SERVICES
How The New Tax Legislation in Cyprus Affects
The International Business Companies (IBC’s)
I. Introduction
In the course of accession to the European Union, Cyprus has reformed
its tax law in an effort to:
- harmonise it with the acquis communautaire;
- comply with the EC Law in light of the EU provisions regulating
state aid;
- comply with the EU Code of Conduct for Business Taxation and
with the commitment to the Organisation for Economic Co-operation
and Development (OECD) to curb harmful tax practices;
- transpose EU Directives into Cyprus tax law.
As a result in mid 2002 the new amending laws were passed. The
main provisions of these laws affecting IBCs (though no specific
definition is provided as to what constitutes an IBC) with effect
from 01.01.2003 are the following:
II. Jurisdiction to tax
The term "resident" has been added due to the new concept
of the taxation system. Tax liability will be based and henceforth
the jurisdiction of the Cyprus tax authorities to tax any person
(legal or physical) will depend either on residence (world-wide
income for residents) or on Cyprus source income only for non-residents.
The term "resident in the Republic" when applied to
a company means a company whose management and control is exercised
in the Republic. The concept of management and control is derived
from the common law system and though no specific definition is
provided as to what is the meaning of this term it may (in simple
terms) be taken to mean that management and control is where the
board decisions of the company are taken. It must be noted that
the place of incorporation of the company is irrelevant for these
purposes. However careful tax planning is essential to handle and
deal with the differing circumstances of each case. It is of course
necessary to ensure that an IBC satisfies the residence test to
be able to be taxed under the Cyprus tax law. If the IBC does not
satisfy the management and control test there is no residence in
Cyprus and therefore no taxation can be imposed in respect of such
a company.
In the case of an individual "resident in the Republic"
means an individual who stays in the Republic for a period or periods
exceeding in aggregate 183 days in the year of assessment and "non-resident
or resident outside the Republic" shall be construed accordingly.
III. Transitional Provisions up to 2005
As from 1.1.2003, IBCs having the management and control of their
business in Cyprus or having a permanent establishment in Cyprus,
the shares of which belong directly or indirectly exclusively to
aliens and which during the year 2001 had income, and continue after
that to have income exclusively from sources outside Cyprus or it
is expected that they will have such income which has not yet arisen
at the said period due to the nature of their business, will have
the option to be taxed at 4,25% (instead of 10% corporate tax rate
as from 1.1.2003) for the three years 2003, 2004 and 2005 as long
as they continue to satisfy the above conditions applicable to them.
In other words some IBCs will enjoy the tax rate of 4,25% for a
transitional period of 3 years but certain exemptions (explained
below), to be effective from 1.1.2003, will not be applicable to
them during the transitional period, such exemptions being the following:
- the exemption of 50% of interest receivable
- the exemption of dividends received
- the exemption of profit from the sale of shares
- group tax loss relief will not apply to them
- any loss incurred in years up to and including the year 2000
may not be carried forward after the expiration of five years
from the end of the year in which the loss incurred, e.g. the
loss of the year 1997 may not be carried forward to 2003, the
loss of the year 1998 may not be carried forward to 2004 and the
loss of the year 1999 may not be carried forward to the year 2005
and losses for the years 2000 and after may be carried forward
without any restriction.
- exemptions which will normally apply in case of reorganisations
to other companies will not apply to IBCs
- foreign taxes treated as expenses (credit relief in respect
of foreign taxes is given instead in the case of a double taxation
convention)
During the transitional period such companies:
- will not be subject to any special defence contribution in
respect of profits, dividends, interest and rents
- will be exempt from the payment of the employer's contribution
to the special cohesion fund in respect of their foreign employees,
(fixed at 2% on the emoluments of employees)
- will be liable to pay employer's contribution to the social
insurance fund not only in respect of the Cypriot employees (as
in the period before 01.01.2003) but also in respect of their
foreign employees working in Cyprus
IV. Taxation of IBCs from 01.01.2003 onwards
As from 2003, the chargeable profits of resident IBCs being eligible
but not electing to be taxed under the transitional provisions explained
above as well as IBCs not being eligible to be so taxed as aforesaid
will be subject to corporation tax at the rate applicable to all
companies which is 10%.
In addition IBCs will pay only for the years 2003 and 2004 on
their chargeable income in excess of CY £1m supplementary
tax (the so-called windfall tax) of 5%.
Taxation of dividends
As from 2003:
- dividend income will not be charged under the income tax law
but under the Special Defence Contribution Law and will be charged
only on resident persons subject to 15% on dividends from resident
or non-resident companies (but exemption may apply as explained
below); non resident persons are not liable;
- inter-company dividends: dividends between resident companies
will not be subject to tax and therefore no withholding tax will
apply (however deemed distribution will apply, see below);
- exempt dividends: dividends received from non-resident companies
are exempt from tax if the holding in the paying company is at
least 1% (implementing the European Union Parent/Subsidiary Directive,
90/435/EEC with application to all non resident subsidiaries and
not only EU subsidiaries). Portfolio investments therefore (shareholdings
of less than 1%) are taxable. This exemption does not apply if
the company paying the dividends engages more than 50% in activities
which lead to investment income and the foreign tax burden on
the income of the company paying the dividends is ubstantially
lower than the tax burden of the company in Cyprus. If one of
the conditions is not applying, the dividend still enjoys the
exemption.
Credit relief
Underlying tax (tax on the profits of the company out of which
the dividend is paid) may be given as a credit against the Cyprus
tax if provided under the double taxation agreement. The double
taxation agreements now in force between Cyprus and the countries
mentioned below provide for credit against Cyprus tax, in respect
of underlying tax, when the recipient of the dividend in Cyprus
is a company:
- irrespective of shareholding: Norway, Ireland, Greece, Austria,
South Africa, Belarus, Russia, Mauritius, Bulgaria and Singapore;
- only to companies holding directly or indirectly at least 10%,
in the case of U.K. and 25% in the case of Germany, Denmark, France,
Sweden and Belgium.
• Deemed dividends: As from the year 2003,
IBCs will be deemed to have distributed to their resident shareholders
70% of their after tax accounting profit as at the end of two years
from the end of the year to which the profits relate, and account
for a 15% tax, called special contribution, to the Revenue. The
deemed dividend provisions do not therefore apply as regards non-resident
shareholders.
Accounting profits are calculated in accordance with acceptable
accounting principles but after deducting transfers to reserves
provided in any law. The provisions relating to the set-off of losses
in the income tax law do not in any way affect the accounting profits.
• Payment of dividends: dividends paid
by an IBC, will not be subject to withholding tax of 15% if paid
to another company or to a non-resident shareholder, whereas dividends
paid to resident shareholders other than a company, will attract
15% withholding tax in the form of special contribution.
The deemed dividend provisions will not affect IBCs as regards
non-resident shareholders. IBCs opting for taxation at 4,25% during
the transitional period 2003-2005 will not be subject to the application
of these provisions anyway. These provisions are applicable also
to inter-company dividends, even though actual dividends are not
subject to withholding.
Taxation of interest
Interest income from whatever source, whether from Cyprus or outside
Cyprus, and subject to the provisions explained below, earned by
a resident person is subject to special contribution at 10%. It
must be noted though that:
- Interest derived from the ordinary carrying on of a business,
including interest closely connected with the ordinary carrying
on of a business, is not treated as interest but as business profit.
- Interest deemed to be payable to a company under the Income
Tax Law under the provision in respect of loans to directors etc,
is subject to special defence contribution.
Capital gains tax
The Capital Gains Tax (Amendment) Law of 2002 has made the following
changes in the basic law:
- The EU directive 90/434/EEC on mergers, has been transposed
into this law so as to exempt from capital gains tax any disposals
of property by reason of a reorganization;
- property situated outside the Republic is not taxable under
the new law; in view of this, the exemptions of the gains made
by IBCs in respect of property outside Cyprus, have been abolished;
and
- the exemption of any gains from the sale of shares of companies
listed on the Cyprus Stock Exchange (CSE) has been changed so
that the exemption will refer to the companies listed in any recognized
Stock Exchange (and not the CSE).
V. Provisions applicable to IBCs in the transitional period
and IBCs not in the transitional period
- Unrestricted deductions in respect of donations or contributions
to approved charities.
- No expense deduction in respect of professional tax.
- Business entertainment expenses restricted to 0.5% of turnover
or CYP £5.000 whichever is the lower.
- No expense deduction in respect of private saloon cars.
- Interest payable restricted by reference to the cost of private
motor saloon cars (whether used in the business or not) and other
assets not used in the business.
- No investment allowances on business assets.
- Transactions between connected persons subject to arm's length
rules.
- Subject to capital gains tax on gains from the sale of immovable
property in Cyprus.
- No stamp duty in case of reorganisations.
- Interest on overdue income tax at 9% p.a. irrespective of period
of delay (5% rate for delay under six months abolished).
- Subject to immovable property tax on property in Cyprus (of
1.1.80 value in excess of CYP100.000).
- No immovable property towns tax (such tax being abolished).
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