Introduction
During the past thirty years Cyprus has developed into a formidable financial centre, renowned for its high quality services.
The local tax system is a key reason for this development. Cyprus is well known for its simplified tax system that provides numerous advantages to international investors.
The purpose of this paper is to provide a detailed analysis of the three most popular types of international Businesses, operating through Cyprus, financing, holding and trading companies.
Financing companies
Back to back loans
During 2011t the Institute of Certified Public Accountants of Cyprus (ICPAC) has agreed with the Commissioner of Income Tax that the below spreads would apply in the case of back to back loans:
Loan amount Minimum acceptable spread
Up to €50m 0,35%
Between 50m- €200m 0,25%
Above €200m 0,125%
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| It should be noted that the above spreads apply only when the Cyprus Company acts as an intermediary and obtains loan(s) from a related company which are further granted to another related company. |
However the scheme also applies for loans obtained from 3rd parties ( ie. from a bank), when the covenants and guarantees given for the loans are not from the Cyprus Company ( but from the owners or any other related party), as according to the guidance issued for such loans, those should not be subject to any risks in order to justify the low spreads.
Subsequently, if the loan(s) granted cannot be collected the Cyprus Company would not be able to claim this bad debt as tax deductible.
The time period between obtaining and granting the loan should not be more than 6 months.
The above spreads should result after taking into account any expenses and exchange differences arising. Therefore a loan of let’s say €20m should result a taxable income of €70k and a tax of €8.750.
Loans not considered as B2B
In relation to provision of financing facilities to any party, related or non-related, other than back to back loan, a “market interest rate” should be charged on the loan facilities.
There are no provisions in the tax legislation to what constitutes a “market interest rate”. In practice the Tax Authorities generally consider as an arm’s length interest rate the rate of 5- 6%, although different factors like the jurisdiction of the borrower( i.e Western European countries in which a company could obtain a business loan for 3% p.a vs Russia in which such loans bear interest of 11%)should also be taken into consideration when deciding what rate to use.
Holding companies
As per the Cypriot tax legislation any gain/ (loss) arising from the disposal of “titles” is exempt / (not allowable) for income tax purposes. Please see below a list of such instruments, as stated in tax circular 2008/13.
- Ordinary shares
- Founder’s shares
- Preference shares
- Options on titles
- Debentures
- Bonds
- Short positions on titles
- Futures/forwards on titles
- Swaps on titles
- Depositary receipts on titles (ADRs and GDRs)
- Rights of claims on bonds and debentures (interest
- Income is excluded and taxed under normal rate)
- Index participations only if they represent titles
- Repurchase agreements or Repos on titles
- Participations in companies
- Units in open‐end or closed‐end collective investment schemes
Any profit from the disposal of the abovementioned products is not taxable ( it is deducted from the company’s income) when determining the tax charge of a Cyprus resident Company. On the other hand, any loss deriving from the trade of the such instruments is also not tax allowable ( it is added back to income, thus eliminating the effect of such loss).
Dividend income from participations in companies
Dividends received from abroad are tax exempt unless both of the following conditions are not satisfied.
- The company paying the dividend must not engage directly or indirectly more than 50% in investing activities, and
- The foreign tax burden on the income of the company paying the dividend is not substantially lower than the tax burden in Cyprus (the lowest acceptable rate is considered to be 5%, even though CTA has not provided this in writing in the form of circular or guidance).
If both conditions fail then the company is taxed under Special Contribution for Defence (SCD) at 20% for the years 2012 and 2013 and 17% from 2014 and onwards.
Trading companies
Cyprus Tax Authorities expect that a Cyprus tax resident company will be selling goods and/or services at a reasonable gross profit margin resulting to reasonable net taxable margin after deducting administration and banking expenses.
Trading companies are taxed under the normal rate of 12.5%. All expenses that are wholly and exclusive for the generation of taxable income are allowable for tax purposes. All other expenses (which relate to non-business assets or activities are not allowable and are restricted during the computation of the taxable income( please see ‘’disallowable expenses ‘’ section below).
The tax legislation does not provide any guidance as for what should be the reasonable margin for every specific type of business. In practice though the tax office accept a reasonable margin between 5% to 10% for such companies. It worth noticing that as the absolute amount of annual income increases the acceptable net profit margin decreases. Furthermore the net profit margin should be in line with the financial and operating risks undertaken by the company.
In addition to the above the arm’s length provision of the Cyprus tax legislation should be considered which requires transactions between related parties to be conducted at an arm’s length basis.
Arm’s length transactions
According to the Cyprus tax legislation, article 33 of the Income Tax Law, transactions between related parties must be carried out on an arm’s length basis. This means that they should be carried out at no different terms to those applied in transactions between unrelated parties.
In case the Cyprus Tax Authorities (CTAs) consider that transactions between related parties are carried out on a non-arm’s length basis, they could adjust the tax base of the company accordingly.
Restriction of disallowable expenses
As discussed above expenses that are not wholly and exclusively for the purpose of trade are not allowable when determining the Cyprus chargeable income.
Example: The servicing cost of a loan used for the purchase of any asset following under ‘’ titles’’, in which case the restriction of interest should be calculated using the weighted average cost of borrowings and the cost of “non-business assets” or in case where it can be proved that the investment has been financed out from a specific loan, the interest rate of that specific loan could be accepted.
According to the Cyprus tax legislation and to the circular 2010/8, interest expense relating or deemed to relate to the cost of acquisition of “non-business assets”( assets that do not generate taxable income) should not be allowed as tax deductible for income tax purposes.
In addition circular 2008/14 states that expenses which relate directly or indirectly to exempt income and portion of the overheads expenses should not be treated as tax deductible expenses.
The same circular further clarifies that expenses should be apportioned to taxable and exempt activities according to the proportion of the assets used for generating taxable and exempt income.
Therefore, administration expenses apportioned to assets or activities that result to the production of income which is exempt from Cyprus income tax should not treated as tax deductible expenses for income tax purposes.
However as from 1.1.2012 the serving cost of loans obtained for the acquisition of 100% of investments ( either Cyprus or foreign entities) are considered as an allowable deduction provided that the acquired entity has no access that are not used in the business. If the acquired entity has such assets, the interest expense will be restricted in the extend that corresponds to those non business assets.
Non-resident companies with local presence
Companies that are non-residents in Cyprus are only taxed for their profits generated in the Republic.
Losses
According to the circular 2013/08 taxable losses are carried forward for five years. Any unitized losses of more than five years, are lost.