Updated: March 2015
18 Solutions for OECD Beneficial Owner and Economic Substance Requirements:
The Case of Cyprus
The viability of international tax planning and business structures has been affected by a coordinated effort by the G8 to address tax evasion and ultimate beneficial ownership of offshore companies.
A legislation (FATCA) introduced by the United States to encourage better tax compliance by preventing US Persons from avoiding US taxation on their income and assets.
As from 2014, the Organisation for Economic Cooperation and Development (OECD) focused on Base Erosion and Profit Shifting (BEPS).
In Cyprus and according to Cyprus Law, a Cyprus Company is considered a Cyprus tax resident company and therefore taxed in Cyprus if ιt is effectively managed in Cyprus. Ιt is generally accepted that a company qualifies as a tax resident of Cyprus if 1) decisions are taken in Cyprus – this includes board meetings, as well as the review and subsequent signing of agreements etc. 2) The majority of directors are tax resident in Cyprus.
These changing regulatory requirements raise important questions for owners of Cypriot companies:
PKF Cyprus has been working intensively to support its clients in complying with the letter and the spirit of the various efforts made to regulate international business taxes on transactions and holding companies. We have identified 18 solutions for compliance based on a careful analysis of policy announcements and regulations, and their implementation in practice.
Ultimate Beneficial Ownership
Cases like Vodafone, Prevost (Volvo), and Google have been scrutinised the use of tax ‘efficient’ structures as part of international tax planning to avoid paying taxes or minimising tax liabilities. Prevost (Volvo) was scrutinised as owning a holding company registered in Netherlands with no employees in order to get benefit from The Netherlands’ low withholding tax rates.
An intermediary company may not be regarded as the beneficial owner of income received in form of dividends, interest or royalties if a third party i.e. fiduciary provider or administrator, is acting on its behalf and consequently for the beneficial owners. If the tax authorities of the country of source are able to demonstrate that the intermediary company is not the beneficial owner, then it is likely that such a company will be taxed in the source country, thus lifting the veil of incorporation of that company.
What might then be a definition of a beneficial ownership? A beneficial owner is a person that, either directly or indirectly, has the power to influence decisions emanating mainly from direct or indirect ownership.
The Organisation for Economic Co-operation and Development (OECD) recent attempt was to describe the term of the beneficial owner relating to the receipts and payments of dividends, interest and royalties mainly by conduit companies.
In particular an intermediary company is not a beneficial owner if the right to use and enjoy the dividend is constrained by a contractual or legal obligation to pass on the payment. In substance, the recipient does not have the right to use and enjoy the dividend unconstrained and if the obligation relates to the payment received. Each case will be treated on the interpretation of legal documents, facts and circumstances.
Economic Substance / Physical Presence
Another important aspect considered by the OECD is the concept of economic substance. Sufficient economic substance should be present at the level of the intermediary Company and therefore allocation of risks should be consistent with the economic substance of that company.
The OECD and European Commission have both examined the issue of economic substance, while the issue is also enshrined in the Double Tax Treaties that Cyprus has with many countries like Russia and Greece.
Economic substance is now an absolute necessity for investors using Cyprus or any other international jurisdiction. The typical definition of economic substance is that a transaction or entity must have an economic purpose besides reducing tax liability in order to be considered valid.
A key aspect of this is that holding companies, for instance, must have a real physical presence in Cyprus, documented through establishing independent offices with staff administering the day-to-day management of the company.
18 Solutions for Compliance
Structuring activities internationally through a Cyprus international company the following 18 solutions and issues should be taken into account:
1. Apply Proportionality
It is important to remember that at this time, there is no standard approach as to when sufficient substance is actually achieved. Each company and its corporate structure should be reviewed on a case-by-case basis. Each jurisdiction has multiple interpretations possible. As a rule of thumb, the entity owning the most valuable intangibles and performing the most important functions within a corporate structure will typically be entitled to the largest share of the profits or losses. PKF utilises a specific review process that checks each tax case for proportionality, relying on our in-house expertise as well as the 440 PKF partner tax offices, providing global coverage.
2. Structure Beneficial Ownership
The Cyprus Company should beneficially own the income it receives. The Cyprus Company receiving foreign dividend income under the terms of a double tax treaty should not receive that income on behalf of another person. The income should accrue to the Company itself and be reported in its bank account and financial statements. The company should freely deal with inflow of funds representing the dividend received at its full discretion.
3. Make Qualified Director Appointments
Appointing qualified directors residing in Cyprus who have the ability to make decisions and really understand the nature of business is a critical point in compliance. Directors must be resident in Cyprus and must have the requisite CVs and qualifications to manage the firm.
4. Maintain Office Presence
Cyprus economic substance may be achieved by maintaining the group head offices in Cyprus, as well as having fully fledged offices with business telephone lines, telephone answering and call forwarding machines, own website and employ full time or part time employees.
5. Maintain Business Records
Original minutes of conferences, general meetings, electronic mail, general administration, accounting are kept at the seat of the Cyprus International Company.
6. Contract via the Cyprus International Company
The status and Cyprus economic substance of a Cyprus International Company may not be challenged if the Cyprus company is entering into contracts of purchase and sale; ordering of goods or services from third parties; raising of invoices; opening and administering of Cyprus bank accounts and International bank accounts; acquiring property and share assets.
7. Invest via the Cyprus International Company
Investment in associated companies in the form of interest-bearing debt. The transaction should be structured in accordance with the economic and commercial reality of parties dealing at arm’s length.
8. Continually Develop the Company
When setting up a Cyprus International Company, it is extremely important not just to demonstrate the initial reasons for forming it but also to continuously demonstrating Cyprus economic substance throughout the Cyprus Company’s lifetime. For example, if one of the reasons for forming a Cyprus Company is to improve cost control and enhance risk management, at all times should provide evidence and demonstrate the new controls and methods of improving cost control. Additionally at all times there should be a review of documents such as articles of association, financial statements, board resolutions, expense information, functions and risks associated to the Cyprus company, loan agreements, license agreements, patent/copyright registration certificates, and agency/proxy agreements etc.
9. Utilise Transparent Tax Planning Decisions
There are certain cases where even they are largely tax-motivated, the treatment of taxation might not be altered by a tax authority. For example the choice between capitalizing a business enterprise with debt or equity, or a person’s choice between utilizing a foreign corporation or a domestic corporation to make a foreign investment, the choice to enter a transaction or series of transactions that constitute a tax-free corporate reorganization and even the choice to use a related-party entity in an arm’s length transaction.
10. Avoid Multiple Directorships
Avoid setting-up a structure in which directors of the Cyprus International Company or a foreign company are coincidentally the same directors of the source company. In this case almost in all jurisdictions tax authorities will easily consider that in reality all decisions are taken in the source country and not in the foreign company, resulting in a lack of economic substance. Therefore it should be seen clear that the company is in reality operating in itself and not under the supervision or control of the company of the source country.
11. Allocate Group Assets to the Cyprus International Company
To the extent that it is feasible, allocate to Cyprus International Company as much group assets as possible. This avoids the threat of “thin capitalisation”, and provides evidence that the Cyprus company has real activities behind it. In contrast to other EU countries, the treatment of overseas holdings by the Cypriot Inland Revenue Department ITO is among the most flexible and competitive in the European Union.
12. Hold International Assets via a Cyprus Holding Company
A Cyprus Holding Company with multiple investments in foreign companies is considered to have greater economic substance than a holding company with only one investment.
13. Manage Interest Income and Dividends
Income received in a form of interest from a foreign company and distributed to the source country by a Cyprus company in a form of dividend, might be considered a form of unrelated payment received.
14. Structure Loan Income and Loan Agreements Rationally
Payments in respect of loans between foreign companies, Cyprus Finance Company and foreign source company should be unrelated. Is the beneficial ownership waived due to the fact that interest collected by the Cyprus Company is to meet its obligations under another financing agreement? In such a case identifying the beneficial owner is rather a complex task. The problem even becomes more complex on income arising on securities and financial derivatives. The solution to this might be:
15. Manage Intellectual Property Rights (IPR)
Transfer intellectual property rights (IP) to a Cyprus Company. The Cyprus Company licences the intellectual property rights (IP) to a multiplicity of different foreign companies in foreign countries. Foreign payments to a Cyprus Company should be commercially justifiable. In addition the Cyprus Company may incur regular expenditure which may add value to the intellectual property rights (IP) activities.
16. Use of Cyprus Alternative Investment Funds for Major Investments
If possible, transactions should be subject to a statutory or regulatory scheme. One such example are the Cyprus Alternative Investment Funds – AIFs). Shares or units of a Cyprus Investment Fund – Cyprus Alternative Investment Fund (AIF) are held by a custodian bank, administered by the administrators and regulated by relevant government bodies. The true owner is the beneficial owner even though for safety, control and convenience, shares or units are held by the custodian bank and administered by the administrators.
17. Consider a Cyprus Stock Exchange Listing
Another option to consider is listing the Cyprus International Company to the Cyprus Emerging Capital Market. History requirements are minimum; listing and maintenance costs are not restrictive; no minimum share capital must be dispersed among the general public.
18. Establish a Cyprus International Trust
Setting up a Cyprus International Trust to own the shares of a Cyprus company is a further step to secure beneficial ownership. If a Cyprus International Trust is a discretionary Cyprus International Trust, the beneficiaries will not have ownership or control over the shares of the Cyprus Company.
Conclusions: Cyprus Economic Substance and Beneficial Ownership
In demonstrating beneficial ownership and Cyprus economic substance, Cyprus is not only well-positioned to face the challenges from other tax authorities, but also creates the opportunities for entrepreneurs and managers thinking of locating their business or a particular function of their business to Cyprus.
How PKF Can Help
We assist companies develop value-adding, real solutions using Cyprus as their international business headquarters. Many investors prefer cheap solutions, such as setting up a Cyprus company offering consultancy services, with no economic substance. Under the new international regulatory environment, such entities have a substantial risk of facing challenges by tax authorities.
PKF Cyprus assists you with issues of Cyprus economic substance and beneficial ownership by organising adequate Cyprus substance for your Cyprus business and dealing with matters of beneficial ownership as well as reviewing and assessing your existing structure. Through our network, we can also assist you with issues relating to economic substance and beneficial ownership in other jurisdictions.
We can also offer fully fledged offices and part-time or full-time staff that can be employed by your Company. The offices are located in a corporate business center which was designed to accommodate international foreign companies. Our business center is situated in one of the best business areas of Nicosia.
Please contact us for a free personal consultation. All information will be treated in the strictest confidence. We are happy to sign NDA / NCA or other legal safeguards.
PKF / ATCO Limited is a member firm of the PKF International Limited network of legally independent firms and does not accept any responsibility or liability for the actions or inactions on the part of any other individual member firm or firms. This publication is for information purposes only and should not be considered as professional advice.