There have been significant discussions around the world on taxpayers’ methods of minimizing taxes. Expressions like “beneficial owner, economic substance management and control, place of effective management, resident” have been triggering discussions throughout the world as they are closely related with people’s tax minimisation.
Residents of non – treaty countries have been able to obtain the benefits of the conventions between two treaty countries usually by forming an intermediary company (flow-through company), in a treaty country in order to obtain treaty benefits.
Recent cases like Vodaphone, Prevost (Volvo), Google etc, have been scrutinised and defamed of using tax ‘efficient’ structures as part of their international tax planning to avoid paying taxes or minimising their tax liabilities. Prevost (Volvo) was scrutinised as owning a holding company registered in Netherlands with no employees in order to get the benefits of 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. Furthermore 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 the company. On the contrary, a company is an entity itself and is distinct from its shareholders. Some of the intermediary company’s powers may be exercised by its directors without the interference of its shareholders. Directors may also be advised from other experts and in many cases they have sufficient powers to make decisions.
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 which relates to the receipts and payments of dividends, interest and royalties mainly by conduit companies. In particular a conduit 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 the payment on, 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.
Another important aspect which was considered by the Organisation for Economic Co-operation and Development (OECD) was 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.
Structuring activities internationally through an intermediary company i.e. via a Cyprus international company, important considerations need to be taken into account. Some of these are:
1. Firstly, 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. 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;
2. 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 arise 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. Appointing qualified directors residing in the country of the intermediary company for example in Cyprus which will have the ability to make decisions and really understand the nature of business;
4. Cyprus economic substance may be achieved by maintaining 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. Original minutes of conferences, general meetings, electronic mail, general administration, accounting are kept at the seat of the Cyprus International Company;
6. 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. 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. 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. 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 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. To the extent that it is feasible, allocate to Cyprus International Company as much group assets as possible.
12. It might be unlikely that a Cyprus Holding Company be challenged if it is used to hold multiple investments in foreign companies;
13. 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. Cyprus Company (finance). 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:
– Both transactions shouldn’t be made by same counterparties;
– Time of execution of transactions should not be the same;
– Interest rates should not be similar but instead should be at arms length and related to commercial rates;
– Adequate returns (profits) allocated to each company and in relation to risk undertaken;
– Same duration of loans might not be the same;
– Amount of loans received and loans granted might not be the same;
15. A foreign company assigns intellectual property rights (IP) to a Cyprus Company and Cyprus Company sub – licences the intellectual property rights (IP) to a multiplicity of different foreign companies in foreign countries. Foreign payments from foreign company to a Cyprus Company and from Cyprus Company to multiplicity of different countries should commercially justifiable. In addition the Cyprus Company may incur regular expenditure which may add value to the intellectual property rights (IP) activities;
16. If possible, transactions should be subject to a statutory or regulatory scheme for example Cyprus funds – International Investment Collective Schemes (ICIS). Shares or units of a Cyprus fund – International Investment Collective Schemes (ICIS) are held by a custodian bank, administered by the administrators and regulated by the Central Bank of Cyprus. 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. 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. The setting up of a Cyprus International Trust to own the shares of a Cyprus company. 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;
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 even small businesses who might think of locating their business or a particular function of their business to Cyprus.
How PKF can help
We can assist companies which want to get away from cheap solutions i.e. ‘setting up a Cyprus company offering consultancy services’ with no economic substance which are at all times running the risk of being challenged by tax authorities. We are able to assist 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.