Cyprus: Adoption of Rules Against Tax Avoidance Practices

Following the publication of the EU Anti-Tax Avoidance Directive (ATAD I) on 12 July 2016, the House of Representatives voted into Cyprus Law its provisions on 5 April 2019. 

The three measures explained below are applicable from 1 January 2019. Additional measures based on ADAD II are expected to be voted by the House of Representatives by 1 January 2020. These measures apply to all companies and entities that are subject to Cyprus tax, including entities that while are not Cyprus tax residents, they have a Cypriot permanent establishment. 

Interest limitation rule 

The purpose of this rule is to prevent provision of group financing to companies based in high tax jurisdictions from companies based in low tax jurisdictions and limits the deduction of interest resulting from this financing facilities. 

More specifically, this rule provides that exceeding borrowing costs are deductible in the tax period they incurred up to 30% of taxable income before interest, tax, depreciation and amortisation (EBITDA) and up to €3.000.000 per year per company or Cypriot group. 

Whenever, a company is a member of a Cypriot group, the rule is applied at the level of the Cypriot group as defined in the Income Tax Law, including permanent establishment in Cyprus. 

The rule does not apply to: 

• Financial undertakings (credit institutions, insurance/reinsurance companies, pension institutions, alternative investment funds (AIF), undertaking for collective investment in transferable securities (UCITS), derivative counterparties, central securities depositories and securitisation special purpose entities (SSPE) 

• Standalone entities 

• Loans concluded before 17 June 2016 until any subsequent modifications 

• Loans used to fund long-term infrastructure projects which are considered to be in the general public interest 

Furthermore, the rule has an escape clause in the case the company is a member of a consolidated group for financial accounting purposes. It may receive the right to fully deduct exceeding borrowing costs if it can demonstrate that the ratio of its equity over its total assets is equal to or higher than the equivalent ratio of the group. This applies when the ratio is equal or at most lower by 2% of the group ratio and all assets and liabilities are valued using the same method as in the consolidated financial statements.

Taxpayers may carry forward such borrowing costs and deduct them from taxable profits for the next 5 years. 

Control Foreign Companies (CFC) rule 

This rule aims to prevent the redistribution of revenue within groups towards entities that are based in low tax jurisdictions. 

A company or a permanent establishment which is not subject to Cypriot tax is considered a CFC when the following conditions are met:

• Cyrus tax resident company itself or together with associated entities holds a direct or indirect participation of more than 50% of the voting rights or of the capital or is entitled to received more than 50% of the profits of such entity 

• The corporate income tax actually paid by the entity is less than the 50% of such tax that would be paid in Cyprus 

The rule states that the non-distributed income of a CFC, which arose from non-genuine arrangements that have been put in place for the essential purpose of obtaining a tax advantage, should be added to the tax base of the Cyprus tax resident entity. Non-distributed income relates to post accounting profits that has not yet been distributed within the year the profit is derived or within a period of seven months after the year end. 

The CFC rule is not applied when accounting profits are less than €750.000 or accounting profits do not exceed 10% of the operating costs of the period. 

In addition, there should be no CFC charge if there are not significant people functions in Cyprus that are essential in generating income of the CFC. In such case, a transfer pricing study will be required. 

The income or loss to be included in the tax base of the Cyprus tax resident company should be restricted to amounts generate from assets or risks associated to significant people functions performed by the same company. The income should be attributed based on arm’s length principles and it is restricted to the amount of non-distributed income of the CFC. Such income or loss should be included in the tax period of the Cyprus tax resident company in which the tax period of the CFC ends. 

General Anti-Abuse rule 

This rule aims to prevent abusive tax practices that have not yet been dealt with any specific provision. In particular, any arrangement or series of arrangements that have not valid commercial reasons reflecting economic reality and/or are not genuine and their main purpose is to obtain a tax advantage should be ignored in the calculation of corporate tax liabilities in Cyprus. 

The Erosion of Member States (MS) Tax Sovereignty in the European Union (EU) 

In its 2019 European Semester the European Commission (Commission) communicated to the European Parliament, the European Council, the Council and other bodies, its country specific recommendations. In the area of taxation the Commission states < The transposition of EU legislation and of international agreed initiatives will help curtail aggressive tax planning practices. Certain features of some Member States’ tax systems, i.e. Cyprus, Hungary, Ireland, Malta and the Netherlands however may be used by companies that engage in aggressive tax planning>. 

Governments aim to maximise tax collections. But they do not attack evaders of tax. They attack avoiders of tax those who in the opinion of the governments avoid tax aggressively. There is no gradation in avoidance. There is no polite and aggressive avoidance. Tax avoided under the law is legal. Evasion is illegal. So they attack legality? 

The European Court of Justice (ECJ) commented. < Furthermore, where the taxable person has a choice between two possibilities, he is not obliged to choose the one which involves paying higher amount of tax but, on the contrary, may choose to structure his business so as to limit his tax liability . . . . . taxable persons are generally free to choose the organisational structures and the form of transactions which they consider appropriate for their economic activities for the purpose of limiting their tax burdens. The mere fact that a business structure was chosen . . . . . that did not generate maximum tax burden . . . . . cannot in itself qualify as abuse . . . . . indeed every undertaking must be expected to want to maximise its profit>. 

Under the EU treaty MS have sovereignty over their tax law. Directives require unanimous decision. Nevertheless directives are issued that erode the tax sovereignty of MS even with provisions rejected by the ECJ such as Controlled Foreign Corporation (CFC). 

How does the interest limitation rule protect from Base Erosion and Profit Shifting (BEPS) when applied within the country. Its application results in double taxation both when applied cross boarder and internally! 

The ECJ protects the fundamental freedoms enshrined in the European treaty. The directives violate this. 

Even though there is opposition against the Common Corporate Tax Base (CCTB) and the Common Consolidated Corporate Tax Base (CCCTB) discussion continues. It is a mystery beyond comprehension why MS opposing allow the discussion to continue. The dark corridors of Brussels seem very powerful. 

MS are deprived form using traditional economic tools such as money supply and interest rates, government spending and exchange rates in their economic planning. The EU is an organisation with a common market not a common economy. So the surpluses in one geographical area are not shared with the deficits of another geographical area because they are not one economy. The only tool left to a MS to apply its own economic policy is the taxation system. With the tax directives that are imposed by the wealthy upon the weakest economies the EU is cementing and enlarging the gap between the rich and the poor. Is the EU solidarity a fallacy?

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