Tax Environment in Cyprus - Double Tax Treaties & More
As part of the accession process to the EU and in compliance with the OECD requirements against harmful tax practices, the Cyprus Tax Legislation has undergone major reforms. These reforms greatly enhance Cyprus' competitiveness and make it an even more attractive jurisdiction through which to conduct international business. The new legislation came into effect on 1 January 2003. Cyprus accession to the EU offering enhanced business opportunities in an enlarged European Common Market and the New Taxation System renders Cyprus one of the most attractive International business centres.
Cyprus is a signatory to a treaty for the Prevention of Double Taxation with many countries all over the world. A Double Taxation Prevention Treaty, in principle, enables offsetting tax paid in one of two countries against the tax payable in the other, in this way preventing double taxation for businesses and individuals.
Tax costs play a significant role in investment decisions, investors aim in maximising after tax return on investment. Therefore, investment structures which have the least tax leakage are preferred by investors and are recommended by professional advisers. As such, a Cyprus investment vehicle can collect income which is a charge against high tax income. Withholding tax is eliminated or reduced under double tax treaties or under EU directives. The rate of tax in Cyprus is low compared to other EU countries. The income can then be repatriated in any form the investor wishes without withholding tax.
A Cyprus entity is suitable both for EU inbound and outbound investments. There are no investment activities which are inappropriate for the Cyprus tax environment. However, there are investment activities which are indeed ideally suited to the Cyprus tax environment such as:
- Holding Companies
- Investment Funds and Companies
- Finance Companies
- Royalty Companies
- South Europe, Middle East, Russia, Central and Eastern Europe headquarter business activities.
DOUBLE TAX TREATY
Cyprus is considered to be a country holding a quite significant position in international tax planning as a number of fiscal benefits can be accumulated to foreign entities by using the advantages offered from the use of a Cyprus offshore company for a successful application of the theory of International Tax Planning. The actual theory of International Tax Planning refers to the arrangement of financial and business affairs in a way so as to be able to magnetise the minimum tax either locally or internationally, without being in any event in conflict with any tax laws or without deceiving the Inland Revenue authorities by not declaring profits or by other ways of fraudulent actions. The position held by Cyprus in the field of International Tax Planning derives both from the favourable tax regime established as well as for the wide network of double tax treaties.
The central purpose for the conclusion of these treaties is the avoidance of double taxation of income earned in both in any of the two contracting states. According to these agreements:
- either a credit is allowed on any tax paid in another country against the Cyprus tax
- or the income is totally exempted from tax.
BASIS OF TAXATION / THE CYPRUS HOLDING COMPANY
A Cyprus Holding Company can be effectively utilised for International Tax Planning purposes, and at the same time enjoy the status of being located at a reputable business centre.
All Companies tax resident of Cyprus are taxed on all their income accrued or derived from all sources in Cyprus and abroad. A non Cyprus tax resident Company is taxed on income accrued or derived from a business activity which is carried out through a permanent establishment in Cyprus. A Company is resident of Cyprus if it is managed and controlled in Cyprus.
Corporate tax for resident Companies is imposed at the rate of 12,5% for each year of assessment upon the taxable income derived from sources both within and outside Cyprus.
A Company is considered to be tax resident in Cyprus if its management and control is exercised in Cyprus. In order to achieve tax residency, several factors are taken into consideration by the Tax Authorities such as the make up of the Board of Directors, the place where major decisions are taken and where major contracts are signed. Tax residency is required in order for a Company to be taxed under the Cyprus tax laws and also for taking advantage of all European directives as well as the Double Tax Treaty (DTT) network that Cyprus has secured for tax resident persons.
Dividends paid from one Cyprus Company to another are free from withholding or any other tax in Cyprus.
Dividends received from abroad
There is no withholding tax dividends received from other Cyprus resident Companies. Dividends received from abroad are also tax exempt if the following two conditions are satisfied:
- The Company receiving the dividend must hold directly at least one percent (1%) of the share capital of the Company abroad paying the dividend, and
- The Company paying the dividend
- must not engage more than fifty percent in activities which lead to passive income (non-trading income) OR
- The foreign tax burden on the income of the Company paying the dividend is not substantially lower than the tax burden in Cyprus.
(A tax rate of five percent (6.25%) or more in the country paying the dividend satisfies this condition)
Passive Interest Income
Before 2009: Fifty percent (50%) of interest income is exempt from corporate tax and the rest is taxed at ten percent (10%), thus effectively reducing the income tax to just five percent (5%), but the whole gross interest income is subject to the Special Contribution tax at the rate of ten per cent (10%) thus leading to an overall effective tax rate of 15%.
After 2009: Passive interest is taxed at Defence tax of 30%.
Active Interest Income
Active interest is the interest accruing from, or is closely connected with, the ordinary carrying on of any business. Active interest income is taxed like any other income at the flat corporate tax rate of twelve point five percent (12.5%).
The taxation of gross amounts of royalties earned from sources within Cyprus by a company which is not a resident of Cyprus is liable to ten percent (10%) withholding tax, If such right however is granted to a Cyprus company for use outside Cyprus, then there is no withholding tax and corporate rate is applied only on the profit margin left in the Cyprus company.
Income, generated by a Cyprus tax resident Company, arising from the letting of immovable property is taxable both under the Cyprus Income Tax (10%) and the Special Contribution Tax legislation (3%) as follows:
The net taxable rental income (after deducting all related expenses such as wear and tear allowances, repairs, maintenance expenses etc.) arising in Cyprus is included in the taxable base of the Company and taxed at the flat Corporate Income Tax (CIT) rate of twelve point five percent (12.5%).
Special Contribution Tax
Under the Special Contribution tax, an amount of twenty five percent (25%) is deducted from the gross amount of rental income. After such deduction has been effected, the taxable amount of rental income is subject to tax at a rate of three percent (3%).
CAPITAL GAINS TAX
Capital Gains are not included in the ordinary trading profit of a business but instead are taxed separately under Capital Gains Tax Law.
Capital Gains Tax from the sale of immovable property situated in Cyprus and/or sale of shares in Companies (other than quoted shares) that own immovable property situated in Cyprus, are taxed at a flat rate of 20% after allowing for indexation.
Capital Gains that arise from the disposal of immovable property held outside Cyprus or shares in Companies which may include immovable property held outside Cyprus are completely exempt from Capital Gains Tax.
Therefore, if a non resident shareholder decides in the future to dispose off its shares in a Cyprus Company, he/she will not be subject to any tax in Cyprus.
THIN CAPITALISATION RULES
There are no thin capitalisation rules in the Cyprus tax legislation. Special caution must be exercised in relation to interest deductions in respect of loans of a non-trading nature as interest on balances of a trading nature is allowed as a qualified expense, whilst interest on balances not of a trading nature is disallowed.
There are no transfer pricing rules in Cyprus but a new provision was introduced based on the "arm's length principle". Cyprus legislation incorporates the OECD model and a guideline to determine what arms’ length is.
FOREIGN PERMANENT ESTABLISHMENT (PE)
The Profits from a foreign PE held by the Cyprus Holding company are exempt from corporate tax if one of the following two conditions is satisfied:
- Passive income less than 50% or
- The foreign tax burden is not substantially lower than that in Cyprus.
INHERITANCE OR ESTATE TAXES
Although Cyprus is a full member of the EU, there are no taxes on capital. Estate or Inheritance tax was abolished as of January 1st, 2000. This is an extremely useful tool in the hands of a tax advisor as it can save large amounts of money to the individuals involved.
Cyprus imposes no tax on wealth and it is not anticipated to do so in the years to come.
LOSSES CARRIED FORWARD
The tax losses incurred during a tax year and which cannot be set off against other income, is carried forward for only five (5) years and set off against future profits.
The current year loss of one Company can be set off against the profit of another provided that the Companies are Cyprus tax resident Companies of a group (75% possession rule).
Transfers of assets and liabilities between Companies can be effected without tax consequences within the framework of a reorganisation. Reorganisations include mergers, demergers, transfer of activities and exchange of shares.
A CFC is a low taxed non-Cyprus tax resident company in which the Cyprus CIT taxpayer, alone or together with its associated enterprises, holds a direct or indirect interest of more than 50%. A CFC is also a low-taxed foreign PE of a Cyprus tax resident company that is exempt from tax in Cyprus (exempt foreign PE) A non-Cyprus tax resident company (or an exempt foreign PE) is considered as low-taxed if the actual foreign corporate tax paid by it on its profits is lower than 50% of the corporate income tax charge that would have been payable in Cyprus under the Cyprus corporate income tax rules had it been a Cyprus tax resident company.
The CFC rule does not apply to non-Cyprus tax resident companies (or exempt foreign PEs): i) with accounting profits of no more than €750.000 and non-trading income of no more than €75.000; or ii) of which the accounting profits amount to no more than 10% of their operating costs for the tax period. For the purposes of this exception operating costs do not include the cost of goods sold outside the country where the non-Cyprus tax resident company (or the exempt foreign PE) is tax resident and payments to associated enterprises.
SPECIAL TYPE OF COMPANIES
One of the main factors expected to drive forward the shipping industry in Cyprus is the country’s favourable tax regime which has been maintained even after the accession to the EU. The current tax regime offers a ship owner complete tax exemption on all profits and dividends arising form the operation of Cyprus flag ships. Profits distributed by ship owning Companies operating Cyprus flag ships are not considered as dividends for special contribution for defence purposes.
Local or international ship management and crew management businesses (corporated or unincorporated) have the option to be taxed either at the rate of 4,25% or at rates equal to 25% of the rates used to calculate tonnage tax of vessels under management which are registered outside Cyprus. Dividends distributed out of profits generated from ship-management activities are totally tax exempt and are not subject to the 15% special contribution for defence which normally applies.
Profits of insurance Companies are liable to corporation tax similar to all other Companies except in the case where the corporation tax payable on taxable profit of life insurance business is less than 1,5% on gross premium. In this case, the difference is paid as additional corporation tax.
Capital Gains arising from the sale of securities (including shares) are not subject to tax in Cyprus. Therefore, if the non resident shareholder decides in the future to dispose of its shares in the Cyprus Company (assuming it does not hold any immovable property in Cyprus) it will not be subject to any tax in Cyprus.
In case of liquidation of the Cyprus Company the accumulated profits of the last five years prior to the liquidation will be considered as dividends distributed to the shareholders. As stated above there is no withholding tax on dividends payable to the non Cyprus resident shareholder. Accumulated profits in excess of five years are considered to be capital distributions again not subject to any withholding tax in Cyprus.
The new Cyprus tax laws provide significant benefits for all types of international business activities. Cyprus resident Companies have the lowest effective tax rate of any EU member and the treatment of dividends, interest, income and capital gains are amongst the most beneficial of the world.