Cyprus tax planning

Cyprus, an ideal place for international tax planning

During the past thirty years Cyprus has developed into a formidable financial centre, renowned for its high quality services.

The local tax system is a key reason for this development. Cyprus is well known for its simplified tax system that provides numerous advantages to international investors.

Below you may find a detailed analysis as for the Cyprus tax perspective of the three different segments of international Businesses, operating through Cyprus, financing, holding and trading companies. Also you may find details as for the taxation of individuals, shipping companies, royalties and the double tax treaties of Cyprus.

Cyprus financing company

Back to back loans

Please note that the Institute of Certified Public Accountants of Cyprus (ICPAC) has agreed with the Commissioner of Income Tax that the below spreads would apply in the case of back to back loans.

Loan amount

Spread to be earned

Up to €50m

0,35%

Between €50m- €200m

0,25%

Above €200m

0,125%

It should be noted that the above spreads relate only to back to back loans when the Cyprus Company acts as an intermediary which obtains loan(s) from a related company and provides loan(s) to another related company.

Such loans should not be subject to any risks in order to justify the low spreads.

Subsequently, the Cyprus Company would not be able to claim as tax deductible any amounts which cannot be collected.

The time period between obtaining and granting the loan should not be more than 6 months.

The above spreads should result after taking into account any expenses. Any foreign exchange differences arising from such back to back loan arrangements will not be taxable/tax deductible.

In order for the above to apply, the Cyprus Financing Company should be in a position to prove that the funds granted as a loan to its related party were obtained as a loan from another related party. This could be done for example through the movement in the company’s bank statements and the relevant loan agreements.

Other loans

In relation to provision of financing facilities to any party, related or non-related, other than back to back loan(s) arrangement, a “market interest rate” should be charged on the loan facilities.

There are no provisions in the tax legislation or any tax guidance or circular by reference to what constitutes a “market interest rate”. It could be said that currently in practice the Tax Authorities generally consider as an arm’s length interest rate the rate of 5- 6%, although different factors should also be taken into consideration in order to determine the arm’s length rate (e.g. currency, economic risks of the jurisdiction of the borrower).

Cyprus Holding company

As per the Cypriot tax legislation any gain/ (loss) arising from the disposal of “titles” is exempt / (not allowable) for income tax purposes. Taking this opportunity please find attached a list of “titles” as per a circular issued by the CTAs.

  • Ordinary shares
  • Founder’s shares
  • Preference shares
  • Options on titles
  • Debentures
  • Bonds
  • Short positions on titles
  • Futures/forwards on titles
  • Swaps on titles
  • Depositary receipts on titles (ADRs and GDRs)
  • Rights of claims on bonds and debentures (interest income is excluded and taxed under normal rate)
  • Index participations only if they represent titles
  • Repurchase agreements or Repos on titles
  • Participations in companies
  • Units in open‐end or closed‐end collective investment schemes

Any profit from the disposal of the abovementioned products is not taxable ( it is deducted from the company’s income) when determining the tax charge of a Cyprus resident Company. On the other hand, any loss deriving from the trade of the such instruments is also not tax allowable ( it is added back to income, thus eliminating the effect of such loss).

Dividend income from participations in companies

Dividends received from abroad are tax exempt unless both of the following conditions are not satisfied.

  • The company paying the dividend must not engage directly or indirectly more than 50% in investing activities, and
  • The foreign tax burden on the income of the company paying the dividend is not substantially lower than the tax burden in Cyprus (the lowest acceptable rate is considered to be 5%, even though CTA has not provided this in writing in the form of circular or guidance).

If both conditions fail then the company is taxed under Special Contribution for Defence (SCD) at 20% for the years 2012 and 2013 and 17% from 2014 and onwards.

Trading companies

Cyprus Tax Authorities(CTAs) are expecting that a Cyprus tax resident company will be selling goods and/or services at a reasonable gross profit margin resulting to reasonable net taxable margin after accounting for administration expenses.

Trading companies are taxed under the normal rate of 12.5%. All expenses that are wholly and exclusive for the generation of taxable income are allowable for tax purposes. All other expenses ( which relate to non-business assets or activities are not allowable and are restricted during the computation of the taxable income( please see ‘’disallowable expenses ‘’ section below).

There are no "safe harbor" regulations regarding net profit margin to be generated for trading companies. In practice though the CTAs accept a reasonable margin between 5% to 10% for companies with trading activities, of the gross annual income after the administrative expenses are deducted there from. The actual percentage margin should also be a function of the absolute amount of the annual income. The higher the amount of annual income the lower the acceptable net profit margin could be in percentage terms. Furthermore the net profit margin should be a function of the actual financial and operating risks undertaken by the company.

In addition to the above the arm’s length provision of the Cyprus tax legislation should be considered which requires transactions between related parties to be conducted at an arm’s length basis.

Arm’s length transactions

According to the Cyprus tax legislation, article 33 of the Income Tax Law, transactions between related parties must be carried out on an arm’s length basis. This means that they should be carried out at no different terms to those applied in transactions between unrelated parties.

In case the Cyprus Tax Authorities (CTAs) consider that transactions between related parties are carried out on a non-arm’s length basis, they could adjust the tax base of the company accordingly.

Restriction of disallowable expenses

As discussed above expenses that are not wholly and exclusively for the purpose of trade are not allowable when determining the Cyprus chargeable income.

Example: The servicing cost of a loan used for the purchase of any asset falling under ‘’ titles’’, in which case the restriction of interest should be calculated using the weighted average cost of borrowings and the cost of “non-business assets” or in case where it can be proved that the investment has been financed out from a specific loan, the interest rate of that specific loan could be accepted.

According to the Cyprus tax legislation and to the circular 2010/8 issued by the Cyprus Tax Authorities, interest expense relating or deemed to relate to the cost of acquisition of “non-business assets”( assets that do not generate taxable income) should not be allowed as tax deductible for income tax purposes.

In addition the circular 2008/14 states that expenses which relate directly or indirectly to exempt income and portion of the overheads expenses should not be treated as tax deductible expenses for income tax purposes.

The same circular further clarifies that overhead expenses can be apportioned to taxable and exempt income according to the proportion of cost of the assets used for the production of taxable and exempt income.

Therefore, administration expenses apportioned to assets or activities that result to the production of income which is exempt from Cyprus income tax (i.e. dividend income, profits from the disposal of titles etc) are not treated as tax deductible expenses for income tax purposes.

Foreign exchange differences

Foreign exchange (FX) differences recorded through the profit and loss should be as follows:

(i) realised and unrealised FX gains/(losses) of a capital nature are treated as exempt/(non deductible)

(ii) realised FX gains/(losses) of a revenue nature are treated as taxable/(tax deductible)

(iii) in the case of unrealised FX gains/(losses) of a revenue nature, a company can opt either:

(a) to treat such FX gains/(losses) as taxable/(tax deductible) as they accrue, or

(b) to treat such FX gains/(losses) as exempt/(non deductible) as they accrue until realization (i.e. upon settlement)

Once a company opts for one of the two methods (a) or (b) mentioned above, it should be followed consistently in all years.

Due to a recent piece of legislation the abovementioned treatment has changed and as from 1.1.2015 the effect of both realised and unrealised exchange differences are considered as tax neautral during the determination of taxable income.

Interest income

Interest income is distinguished as follows:

  • Interest received by companies in the ordinary course of their business including interest closely connected to the ordinary course of business. Interest derived by group finance companies is also considered as closely connected to the ordinary course of business. All the types of interest discussed above are considered as “active”
  • Interest received by companies which does not satisfy the conditions prescribed above is considered as “passive”.

“Active” interest income is subject to income tax at the rate of 12.5%.

“Passive” interest income is taxed only under Special Defence Contribution (SDC) at the rate of 30%, without deducting any expenses.

Non-resident companies with local presence

Companies that are non-residents in Cyprus are only taxed for their profits generated in the Republic.

Losses

According to the circular 2013/08 taxable losses are carried forward for five years. Any unutilized losses of more than five years, are lost.

Royalties

Based on the Cyprus IP BOX regime, a Company is allowed to deduction of 80% of tax, after all expenses that are suffered wholly and exclusively for the purpose of trade are deducted resulting in the effective tax rate of less than 2.5% of the company’s revenue.

In addition, as Cyprus has no Transfer Pricing rules, the transferor may choose to transfer the intangible asset at any value that benefits his / her personal tax strategy.

Please note that due to OECD Nexus approach, entrance to the Cyprus IP BOX regime (and to any other similar regimes worldwide) has to be done on or before June 2016, as failure to do so according to the deadline will result in restriction of participation. In case someone is registered for Cyprus IP BOX regime before the deadline, that will result in the regime being applicable until June 2021.

Shipping companies

As from January 1st 2010, Cyprus became the only EU country with an EU approved Tonnage Tax system, resulting in all vessels under Cyprus, EU or under specific conditions flags of a non EU country can be taxed under Tonnage Tax ( TT) on the vessels light weight instead than corporation tax based on their actual profits.

TT is a simplified and cost effective method for ship owners and/or ship managers to be taxed.

Taxation for individuals

An individual is considered as a Cyprus tax resident, if he/she stays in Cyprus for at least 183 days in a calendar year. In that case the individual’s worldwide income is considered as taxable in Cyprus. The taxpayer is eligible to claim credit for taxes suffered in another country.

A non-Cyprus tax resident is only liable to Cyprus tax on income gained in Cyprus. In that case the individual is eligible to the tax free band of EUR19. 500.

Tax incentives for individuals reside to Cyprus

  • Exemption of 50% of their package for non-residents earning more than EUR 100.000. This exemption applies for individual employed from 2012 onwards, under the conditions that those were not Cyprus tax residents prior to the commencement of their employment and that their employment will be in exclusively in Cyprus. The abovementioned exception is granted for five years and the employee is eligible to the exemption from the first day of employment. This exemption is also granted if in the first year the actual payments are less than EUR100.000 as the basis for determination is the agreement regardless the actual payment. it is expected that this incentie will be prolonged to 10 years in late 2015.
  • The lowest of EUR 8.550 or twenty percent (20%) of the gross income of an individual who was not a tax resident in Cyprus before the commencement of her/her employment in Cyprus. This exemption applies for a period of three years commencing on the 1st of January following the year of commencement of the employment and it is expected to be further prolonged during late 2015.
  • Remuneration from the rendering of salaried services by a Cyprus tax resident, to a non-tax resident employer or to a resident employer’s permanent establishment located outside Cyprus, for an aggregate period of more than 90 days in a calendar year.
  • As from 16 July 2015, physical persons that are Cyprus tax residents but are not Cyprus domiciled are exempted from Special Defense Contribution on dividends, interest and rent. This massive development result in zero taxes when receiving dividends from a Cyprus Company which in turn receives dividend income from another country and as the individual is Cyprus tax resident ( lives in the Island for more than 183) it is practically impossible for the tax office of another country to claim that the decision making and strategic planning of the Cyprus holding Company is not done locally and that the whole structure is abusive.

Double tax treaties

Cyprus has an extensive double tax treaty network with approximately 50 tax countries including the majority of the EU counties, Russia, China, India, US and the C.I.S countries aiming in avoidance of double taxation of income in both Cyprus and the respective other treaty country.

Under a Double Tax Treaty (DTT) the country of resident ( Cyprus) will give credit for taxes suffered in the other treaty country. Also in many cases, the DTT clearly provides the taxability for a specific sources of income(i.e dividend income from Russia or passive interest income from the same country), including rates, country in which the tax will be suffered and any other details needed in order to determine the taxability of a specific transaction.