd in accordance with Cyprus income tax legislation. Tutorial note: The case should be differentiated from that of a professional who performs their services in Cyprus. 4 Zimia Ltd (a) Sales of shares by Andri to Maro The profit from the sale of company shares is specifically exempt from tax in Cyprus unless the relevant company owns immovable property in Cyprus, when the sale of the shares is treated as an indirect sale of the immovable property at its current market value and for the relevant percentage of the shares being transferred. Zimia Ltd does not own any immovable property in Cyprus, therefore no tax will be payable on the disposal of Andri s shares. (b) Effect of loss relief provisions for the years 2009 to 2015 According to the Cyprus tax legislation, losses can only be carried forward and relieved against future years profits. They can never be carried back and relieved against previous years profits. Losses can only be carried forward subject to the company having their financial statements audited (regardless of their level of turnover). The amounts provided for Zimia Ltd have been taken from its audited financial statements, so this condition is satisfied. No amount of loss may be allowed in respect of any year of assessment for which a company delays the submission of its tax return for such year for a period exceeding six years from the date when the company ought to have submitted the accounts for the said year. There is nothing to indicate that Zimia Ltd has delayed the submission of its tax returns, therefore it can be assumed that this condition is satisfied. Starting from the year of assessment 2012, there is a restriction of five years for the losses brought forward, i.e. the losses eligible for deduction in the year of assessment 2012 will be restricted to the losses made in the five years 2007 to 2011 inclusive, and similarly, for all subsequent years of assessment. In 2014, Zimia Ltd can only benefit from the losses made from 2009 to 2013. Any losses remaining unutilised from 2008 cannot be used and are lost. Change of shareholders and/or change of business A loss made by a company cannot be carried forward in the following cases: (i) if within any three-year period there is a change in the ownership of the shares of a company and a substantial change in the nature of the business of the company, or (ii) if at any time since the scale of the company s activities has diminished or has become negligible and before any substantial reactivation of the business there is a change in the ownership of the company s shares, no loss which has been incurred before the change in the ownership of the shares of the company can be carried forward in the years subsequent to such change. A change in the ownership of the shares of a company occurs: (i) if a person acquires more than 50% of the ordinary share capital of the company, or (ii) if two or more persons jointly or severally acquire at least 5% of the ordinary share capital of the company so that all together they acquire more than 50% of the ordinary share capital of the company. There is no change in the ownership of the shares of the company if the change involves a gift made from a parent to a child, between spouses or relatives up to the second degree of kindred, or to a limited company all the shareholders of which are and continue to be members of the disposer s family for a period of five years after such gift. The purchase of the shares by Maro from her business partner Andri involved only 40% of the Zimia Ltd shares and there was no change in the nature of the business of the company, so the carrying forward of losses was not affected by this transaction. The transfer of 60% of the company to members of Maro s family by way of gift does not affect the carry forward of losses as they are all members of the same family and, even if they were not, there was no change of business. In the case of the sale of shares to Fashionshark Ltd, the holding sold was more than 50% but, again, there was no change in the nature of the company s business. Although Zimia Ltd is a manufacturer and wholesaler of women s clothing, the opening of a retail shop in Athens would not represent a significant change of business. 20
Permanent establishment s losses In accordance with the legislation, if a company suffers a loss from a permanent establishment (PE) abroad, then this loss can be deducted from the taxable profits of the company in the same year. To the extent that the loss cannot be fully utilised in that year, it can be carried forward and utilised against the taxable profits of future years, subject to the five-year time limit. Therefore, the PE loss from the shop in Athens of 7,000 can be deducted from the 2015 profits, and the balance of 2,000 can be carried forward and utilised against future profits. 2009 Taxable loss (20,000) Losses brought forward from 2008 (100,000) Losses carried forward (120,000) 2010 Taxable loss (10,000) Loss brought forward from 2008 (100,000) Loss brought forward from 2009 (20,000) Losses carried forward (130,000) 2011 Taxable profit 40,000 Loss brought forward from 2008 (40,000) Taxable profit for year 0 Losses carried forward 2008 100,000 Less utilised against 2011 profits (40,000) 60,000 2009 20,000 2010 10,000 Losses carried forward 90,000 2012 Taxable profit 20,000 Loss brought forward from 2008 (20,000) Taxable profit for year 0 Losses carried forward 2008 100,000 Less utilised against 2011 profits (40,000) Less utilised against 2012 profits (20,000) 40,000 2009 20,000 2010 10,000 Losses carried forward 70,000 2013 Taxable profit 5,000 Loss brought forward from 2008 (5,000) Taxable profit for year 0 Losses carried forward 2008 100,000 Less utilised against 2011 profits (40,000) Less utilised against 2012 profits (20,000) Less utilised against 2013 profits (5,000) 35,000 no longer available (lost) (35,000) 0 2009 20,000 2010 10,000 Losses carried forward 30,000 21
2014 Taxable profit 55,000 Loss brought forward from 2009 (20,000) Loss brought forward from 2010 (10,000) Taxable profit 25,000 Losses carried forward 2009 all utilised against 2014 profits 0 2010 all utilised against 2014 profits 0 Losses carried forward 0 2015 Taxable profit 5,000 Less current year loss from permanent establishment in Athens (5,000) Taxable profit 0 Loss carried forward for the next five years (7,000 5,000) 2,000 (c) Group loss relief Losses may be surrendered by a company resident in the Republic (the surrendering company ) and, on the making of a claim by another company resident in the Republic (the claimant company ), may be allowed to the claimant company by way of relief from corporation tax. Two companies are deemed to be members of a group if one is a 75% subsidiary of the other or both (each one separately) are 75% subsidiaries of a third company. Set off of group losses is allowed in a case where the surrendering company and the claimant company are both members of the same group for the whole of the year of assessment. Tutorial note: From the year 2012, a set off of losses may be made even though a member of the group which is a company incorporated by its holding company is not a member for the whole year. The losses surrendered have to be losses of the same year. Losses brought forward by one group company cannot be used by another group company in a future year. Zimia Ltd was an 80% subsidiary of Fashionshark Ltd for the whole of the year 2016, therefore it can surrender all or part of its losses to Fashionshark Ltd. Fashion Holdings Ltd only owns 64% of Zimia Ltd (80% of 80%), therefore it cannot benefit from the losses made by Zimia Ltd. Fashionshark Overseas Ltd is tax resident in Notaxland, a non-eu country, whereas Fashionshark Ltd and Fashion Holdings Ltd are both Cyprus resident companies. The losses of Fashionshark Overseas Ltd will not be available for relief against the profits of either Fashionshark Ltd or Fashion Holdings Ltd because the losses of a non-eu resident company cannot be surrendered to a resident company. Tutorial note: Following an amendment to the legislation in 2015, a company which is tax resident in an EU state other than Cyprus can surrender losses to a Cyprus tax resident company provided the 75% control criteria is satisfied and the non-resident company cannot utilise the losses in the other EU state. 5 Stolos group (a) Taxation of profits of each company in the Stolos group Varka Local Ltd Profits from the operation of a ship under a Cyprus flag (a Cyprus registered ship) are exempt from tax (under the Merchant Shipping (Fees and Taxing Provisions) Law). This exemption covers the following types of income: (i) profits derived from the use/chartering out of ships; (ii) interest income relating to the working capital of the company; (iii) profits from the disposal of qualifying ships; (iv) dividends received from the above profits at all distribution levels; (v) profit from the disposal of ship-owning companies and its distribution. Therefore the income of Varka Local Ltd will be exempt from corporation tax and special defence contribution (SDC), i.e. the normal tax system, but will instead be subject to the tonnage tax system (TTS). Tutorial note: The application of the tonnage tax system is compulsory for Cyprus flag ships and optional for non-cyprus flag ships, charterers and ship managers. 22
Varka EU Ltd Varka EU Ltd will not own a ship under the Cyprus flag, therefore it will not be automatically exempt from taxation. As a Cyprus tax resident company, Varka EU Ltd will be taxed in the same way as any other company in Cyprus, irrespective of the fact that it is involved in the shipping business. However, Varka EU Ltd has the option to elect to be subject to TTS (under the Merchant Shipping (Fees and Taxing Provisions) Law 44(I)/10). If it does so elect, Varka EU Ltd will be exempt from the normal tax system, and will be taxed in the same way as Varka Local Ltd. If a company elects to enter TTS, it must remain in the system for at least ten years, unless it has a valid reason to exit such as the disposal of its vessels and the cessation of its activities. Varka Overseas Ltd Varka Overseas Ltd will not be tax resident in Cyprus, therefore, according to the basic rule, the company will be exempt from tax in Cyprus. However, the profits from operating a ship in respect of fares or freight for passengers or goods or mail shipped in the Republic are specifically subject to tax in Cyprus under the Income Tax Law, irrespective of the existence of a permanent establishment and/or tax residency. Varka Overseas Ltd will have to file a certificate from the taxing authority of the country in which it has its principal place of business. The certificate must state: (i) that the owner of the ship has furnished, to the satisfaction of that authority, an account of the whole of the business; and (ii) the ratio of the profits or benefits for the relevant accounting period to the gross income of the owner of the ship for that period, as computed according to the income tax law of that country, after deducting interest on any monies borrowed and employed in acquiring the profits or benefits. Stolos Ship Management Ltd Stolos Ship Management Ltd will be considered to be a ship management company. Ship managers are subject to the normal tax system. However, a ship manager has the option to elect to be taxed under TTS, in the same way as a ship owner, and so become eligible for exemption from corporation tax and SDC in respect of its ship management profits, and interest income on bank accounts used in paying ship management expenses. In order to qualify, ship managers must satisfy the following additional requirements: (i) Maintain a fully-fledged office in Cyprus with personnel sufficient in number and qualifications. (ii) At least 51% of all onshore personnel must be community citizens. (iii) At least two-thirds of the total tonnage under management must be managed within the community (any excess over one-third is taxed under corporation tax). Stolos Ltd Dividends received by Stolos Ltd from the rest of the group companies will be exempt from corporation tax and SDC irrespective of whether the company paying the dividend does or does not benefit from the shipping or ship management exemptions. Profit from the sale of the shares of one of the subsidiary companies will also be exempt from tax. As Stolos Ltd s shareholders are not tax residents of Cyprus, there will be no SDC on dividends paid to them by the company. (b) Tax residency of foreign individuals working for Stolos Ship Management Ltd For income tax purposes, an individual (including a foreign employee who relocates to Cyprus to work) is considered resident in the Republic, if he or she stays in the Republic for a period or periods exceeding in aggregate 183 days in the year of assessment. Resident persons are liable to income tax in respect of their worldwide income, while non-resident persons are subject to tax only in respect of certain Cyprus-source income. If an individual is considered tax resident for income tax purposes, they may also be considered resident for special defence contribution (SDC) purposes, in which case SDC will be payable at 30% on their worldwide interest income, and 17% on their worldwide dividend income. To be liable under the SDC legislation, an individual must be domiciled as well as tax resident (a recent addition to the legislation). Individuals who have not been tax resident for 17 out of the last 20 years before the tax year in question are not considered to be domiciled in Cyprus. It is unlikely that Stolos Ship Management Ltd s foreign employees will be considered Cyprus domiciled, thus they are unlikely to be liable to SDC on their worldwide interest and dividends. Each case has to be considered separately, as there may be foreign employees who have been resident in Cyprus before. Dividend and interest income of individuals is specifically exempt from income tax in Cyprus. 23
(c) Double tax treaty A double tax treaty (DTT) is an agreement made by two sovereign countries (referred to as the contracting states) with the main object of avoiding or minimising territorial double taxation of passive income like taxation of interest, dividends and rents, and active income like salaries and profits from a business. The DTT sets out rules on how and where income will be taxed in order to avoid the same income being taxed in both the country of source and the country of residence of the recipient. Such agreements have the force of law and supersede any existing local legislation, i.e. if there is a conflict, the DTT provisions prevail. In the case of the Stolos group, its ships will operate in several different countries, which its employees will visit during any tax year, and the employees of the group relocating to Cyprus may be considered a tax resident of both Cyprus and the country where they were tax resident before their relocation in the same tax year. A DTT between Cyprus and these other countries will help to minimise their tax burden. With regards to withholding taxes, most DTTs provide for a rate lower than the normal local rate to be levied on income (interest and dividends) earned from securities owned by a non-resident of the state, who is resident in the other contracting state. 24
Professional Level Options Module, Paper P6 (CYP) Advanced Taxation (Cyprus) June 2017 Marking Scheme Available Maximum 1 (i) Vita is a company, therefore SDC is deducted at source 1 Basis of charge and calculation 1 5 Date of payment of SDC to Taxation Department 0 5 Provision of certificates to PPI 1 4 4 (ii) Recognition of withdrawal as a loan to a shareholder/director 1 Explanation of legislation 1 Effect on Anna no tax payable 1 Irrelevance of purpose to which funds are applied 0 5 3 5 3 (iii) Computation of 2017 corporation tax payable (Schedule A) Add back of non-allowable expenses (0 5 each) 1 5 Deduct capital allowance (as calculated in Schedule B) 0 5 Application of corporation tax rate 12 5% 0 5 Assumption re method and dates of payment stated 1 Computation of capital allowance on building (Schedule B) Exclude cost of land 1 Total cost for capital allowances 2 Calculation of annual capital allowance 0 5 Explanation of basis of calculation 2 Computation of 2015 minimum dividend Deduct corporation tax for 2015 profits 1 Take account of 2014 losses brought forward 1 Deduct SDC on rent deducted at source 1 Application of minimum dividend percentage 70% 0 5 SDC rate on dividend 17% 0 5 Comparison to minimum required for instalments/identification of excess available to Anna 1 Cash flow projection (Schedule D) Rental income net of SDC deducted 1 Cash outflows (4 items, 1 mark each) 4 Comments on surplus funds available 1 20 19 (iv) Anna and PPI related, Taxation Department will determine an arm s length price 1 Description of comparative method 1 Description of development/residual method 1 Valuations available on internet by land and surveys 0 5 Valuation will be effected by existence of a rental income stream 0 5 Explanation of SDC provisions for asset transfers to related parties at an undervalue 2 6 5 Format and presentation of the memorandum 1 Clarity and effectiveness of communication 2 Logical flow of calculations 1 4 4 35 25
Available Maximum 2 (a) Management and control principle and criteria used 2 Discussion of control in fact 1 Not location of central office or AGM, or place of incorporation (0 5 marks each, maximum 1) 1 4 4 (b) Option 1 Exempt from income tax 0 5 Taxable under SDC at 30% 0 5 Explanation of deduction of SDC at source 1 Date of payment to Taxation Department by bank 0 5 No automatic certificate by bank but only on request 1 Option 2 Taxable under SDC at 30% 1 Six-monthly returns, one month from the end of each period 1 5 Unilateral double tax relief for 10% tax suffered at source 1 5 Option 3 Tokos Ltd a Cyprus tax resident company 0 5 Taxable under SDC at 30% no corporation tax 1 Part of accounting profits for SDC minimum dividend purposes 1 Explanation of deemed dividend effect, with figures 2 Option 4 File six-monthly returns and DTR as in Option 2 1 Minimum dividend effect as in Option 3 1 Option 5 Tokos Overseas a Cyprus tax resident company 1 Same as in Option 3 1 Option 6 Same as in Option 4 1 Option 7 Tokos Overseas not tax resident in Cyprus, outside the scope of Cyprus taxation 1 No charge to SDC on interest received 0 5 Deemed distribution rules not applicable 0 5 SDC is payable by Paula on dividends received at 17% 1 Six-monthly reporting required 0 5 20 5 17 (c) Two companies are related, with reason 1 Transactions should be at arm s length 0 5 Increased rate not unreasonable/discussion 1 5 No deduction of SDC at source by Pare-Fere Ltd 0 5 Interest deduction available as for bank loan 0 5 Decision to make the loan may affect Tokos Overseas residence status/discussion 1 5 5 5 4 25 26
Available Maximum 3 (a) Supply of a good/19% 0 5 Basic tax point definition 1 Need for invoice to be issued within 14 days 1 Actual tax point definition 1 Application to prepayment, including identification of actual tax point, VAT amount and inclusion in quarter s VAT return 2 Application to delivery, including identification of basic tax point, need for invoice within 14 days for total amount and deduction of VAT on prepayment already accounted for 2 No VAT consequences of balancing payment 1 8 5 8 (b) Supply of a good/19% 0 5 Place of supply of goods definition 1 Conclude goods not in Cyprus thus outside scope 1 Irrelevant that it is to a local customer 1 3 5 3 (c) Non-EU business and non-business customers zero rated 1 EU VAT registered business customers, inter-community supply, no VAT 1 Need details and must check VAT registration 1 EU non-business/non-vat registered/no VAT number supplied, Cyprus VAT at 19% applies 1 5 Need to monitor level of sales and register abroad if distance selling limit exceeded, and charge that country s VAT rate 1 VAT rate may be lower therefore beneficial in some cases 0 5 6 5 (d) Place of supply of services is Cyprus 1 Reverse charge procedure applies 1 Explain why no net effect on K-Parts Ltd s VAT due 1 Professional service but not in Cyprus thus outside scope of income tax no deduction at source 2 5 4 20 27
Available Maximum 4 (a) Profits from sale of shares specifically exempt from tax unless company owns immovable property when treated as an indirect sale 1 5 Does not own immovable property, so no tax implications 0 5 2 2 (b) Explanations: No carry back allowed 0 5 Only if financial statements audited 0 5 Tax return submission not delayed by more than six years 0 5 Losses only carried forward for five years 1 Change of shareholders/business rules/definitions 3 Application to Zimia Ltd in 2011, 2012 and 2013 (1 mark each) 3 Treatment of permanent establishment losses 1 Calculations: Carry forward of losses for years 2009 and 2010 (0 5 each) 1 Utilisation of 2008 losses in 2011, 2012 and 2013 (0 5 each) 1 5 Identification of 2008 losses no longer available/lost 0 5 Utilisation of 2009 and 2010 losses in 2014 0 5 Utilisation of permanent establishment losses in 2015 and identification of unutilised losses carried forward 1 14 12 (c) Group definition for loss utilisation 75%/member for whole year 2 Only current year losses available not losses brought forward from previous years of other group companies 1 Fashionshark Ltd can benefit as more than 75% 1 Fashion Holdings Ltd cannot benefit as less than 75% 1 Fashionshark Overseas Ltd s losses not available as non-resident of Cyprus and non-eu 1 5 6 5 6 20 28
Available Maximum 5 (a) Varka Local Ltd: Profits from the operation of a ship under a Cyprus flag exempt 1 Definitions of exempt income for this purpose (0 5 marks each, maximum) 2 Varka EU Ltd Normal basis 0 5 Option for tonnage tax/must remain for ten years 2 Varka Overseas Ltd Non-resident, exempt under basic rules 0 5 Special rules apply to profits from ship operation 1 Certification requirements explained 1 5 Stolos Ship Management Ltd Normal basis 0 5 Option for tonnage tax as for ship operators 1 Additional requirements (0 5 marks each) 1 5 Stolos Ltd Dividends exempt regardless of tax basis applying to payee 1 Sale of shares exempt 0 5 No SDC on dividends paid, shareholders non-resident 1 14 12 (b) Definition of residency for individuals 183 days 1 Tax liability on worldwide v Cyprus source income only 1 Dividend and interest income is exempt from income tax 1 Potential liability to SDC 1 Explanation of SDC liability resident and domiciled/17 out of 20 years 2 6 5 (c) Treaty between two countries to minimise/avoid taxation of same income in both states 2 Discussion of application to Stolos group companies and employees 1 More favourable rates of withholding taxes 1 4 3 20 29