Taxable and non-taxable entities
A company is considered to be a tax resident of Cyprus if it is "managed and controlled" in Cyprus. Although no definition of management and control is provided in the tax law itself, this is generally accepted as being the place where board decisions are taken and where the directors reside. Consequently, for a company to be managed and controlled in Cyprus we would expect to see resident directors and regular board meetings being held in Cyprus.
A company that is incorporated in a foreign country is considered to be tax resident in Cyprus if managed and controlled in Cyprus. Similarly, it is possible to incorporate companies in Cyprus that are non-resident for Cyprus tax purposes.
Non-resident companies i.e. entities not managed and controlled in Cyprus are not subject to taxation in Cyprus unless they have a permanent establishment in the island. Where they have such an establishment, they are taxed only on that income that arises from the activities of that establishment. Such companies cannot take advantage of the Cyprus network of double tax treaties and are therefore used mainly for trading activities where treaty benefits are not required. The reputation of Cyprus as a top quality financial centre with highly developed banking, legal and accountancy professions gives a non-resident Cyprus company a clear advantage over known offshore jurisdictions which are often viewed with suspicion or mistrust.
Taxation of resident companies
Resident companies are subject to Cyprus corporation tax at the rate of 12.5 percent. This is the lowest corporate tax rate in the EU.
Dividends, interest, royalties and profits realised for sale of securities are subject to special tax treatment as detailed below:
Taxation of transactions in shares and other securities
Profits realised from the sale of securities are exempt from tax.
"Securities" are defined as meaning shares, bonds, debentures, founders' shares and securities of companies or other legal persons and options thereon.
The definition of security does not embrace all financial instruments. The Cyprus Tax Authorities have not issued a definitive list of all the financial instruments that they consider to fall under this definition but it is generally considered that promissory notes, shares in mutual funds and currency contracts are not considered as securities. Profits realised on dealing in these instruments are not exempt and are subject to corporation tax.
Taxation of dividends
Dividends received by a Cyprus resident company are generally exempt from taxation in Cyprus if they are received from a foreign entity.
The exemption does not apply where the foreign entity:
receives more than 50 percent of its income from investment activities, and
the foreign tax burden of the company paying the dividend is substantially lower than that of the Cyprus resident company
"Substantially lower" has been interpreted as meaning less than 6,25% percent.
The Cyprus Tax Authorities have acknowledged that foreign tax burden does not cover only the tax paid by the company paying the dividend but includes also the tax paid by lower level subsidiaries. In practice, therefore dividends received from subsidiaries or associates are rarely taxed.
Where dividends do not satisfy the requirements for exemption from taxation or where the holding constitutes less than 1 percent of the paying company's share capital, then they are subject to defence tax at the rate of 15 percent. However, any tax withheld at source is allowed as a deduction from this tax even if it is made from a country that does not have a double tax treaty with Cyprus.
EU parent-subsidiary directive
Cyprus holding companies take benefit of the EU parent-subsidiary directive. Dividends paid between associated enterprises that are both situated in the EU are made without any withholding taxes. A company is defined an associate of another, if that other company holds at least 20 percent of its share capital. This percentage fell to 15 percent in January 2007 and 10 percent in January 2009.
Taxation of interest income
The taxation of interest income depends on whether it is derived in the ordinary course of business or it is closely related with that business. In such cases, the interest income earned is included in the calculation of taxable income under corporation tax and taxed at 12.5 percent. Interest earned by banks, financial companies, hire purchase companies or leasing companies is considered to arise from the ordinary course of business.
Interest earned as detailed below is considered to be closely related to that business and is also subject to corporation tax:
(a)businesses such as car dealers, property developers that sell their products on extended payment terms and charge interest on their trade debtors
(b)interest on current account balances at banks
(c)interest earned by companies which act as a vehicle through which a group finances the operations of companies within it. No formal definition of "group" has been provided but it is generally considered that a group comprises any relationship where the companies are ultimately controlled by one entity. Consequently, two entities that are owned by a physical person without a common holding company are not considered a group.
In all other cases where the interest is considered to arise outside the ordinary course of business, only half of that is treated as income for corporation tax purposes but the gross interest received is also subject to defence tax at the rate of 30 percent. Interest on deposit accounts and interest earned on loans granted to third parties are treated in this way. A credit is provided against the defence tax payable for any taxes withheld at source irrespective of whether a double treaty exists or not.
A credit is provided against the defence tax payable for any taxes withheld at source irrespective of whether a double treaty exists or not.
EU interest and royalty directive
The EU interest and royalty directive came into effect on 1 January 2005 and provides that interest and royalty payments arising in one EU member state are exempt from any taxes imposed on those payments in that state, whether by deduction at source or by assessment, provided that the beneficial owner of the interest is a company in another EU member state.
For the directive to apply the companies must be associated. One company is defined as an associate of another if that other company holds at least 20 percent of its share capital. This percentage fell to 15 percent in January 2007 and 10 percent in January 2009.
The company receiving the interest or royalty payment must not be acting as a trustee, agent or intermediary. It should be receiving the income for its own benefit.
The interest or royalty must be on an arm's length basis. The directive will not apply to what is considered to be "in excess of an arm's length amount".
The low tax regime of Cyprus makes it the ideal route through which non-EU residents can extract profits from their EU operations. Interest and royalties are allowed as an expense in the EU payer reducing its tax base and is taxed at low rates, often nearly zero in Cyprus.
Greece, Czech Republic, Slovakia, Poland, Portugal, Spain, Latvia and Lithuania have been granted a transitional period in which to apply the directive as the economic effect of immediate compliance would be onerous. They can charge a maximum withholding tax of 10 percent up to 2007 and 5 percent until 2011. However, the Cyprus network of double taxation treaties includes Greece, Czech Republic, Slovakia and Poland.
The overall tax burden on interest and royalties remitted to Cyprus from these countries is not affected by the transitional provisions as Cyprus grants a tax credit for the taxes withheld by these countries.
Taxation of royalties
Royalties received by a non-resident from sources within Cyprus are liable to 10 percent withholding tax. However, if a Cyprus company is granted the right to use a patent, trademark or innovation outside Cyprus, then there is no withholding tax and the Cyprus company is taxed at the corporate tax rate on the profit margin that it realises on the use of the right.
Other provisions of the Cyprus Tax Law
The treatment of tax losses
Taxable losses incurred during a tax year which cannot be set-off against other income of the same tax year are carried forward up to five years. Taxable losses cannot be carried forward if there is a change in the ownership of the company and a significant change in the nature of business within three years from the year in which the loss arose.
The taxable losses of any company may be set off against the taxable profits of another company in the same group provided that the two companies are members of the same group for the whole year and are both tax residents of Cyprus. For the purpose of group relief, a company is deemed to be a member of the same tax group if:
(a) it is 75 percent subsidiary of another company, or
(b) both are 75 percent subsidiaries of a third company
Any profits arising on the transfer of assets and liabilities between companies during a reorganisation plan are tax free. A reorganisation plan includes mergers of companies, remerges, transfer of activities or exchange of shares.
Inheritance or estate taxes
There are no inheritance, estate or other taxes on shares held in a Cyprus company.
Cyprus imposes no taxes on wealth and it is not anticipated it shall do so in the years to come.
Thin capitalisation rules
There are no thin capitalisation rules in the Cyprus tax legislation. Caution needs to be exercised in relation to interest deductions in respect of loans used for the purchase of assets not used in business as such interest is disallowed.
Controlled Foreign Company (CFC) legislation
Compared with many other jurisdictions, Cyprus CFC legislation is limited, targeting only certain types of income that are not derived from real business activities to create a distinction between participation (active) and investment (passive) income.
There are no transfer pricing rules in Cyprus but a provision in the Cyprus Tax Law, requires transactions to be based on an "arm's length" principle. Cyprus legislation incorporates the OECD model and pertinent guidelines to determine what an arm's length transaction is.
Royalties (IP "box regime")
The provisions introduced in 2012 provide exemptions from tax on income related to Intellectual Property (IP). More specifically:
80 percent of worldwide royalty income generated from IP owned by Cypriot resident companies net of any direct expenses, is exempt from income tax
80 percent of profit generated from the disposal of IP owned by Cypriot resident companies net of any direct expenses, is exempt from income tax
effective tax rate of 2,5 percent or less
any expenditure of a capital nature for the acquisition or development of IP is claimed as a tax deduction in the year in which it is incurred and the immediate four following years on a straight line basis
The above exemptions are also available for IPs acquired or developed before January 2012.
no withholding taxes on payment of royalties apply when distributed out of Cyprus, provided that the holder is not a Cyprus resident and the royalty is used outside of Cyprus
Cyprus has an extensive worldwide network of double tax treaties
the EU Directive on Interest and Royalties providing for nil withholding taxes between EU countries and which extends also to Cyprus
Cyprus does not impose any withholding tax on dividend, interest and royalty payments made to non-Cypriot resident recipients.
In the case of royalties, the exemption applies for royalty payments when the right/asset is used outside of Cyprus.
When the royalties are connected with the use of the right/asset within Cyprus, there is a 12,5 percent withholding tax subject to treaty provisions, and where applicable, to the EU Interest and Royalties Directive.