2015 ICPAC SEMINAR 15 th & 16 th January 2015 [CORPORATION TAX BRIEFING] The contents of the notes to follow constitute a general overview of the corporate tax system in Cyprus.
Corporation tax Introduction A company is not considered as a Cyprus tax resident company just through incorporation. A company is subject to Cyprus corporation tax (at the flat rate of 12.5%) irrespective of its country of incorporation, if such company proves that it is effectively managed and controlled in Cyprus. There are no detailed guidelines (nor a proper definition) of what are the management and control requirements. It is however used as basic principles that at least the following need to be adhered to: 1. The majority of the Board of Directors are tax residents in Cyprus 2. Strategic (and preferably also administrative, day to day) decisions are performed in Cyprus This is typically achieved through proving that: 2.1 Resolutions prepared and signed in Cyprus 2.2 Board of Director Meetings performed in Cyprus 2.3 Accounting, hard copies, contracts are maintained/performed/kept in Cyprus 2.4 Bank accounts are operated in Cyprus (this does not mean only through Cyprus banks but that the operation of foreign banks is handled through Cyprus) Note however: 2.5 Currently many Companies are registered in Cyprus and maintain nominee shareholders, directors, secretaries and operate through the address of some fiduciary office 2.6 In the strict essence this is not entirely transparent 2.7 Emphasis must be given on creating/establishing true substance of operations in Cyprus (discussion in the seminar on how to achieve such) 2.8 From a Cyprus tax perspective it is easy to prove effective management control. Structures in Cyprus are however continuously challenged from tax authorities abroad (as the objective of setting up a Cyprus company is clear)
Basis of corporation tax Cyprus tax resident companies are taxed on their worldwide income, subject to allowing a tax credit for any tax suffered in a foreign location on income which is also subject to tax in Cyprus. Non - resident companies are taxed in Cyprus only on: 1. Profits attributable to a permanent establishment in Cyprus 2. Rental income derived from immovable property situated in Cyprus 3. Profit from the sale of goodwill of a business exercised/existing in Cyprus Income that is subject to corporation tax Appendix 1 to these notes provides a detailed analysis, together with explanatory notes on: 1. How profits of a Cyprus tax resident company are adjusted for corporation tax purposes (IR4) 2. What reliefs are available 3. Details of how losses can be utilised (either at a Company or Group level) 4. Double tax relief Temporary and final settlement of corporation tax Every Cyprus tax resident company needs to prepay its corporation tax in 2 instalments. For the 2013 tax year, a company prepays its corporation tax through the temporary tax (provisional) system in 2 equal instalments on the 31 st June 2013 and the 31 st December 2013. The balance of any tax due (or refund) is due by the 1 st August 2014 (next year). Special attention is required when addressing the issue of temporary tax. In reality you will consider the past results of the client in conjunction with the current (2013) interim results at the date of submitting the temporary tax. A client can revise its submitted temporary tax before the year-end (i.e. before the 31 st December 2013). Therefore it is recommended that the initial form submitted is as prudent (As low as possible) and that the results are investigated by the tax advisor again before the year end. The tax office imposes a 10% penalty if the temporary tax paid is less than 75% of the actual tax burden of the company. See examples in class on application of all the above that include: 1. Imposition of 10% penalty and interest 2. Revision of temporary tax before the year end
Advanced issues relating to corporation tax Issue 1 Permanent establishment rules Understand that a permanent establishment is not a separate legal entity (i.e. subsidiary) but part of the company in question. As such, the results of the permanent establishment appear in the stand alone financial statements of the Company carrying out the permanent establishment. A permanent establishment set abroad by a Cyprus company is taxed in Cyprus ONLY if the permanent establishment: 1. Pays tax substantially lower in its country of establishment (less than 6%) AND 2. It engages in investment activities that are in excess of 50% of its overall activities If the PE satisfies both conditions mentioned above then the results of the PE are fully taxable in Cyprus. This means that the Cyprus company carrying out the PE abroad will be taxed on the PE profits and will be granted a tax allowance in case of a loss, If at least one of the two conditions stated above are not met, then the PE is taxed abroad. This effectively means that since the results of the PE are included in the financial statements of the Cyprus company then: 1. In the case of PE profits you will always DEDUCT these profits from your tax computation 2. In the case of PE losses note the following: Since a profit is deducted, similarly a loss should be added back. The Cyprus tax office wants to encourage Cyprus companies opening and operating legal PE abroad and as such provides the following incentive when a PE makes a loss: Do not add back the losses of a PE until the PE makes a profit, in which year the losses would be recaptured. Practically this means: No adjustment will be made in the financial statements of the Cyprus company when the PE makes a loss (say loss of Euro 12 m).
When the PE in the future makes a profit then: 2.1 If the profit is say Euro 15m, you will deduct the profits of Euro 15m and at the same time add back the losses of Euro 12m (recapture) 2.2 If the profits are say Euro 10m, again you will deduct the profits of Euro 10m, but you will only recapture previous losses up to the amount of the profit (i.e you will add back losses of Euro 10m). This means that in the future, the company will have to recapture a further Euro 2m of PE losses when the PE makes a profit. See further examples in class to fully understand the taxation of PE abroad. According to the guidelines issued by the OECD, a permanent establishment is: 1. A fixed place of business through which a part of a company is carried on 2. Specifically, the following are considered as permanent establishments: 2.1 A place of management 2.2 A branch 2.3 A office 2.4 A factory 2.5 A place of extracting natural resources (i.e. mine) 2.6 A building site whereby services/supervision offered lasts more than 3 months 3. The following are not considered as permanent establishments: 3.1 Use of storage facilities 3.2 Use of facilities for purchasing orders 3.3 Use of facilities for collecting information 3.4 Use of a broker/commission agent in the ordinary course of business Issue 2 The new legislation on taxation of intellectual property As from the 1 st January 2012, new rules govern the taxation of Cyprus tax resident companies dealing with intellectual property. The new rules provide increased incentives for the set up of Companies in Cyprus with rights to intellectual property, as: 1. Wear and tear of 20% is provided to the cost of the intellectual property 2. An 80% allowance is provided on the profits subject to tax 3. Hence the effective rate of tax for such companies cannot in any case exceed 2.5%
Intellectual property covers the following: 1. Scientific work 2. Literary work 3. Musical work 4. Artistic work 5. Movies 6. Databases 7. Recordings 8. Broadcasting 9. Publications 10. Patents as governed and defined by the Patents Law 11. Trademarks as governed and defined by the Trademarks Law How intellectual property is taxed The new tax laws apply to intellectual property purchased or developed (development meeting the definition of international financial reporting standards) after or on the 1 st January 2012. For tax purposes, the profits subject to corporation tax are derived as follows: Income from intellectual property (say royalties) 20m Less: Research expenses (if any) Nil Amortisation of the intangible asset * (2m) Interest expenses (0.2m) Normal allowable expense (0.5m) ------------ Profit before granted deduction 17.3m Less 80% special deduction granted* (13.84m) ------------ Profit subject to corporation tax 3.46m Corporation tax at 12.5% 0.43m (Effective tax rate in this illustration being 0.43m/20m = 2.15% ====== Notes to the above illustration 1. The tax office allows a wear and tear allowance (to compensate for amortization) at 20%. In the above illustration, it is assumed that the cost of the intangible asset was Euro 10m. 2. An 80% deduction is granted by the Cyprus tax office on resulting profits (as illustrated above).
In case of sale of intellectual property The profits from the sale of the intellectual property are also given an 80% allowance before calculating corporation tax at 12.5%. Issue 3 Capital allowances Capital allowances are granted in two modes by the Cyprus tax office: 1. An annual wear and tear allowance (in replacement of depreciation) 2. A balancing statement when an asset is sold (in replacement of an accounting disposal). Wear and tear guidelines 1. Wear and tear follow the period of the financial statements. If the financial statements are for 12 months, then wear and tear is granted fully. If the financial statements are for say 7 months, then wear and tear will be granted as a fraction (7/12). 2. Full wear and tear in the year of acquiring the asset. Zero wear and tear in the year of disposing an asset. 3. Wear and tear is granted on assets that are used for the generation of taxable income of the Cyprus tax resident company. Hence the following assets do not qualify for wear and tear purposes: 3.1 Privately used assets 3.2 Saloon cars 4. Wear and tear is granted on a straight line method. 5. Fixed rates of wear and tear exist (see appendix). Balancing statement guidelines Accounting wise, when an asset is disposed, the accountant will calculate an accounting profit being proceeds less the carrying value of the asset (carrying value being cost less accumulated depreciation). Since the accountants calculation includes depreciation, the end result whether a profit or a loss is not recognised by the tax office. Hence: 1. An accounting profit on the sale of an asset is deducted from our tax computation 2. An accounting loss is similarly added back In replacement of the above, the tax office demand the preparation of a balancing statement, whereby the taxable profit or loss is: Proceeds less tax written down value of the asset (TWDV) Whereby TWDV is the cost less accumulated wear and tear of the asset
The above calculation (Balancing statement) can give rise to either: 1. Balancing charge (profit) which is added in your tax computation 2. Balancing allowance (loss) which is deducted from your tax computation Note that in case of a Balancing Charge, the taxable amount is restricted to the lower of: 1. Balancing charge or 2. Accumulated wear and tear claimed You will not prepare a Balancing Statement for assets on which wear and tear allowances have not been claimed. Some advanced issues relating to capital allowances are: 1. Second hand buildings If a building is purchased has been previously used (second hand), then the cost eligible for wear and tear is the lower of: 1.1 Price paid to the seller or 1.2 Original cost of construction of the seller Both after deducting the cost of the land portion See illustrations in class for preparing a balancing statement on a second hand building. 2. Electing the replacement model A company disposing an item of PPE and on which a balancing charge has been created, may elect (written confirmation is required by the tax office) to apply the replacement model, that details the following: 2.1 The balancing charge is not taxed in the year of the disposal 2.2 Provided a replacement asset is bought (in replacement to the original disposed), then the balancing charge is credited against the cost of the replacement asset 2.3 This means that the replacement asset will have a lower cost for capital allowance purposes 2.4 In case where the cost of the replacement asset is lower than the balancing charge, then the excess of the balancing charge is taxable immediately, and the cost of the replacement is deemed to be zero for capital allowance purposes