Cyprus company business substance considerations:
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.
As from 2014, the Organisation for Economic Cooperation and Development (OECD) focused on beneficial ownership principles and on Base Erosion and Profit Shifting (BEPS) in order to close gaps in international taxation for companies that allegedly avoid taxation or reduce tax burden.
In Cyprus, for Cyprus company residency purposes, a Cyprus Company needs to demonstrate that management and control is effectively exercised in Cyprus .
These changing regulatory requirements raise important considerations for owners of Cypriot companies.
Ultimate Beneficial Ownership
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) 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 / business Substance / Physical Presence
Another important aspect considered by the OECD is the concept of economic / business 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 / business substance, while the issue is also enshrined in the Double Tax Treaties that Cyprus has with many countries.
Economic / business substance is now a 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 / business purpose besides reducing tax liability.
In structuring activities internationally through a Cyprus international company the following considerations should be taken into account:
1. Cyprus tax residency – Ensure that a Cyprus company is a tax resident of Cyprus
As part of a Cyprus company’s business substance the place of tax residence of a Cyprus company is of the utmost importance. Tax residence is determined by Cyprus legislation, the parent / subsidiary directive applicable in Europe, the double taxation treaties between Cyprus and other countries, the Organization for Economic Cooperation and Development – OECD and other relevant bodies. It is therefore important to demonstrate that a Cyprus company is a Cyprus tax resident Company and therefore not a tax resident elsewhere. Most countries and most of the bodies mentioned above consider that a tax residency can be determined from the company’s place of effective management.
2. Cyprus company key management and decision makers should meet in Cyprus, decisions taken in Cyprus and place of effective management be in Cyprus
For Cyprus business substance purposes Cyprus companies need to demonstrate that key management and decisions are taken Cyprus. Even though there is no specific definition in the Cyprus income tax law or in any other Cyprus law, as to what constitutes a place of effective management, the definition of the OECD Model Convention in relation to the “effective management site” is the definition most likely to be followed by the Cypriot tax authorities. It is understood by Cyprus tax authorities that effective management / management and control is where the Board of directors meets and takes decisions.
3. Making of high-level decisions that set the Cyprus company’s general policies in Cyprus
Generally and globally the place of effective management is the place where the key management and commercial decisions that are essential to conduct the work of the entity as a whole are essentially made. The key element in the control and direction of a company’s operations is the making of high-level decisions that set the company’s general policies, and determine the direction of its operations and the type of transactions it will enter in Cyprus.
4. Emphasize on the type of strategic decisions taken in Cyprus – Investment policies, buying and selling of shares or significant assets, appointing officers
Exercising management and control of a company can involve setting investment and operational policy including buying and selling of stock or significant assets, appointing company officers, overseeing and controlling those appointed to carry out the day-to-day business of the company, and matters of finance, including determining how profits are used and the declaration of dividends.
5. Cyprus company director’s knowledge
The directors’ knowledge is also relevant in demonstrating Cyprus business substance. Lack of knowledge sufficient to enable the Directors of a Cyprus company to make decisions, suggests they are not the real decision makers and hence Cyprus company lacks business substance.
6. Outsiders do not dictate or control the Cyprus company
The Cyprus company may not be considered as having Cyprus business substance if an outsider actually dictates or controls its decisions. It is therefore important that Cyprus company’s directors must not be directed by outsiders or Cyprus company shareholders, but rather should act independently in the interests of the Cyprus company.
7. High – level decision makers should be present in Cyprus
Cyprus companies should appoint high – level decision makers so as to control and direct the Cyprus company from Cyprus.
8. Apply Proportionality
It is important to remember that 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.
9. 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.
10. Maintain Office Presence / Cyprus business substance
Cyprus economic / business 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 employees.
11. Maintain Business Records
Original minutes of conferences, general meetings, electronic mail, general administration, accounting are kept at the seat of the Cyprus International Company.
12. 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.
13. 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.
14. 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.
15. 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.
16. 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.
17. 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 Cyprus Tax Department is among the most flexible and competitive in the European Union.
18. Holding of assets
Holding of assets by Cyprus holding company like investments in shares, intangibles or other assets, including real estate or ships, can enhance Cyprus business substance
19. Cyprus companies established for specific legitimate purpose in Cyprus
Cyprus companies undertaking group financing activities or acting as group treasurer in Cyprus or Cyprus companies established to facilitate currency trades in Cyprus, asset transfers or corporate mergers are more likely to be considered as having business substance.
20. Holding of multiple investments
A Cyprus Holding Company with multiple investments in foreign companies is considered to have greater economic / business substance than a holding company with only one investment.
21. 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.
22. 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 following considerations might also be taken into account:
23. Cyprus company capital adequacy
The Cyprus Company has sufficient capital reserve to take the risks of its operations, so the Cyprus Company is not a mere conduit company, and the profits or losses from the Cyprus company operations will entirely belong to the Cyprus Company
24. Cyprus Company as part of Cyprus business community
Cyprus Company may also actively take part in the Cyprus business community by registering as a member to various Cyprus associations. Registering as a member to various Cyprus associations like the Cyprus Chamber of Commerce, the Cyprus International Businesses Association or similar bodies in Cyprus is an indication that the Cyprus Company is having real presence in Cyprus
25. Manage Intellectual Property Rights (IPR)
Transfer intellectual property rights (IP) to a Cyprus Company. The Cyprus Company licenses 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.
26. Use of Cyprus Alternative Investment Funds for Major Investments
If possible, transactions may 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.
27. 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.
28. 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 irrevocably Cyprus International Trust, the beneficiaries will not have ownership or control over the shares of the Cyprus Company.
Conclusions: Cyprus Business Substance and Beneficial Ownership
In demonstrating beneficial ownership and Cyprus business 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.
Through our affiliates, 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.
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The authors expressly disclaim all and any liability and responsibility to any person, entity or corporation who acts or fails to act as a consequence of any reliance upon the whole or any part of the contents of this publication.
Accordingly no person, entity or corporation should act or rely upon any matter or information as contained or implied within this publication without first obtaining advice from an appropriately qualified professional person or firm of advisors, and ensuring that such advice specifically relates to their particular circumstances.
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