Article as given to World Tax 2008 - November 2007
The Cyprus economy has experienced some radical changes over the past 40 years. Starting with a structure which had as its base agriculture and mining during the 1960s, the Cyprus economy changed and by the mid 1970s the manufacturing sector had gained prominence. The same economy changed again during the 1980s and it is now firmly based on the services sector with tourism being the major source of income for the country. The above changes have allowed Cyprus not only to survive the radical international changes but also to have growth rates and economic indicators which can favourably be compared with those of other developed countries.
The services sector of the Cypriot economy now accounts for about 70 per cent of the GDP and around 70 per cent of the gainfully employed population. It includes a wide range of services such as banking and financial services, insurance, advertising, legal, architecture and civil engineering, accounting and auditing, consultancy, design, electrical and mechanical engineering, film production, market research, medical, printing and publishing, public relations, education, software development, tourism and related services, telecommunications, transportation and other services. The size and rate of growth of this sector, which has been the fastest in recent years, has led some observers to call Cyprus a "service economy".
One of the main factors which contributed to the creation of the service industry is the entrepreneurial spirit and the high level of education and skills of the Cypriot people.
Cyprus as a financial centre
Whereas Cyprus has long been a well established International Financial Centre with an attractive taxation system and excellent infrastructure facilities and financial services, further to the island’s accession to the EU on 1 May 2004, Cyprus is now firmly established as the ideal gateway for EU inbound and outbound investment. The tax reform that took place and the new legislation adopted from 1 January 2003 was aimed at making Cyprus a highly attractive location for international business and in fact the Cyprus tax regime is one of the most attractive in the EU whilst being at the same time fully in line with EU and OECD requirements against harmful practices.
Cyprus is highly ranked on the list of preferential tax jurisdictions for international tax planners with the lowest corporate tax rate in the European Union and several tax advantages for holding companies such as full participation exemption (dividends and capital gains) and zero withholding taxes on dividends, interest and royalties. Even though Cyprus is up against other favorable holding company locations, such as the Netherlands, Switzerland, Ireland, Luxembourg and Malta, it is rising to the challenges ahead including the improvement of a good infrastructure, the decrease of administration procedures and the enhancement of financial and supporting services.
Key benefits offered
The main features of the Cyprus tax system are as follows:
- Tax is imposed on all Cyprus resident persons (individuals and corporations) on their worldwide income. A corporation is tax resident in Cyprus when its management and control is exercised in Cyprus. An individual is tax resident in Cyprus when he/she spends more than 183 days in Cyprus in a calendar year.
- Uniform corporate tax rate of 10%.
- Tax exemption on disposal of shares and similar titles.
- Deduction of costs. Under Cypriot law all expenses incurred wholly and exclusively for the production of income are deducted before arriving at the taxable income.
- Tax exempt dividend income (subject to minor conditions).
- No imposition of any withholding tax on dividend and interest and royalties paid by a Cypriot company to non tax resident shareholders including individuals and corporations.
- Tax relief for group losses.
- No controlled foreign corporation (CFC) legislation.
- No thin capitalisation provisions in the Cypriot tax legislation.
- Tax neutral reorganisations to both EU and non EU members.
- Acceptance of a thin profit margin as being arm’s length.
- Exemption of profits from a permanent establishment/fixed place of business abroad.
- Full adoption of all EU directives.
- Extensive double tax treaty (DTT) network
Tax Planning Opportunities
The key benefits outlined above in brief render Cyprus the ideal location for:
- Holding companies
- Finance companies
- Royalty companies
- Property holding companies
- Trading companies
Holding Company
A Cyprus holding company can act as an intermediate holding company to assist in the repatriation of dividends in a tax efficient manner. The use of a Cyprus holding company also avoids triggering off thin capitalization rules and controlled foreign company rules that exist in countries such as Germany, UK and the Netherlands.
As a holding company location, Cyprus is the obvious choice since it is possible for income to flow through a Cyprus company tax free and what is more Cyprus offers very effective and quick tax free exit routes to investors.
The Cyprus tax system offers full participation on dividend income and on gains on disposal of shares by exempting such gains without the imposition of any conditions.
A non EU investor can therefore gain access to the EU market through a Cyprus holding company. Profits can be distributed to the Cyprus company from the EU trading company location tax free by application of the Parent/Subsidiary Directive. In Cyprus the dividend income will be exempt from taxation, and repatriation from Cyprus to the non EU investor will be tax free since Cyprus does not levy withholding taxes on distributions to persons outside Cyprus. The reverse, is also possible, that is an EU investor wishing to invest in a non European market.
EU operating subsidiary
Dividends will be received in Cyprus with no withholding tax under the provisions of the EU Parent Subsidiary Directive.
Non EU operating subsidiary
Dividends will be paid to the Cyprus holding company net of the withholding tax. The level of the withholding tax is subject to the double tax treaty between Cyprus and the other non EU member state of the operating subsidiary.
- Dividends received by the Cyprus holding company
Exempt from all taxes.
- Dividend paid to non-resident shareholder
There is no withholding tax on dividend paid by the Cyprus holding company to the non-resident shareholder, based in the EU or outside the EU.
- Disposal of the operating subsidiary
The gains arising from the disposal of the shares of the operating subsidiary are not subject to any tax in Cyprus, provided that the operating subsidiary does not own any immovable property in Cyprus.
Finance Company
Finance companies are also favoured due to the low tax rate imposed on interest income (10%). Relief is usually granted on the interest expense charged by the Cyprus company at a higher rate, there is no withholding tax if from an EU location by means of application of the Interest and Royalty Directive and in Cyprus the income is taxed at 10%. Other structures are possible for finance companies, resulting in much lower effective tax rates such as using foreign branches (Switzerland, Ireland or the BVI) of a Cyprus company.
Royalty Company
Royalty companies operate in much the same way as finance companies. Income from royalties is included in the computation of the taxable profits of a Cyprus tax-resident company and is subject to tax in Cyprus at the rate of 10%. Royalty payments are deductible expenses in the computation of the taxable profits of a Cyprus tax resident company. The gross amount of any royalty premiums payable for the use of the intellectual property outside Cyprus are not subject to withholding tax unless the IP is used within Cyprus. In the latter case there is withholding tax at 10% (5% if it relates to cinema films), unless the DTT provides for a lower rate or the EU interest royalty directive applies.
Property Holding Company
Cyprus is more and more frequently used as a property holding company location for investors wishing to invest in countries such as the Russia, Ukraine, UK, Romania, India etc. Usually a Cyprus special purpose vehicle is created to hold shares in a property holding company in the target location. Future taxation on gains on disposal of the property is avoided by disposal of the shares that the Cyprus SPV holds in the property holding company since taxation of the gains on disposal of shares is granted to Cyprus under the DTT and such gains are exempt under local rules.
Trading Company
The low corporate tax rate (10%), lowest in Europe renders Cyprus an attractive location for trading activities. Trading through a Cyprus company allows profits of big multinational companies to be taxed at a low effective tax rate.
Conclusion
International tax planning is becoming one of the most effective strategies to increase returns to shareholders. Cyprus is rapidly becoming the jurisdiction of choice of multinational corporations for holding companies, with a tax system which is in line with EU requirements and the OECD model and in depth knowledge and extesive experience in the international business sector.
The international business community should rest assured that Cyprus is an attractive location which will remain so for many years to come. It is the door for investors who want to enter into the European Union. It is also the door for European Union investors who want to invest in locations with which Cyprus has favorable DTTs. Russia and Ukraine are possibly the best examples with a low 5% WHT on dividend payments to Cyprus, resulting in Cyprus the number one investor in these countries. The huge emerging economies of China and India are also prime targets for investors; Cyprus’ favorable DTTs with these two countries result to new business openings. Cyprus can take an advantage of this status exploiting the future opportunities with optimism.
