Alignment of the Cyprus law with the EU Anti-Tax Avoidance Directive
The first law implementing the EU Anti- Tax Avoidance Directive was voted by the Cyprus Parliament on 05/04/2019. The new law is in effect from 01/01/2019 i.e. for tax year 2019 and forward. The new law affects Cyprus tax resident companies and permanent establishments in Cyprus of non-Cyprus tax resident companies and its provisions pertain to:
- General Anti-Abuse Rules (GAAR)
- Controlled Foreign Companies (CFC)
- Interest limitation
An additional law is expected to be implemented in Cyprus with regards to the EU Anti-Tax Avoidance Directive with implementation date the 1st of January 2020 which will be addressing:
- Exit taxation provisions
- Hybrid mismatch
1. General Anti-Abuse Rule
The new law requires that when calculating the corporate income tax liability of a Cyprus tax payer, any arrangements which were put in place mainly to obtain a tax advantage ( i.e. their existence has no valid commercial reasons reflecting economic reality) to be ignored, and not be included in the calculations.
2. Controlled Foreign Companies (CFC)
a) As per the provisions of the new law, a company is considered a Controlled Foreign Company when:
(i) It is a non-Cyprus tax resident company or a foreign permanent establishment of a Cyprus tax resident company that is exempt from tax in Cyprus and,
(ii) The corporate tax resulting from the company’s profits in the jurisdiction where the company is a tax resident, is lower than 50% of the corporate tax that would result in Cyprus from the same profits and,
(iii) The company is directly or indirectly owned by a Cyprus tax resident company and its related parties, by more than 50%.
b) Application
As per the new law, the Cyprus Tax Resident owner’s share of the after tax accounting profit of the CFC - which has not been distributed to the Cyprus tax resident owner during the period ending up to seven months after the Cyprus tax year in which the CFC profits were incurred - must be included in the taxable profits of the Cyprus tax resident owner and be taxed accordingly, to the extent that such profit arises from non-genuine arrangements. In cases where the CFC generated losses the same provisions apply i.e. the Cyprus Tax Resident owner absorbs its share of the CFC’s losses.
The CFC rules do not apply to non-Cyprus tax resident entities which generated accounting profits of less than €750.000 and non-trading income of less than €75.000; or their the accounting profits amount to 10% or less of their operating costs (only those costs incurred in the country of tax residency of the non-Cyprus tax resident entity qualify) for the year. Payments to associated entities do not qualify as operating costs under the CFC rules.
The new law grants tax credit against the Cyprus corporate income tax for taxes paid outside Cyprus on the CFC’s profit and it also introduces mechanisms for the prevention of the double taxation of the CFC in Cyprus.
c) Non-genuine arrangements
An arrangement under which the Cyprus Tax Resident Company and not the CFC owns the profit generating assets or has the decision-making authority and / or other significant functions and expertise to incur the profit generating risks. Such an arrangement would render the CFC incapable of generating that profit had it not been controlled by the Cyprus Tax Resident company. The amount of the CFC’s profit to be included in the taxable profit of the Cyprus Tax Resident owner is limited to those amounts generated through assets and risks which are controlled by the Cyprus Tax Resident Owner and is calculated on arm’s length basis.
3. Interest limitation rule
a) Explanation of terms used
(i) Taxable EBITDA
Taxable profit of the year + EBCs + depreciation + amortization + deductions in relation to fixed assets. Where applicable, the 80% deduction on qualifying profits from intellectual property is also added back to the taxable profit.
(ii) Borrowing Costs
All interest expenses incurred from any form of debt obligations of the taxpayer, other costs which are in essence interest expenses and all expenses incurred in connection with the raising of debt finance. The annual Notional Interest Deduction which is calculated on new equity introduced in Cyprus companies is not considered as a borrowing cost under this rule.
(iii) Exceeding Borrowing Costs (EBCs)
Exceeding Borrowing Costs (EBCs) is the amount of tax-deductible borrowing costs which is in excess of the taxable interest income of the Cyprus taxpayer in a Cyprus tax year.
b) Application
The new legislation limits the tax allowable exceeding borrowing costs to a maximum of 30% of the Cyprus Tax Resident company’s taxable EBITDA. The rule does not apply if 30% of the company’s taxable EBITDA is below €3.000.000 (i.e. EBCs up to €3.000.000 are tax deductible). The 30% rule applies on a Group level in the cases of Cyprus groups (75% relationship condition) and it applies to all borrowing costs regardless of the costs been incurred from financing arrangements with related parties or third parties. EBCs which are not deductible in a tax year can be carried forward for up to 5 years. In addition, EBCs that has not been utilized for tax purposes within a tax year may be carried forward for the next 5 years (subject to limitations regarding the change of the company’s ownership).
c) Exceptions from the interest limitation rules
(i) Financing arrangements entered into before 17 June 2016 are excluded and remain deductible. Any subsequent addendums to those financing arrangements however do fall under the provision of the interest limitation rules.
(ii) EBCs, incurred from financing arrangements used to finance long-term infrastructure projects in the EU (the contracting parties, borrowing costs, income and assets must all be within the EU) are excluded from the provisions of this rule. The taxable profit from these projects is also excluded from the taxable EBITDA.
(iii) In any tax year when the ratio of “equity/total assets” as per the financial statements of the Cyprus taxpayer or the Cyprus group is higher (or even up to 2% lower) compared to the same ratio from the consolidated financial statements of the group on a world-wide basis, the interest limitation rule, does not apply for that tax year.
(iv) Companies that on a worldwide basis are not members of a group, have no associated companies and no permanent establishments do not fall under the scope of the interest limitation rules.
(v) Companies providing regulated services such as banks, insurance entities, investment funds, pension funds and securitization vehicles do not fall under the scope of the interest limitation rules.
Please contact us for more information regarding the new legislation and how it affects your specific circumstances.