The Cyprus Parliament passed a law implementing the Anti-Tax Avoidance Directive (ATAD 2016) on 5.4.2019 with effect as from 1.1.2019.
The aim of the Directive is to avoid aggressive tax planning and to create a minimum level of protection for companies in the EU against tax avoidance.
The main provisions covered by this amendment are the following:
A) Rule on limiting interest deductibility
B) Controlled foreign company rule (CFC)
C) General Anti-Abuse rule (GAAR)
Official guidance from the Cypriot Tax Department is expected to be issued through which clarifications on the practical application of the above rules will be provided.
Remaining ATAD measures
The exit taxation rules and rules on hybrid mismatches will be transposed into Cyprus tax Law by 1.1.2020.
A) Rule on limiting interest deductibility
A common tax planning practice is for companies in low tax jurisdictions to provide financing to related companies in high tax jurisdictions and by so doing to reduce the taxable income in the high tax jurisdictions. Thus the rule on interest limiting deductibility has been introduced to prevent the above happening.
The interest limitation rule provides that the ‘‘excessive borrowing costs’’ (EBCs) will be tax deductible up to 30% of EBITDA (Earnings before interest, taxes, depreciation and amortization).
‘Excessive borrowing costs’ is defined as the excess of borrowing costs over interest income and other economically equivalent taxable revenues. ‘Borrowing costs’ is the interest expense on all forms of debt, other costs economically equivalent to interest, as well as expenses incurred in relation with the raising of finance.
Interest limitation rules apply on a local group level. There is a de minimis exception of €3 million.
The law defines a Cypriot group as made up by all Cypriot tax resident companies, as well as overseas companies that have a PE (Permanent Establishment) in Cyprus.
Other exemptions where interest limitation DOES NOT APPLY:
Carry forward provision
Any exceeding borrowing cost, whose deductibility is restricted due to the application of the new rule, can be carried forward for the next 5 years. It should however be noted that the non-utilized amount of the €3 million de minimis exception cannot be carried forward.
B) Controlled foreign company rule (CFC)
Controlled foreign company rules are features of an income tax system designed to limit artificial deferral of tax by using offshore low taxed entities.
In the ATAD the relevant CFC article allows Member States to choose between two options; namely (option A) which is generally applicable to passive income of a CFC and (option B), which is applicable to income arising from ‘non-genuine arrangements’, also referred to as the significant people functions approach. Cyprus adopted option B.
The CFC rules apply to resident companies and non-Cypriot tax resident companies which have a permanent establishment (PE) in Cyprus.
Controlled foreign company definition
According to the Law, a non-Cypriot tax resident company, or a foreign PE of a Cypriot tax resident company whose profits are not subject to or exempt from (Corporate) Income Tax in Cyprus, shall be treated as a CFC if the following conditions are met:
a) A Cypriot tax resident company, alone or together with its associated enterprises, holds a direct or indirect participation of more than 50% in a non-Cypriot tax resident company. The threshold is determined in terms of participation in the share capital, voting rights or the entitlement to profits of the foreign company.
b) The actual tax suffered by the non-Cypriot tax resident company or the foreign PE is lower than 50% of the tax that would have been imposed on that company or foreign PE had its profits been taxable in Cyprus. (i.e. lower than 6,25%).
Income to be taxed on the CFC
If an entity is a CFC the tax base of the Cypriot controlling taxpayer shall include any non-distributed income arising from ‘non-genuine arrangements’ which have been put in place for the essential purpose of obtaining a tax advantage under the Cypriot Income Tax Law.
‘Non-genuine arrangements’
An arrangement or series of arrangements shall be regarded as non-genuine to the extent that the CFC would not own the assets or would not have undertaken the risks which generate all or part of its income if it were not controlled by the Cypriot company which carries out the significant people functions which are relevant to those assets and risks that substantially contribute to the generation of the income of the CFC.
The attribution of profits of a CFC and the inclusion into the tax base of a Cypriot taxpayer is made in accordance with the arm’s-length principle as this is defined in the Cypriot Income Tax Law.
Exemptions:
The CFC rule does not apply where the foreign company or the foreign PE has either:
i) Accounting profits that do not exceed €750 000 and non-trading income which is not more than €75 000; or
ii) Accounting profits that do not exceed 10% of its operating costs for the tax year.
Avoidance of double taxation
Provisions for the avoidance of double taxation are included in the law aiming to avoid double taxation of the same profits.
C) General Anti-Abuse rule (GAAR)
The Law provides that for the purpose of calculating the corporate tax liability, any arrangement or series of arrangements should be disregarded if they have been put in place with the main purpose or one of the main purposes of obtaining a tax advantage.
An arrangement or a series of arrangements is considered to be non-genuine, to the extent that they are not put into place for valid commercial reasons which reflect economic reality.
The Cyprus ATAD first implementation law shows Cyprus’s willingness to comply wholly with EU tax initiatives and to adapt fully to a “post-BEPS” international tax environment. Clarifying interpretative circulars are expected to be issued by the Cyprus Tax Authority (CTA) in order to provide more practical guidance on this law.
For more information on the ATAD, please contact us at info@multilysis.com.
