Cyprus business substance requirements:
The viability of international tax planning and business structures has been affected by a coordinated effort by the G8 to address tax evasion. The Organisation for Economic Cooperation and Development (OECD) and the EU are continuously focusing on beneficial ownership principles, on Actions that have been drafted to combat tax evasions, such as the Base Erosion and Profit Shifting (BEPS) Action plan and the EU Anti-Tax Avoidance Directive (ATAD) in order to close gaps in international taxation for companies that avoid taxation or reduce the tax burden.
It is now clear that the Organization for Economic Co-operation and Development (OECD) and the EU will impose more stringent measures that will affect multinationals in general and multinationals operating in Cyprus in general. To this end, Cypriot registered companies are now more urgently required to demonstrate that the management and control of a Cypriot registered company are exercised in Cyprus and that there is sufficient business substance and physical presence in Cyprus. and in the event that these companies fail to do so they are running the risk of being taxed elsewhere.
In order to achieve sufficient business substance and physical presence in Cyprus, multinationals operating in Cyprus are urged to do the following:
1. Cyprus tax residency – Ensure that a Cyprus registered company is a tax resident of Cyprus
As part of a Cyprus registered company’s business substance, the place of tax residence of a Cyprus registered 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 registered 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 registered company key management and decision-makers should meet in Cyprus, the decisions should be taken in Cyprus and place of effective management should be 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 worth noting that for certain countries the place of effective management/management and control might extend to :
• Where the CEO and other senior executives usually carry on their activities
• where the senior day-to-day management is carried out
• Which country law governs the legal status
• Where are the headquarters located
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 conducting 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.
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 a 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 demonstrates they are not the real decision-makers and hence Cyprus company may lack business substance.
6. Outsiders do not dictate or control the Cyprus company
The Cyprus registered 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 registered 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. The business should be carried out by its own personnel. It is also sometimes important to demonstrate that the Cyprus company personnel actually contributes to the generation of the income 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. Take into account the appointment status of directors in terms of participation in the company’s activities and the type of appointment
The appointment of qualified Directors who are likely to be residents of Cyprus, who will be involved in the company’s decision making. Creating a structure in which the Directors of the Cyprus Company are themselves the directors of other affiliated companies should be avoided. Senior clerks / decision-makers may also be relocated to Cyprus.
9. Director’s remuneration
The remuneration of Directors which is equal to a nominal remuneration received by a nominal Director may not be sufficient to demonstrate that the Cypriot registerd Company is self-governed.
10. 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.
11. Beneficial Ownership
The Cyprus registered 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 the inflow of funds representing the dividend received at its full discretion.
12. 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 managed from Cyprus and employ employees.
13. Maintain Business Records
Original minutes of conferences, general meetings, electronic mail, general administration, accounting are kept at the seat of the Cyprus Company.
14. Contract via the Cyprus International Company
The status and Cyprus economic substance of a Cyprus registered 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; acquiring participation in other entities eta.
15. Cyprus bank accounts
Maintaining bank accounts with local banks, where income is first received and deposited. At least one of the signatories of the bank accounts might be located in Cyprus. It is also important about who opened the relevant bank accounts in Cyprus and who is responsible for conducting related banking transactions.
16. Board meetings
Board meetings and regular business meetings need to be held and documented regularly in Cyprus
17. 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.
18. Continually Develop the Company
If to set up a Cyprus 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 to set up 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 with the Cyprus registered company, loan agreements, license agreements, patent/copyright registration certificates, and agency/proxy agreements, etc.
19. 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.
20. Avoid Multiple Directorships
Avoid setting-up a structure in which directors of the Cyprus registered Company or a foreign company are coincidentally the same directors of the source company. In this case, almost 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 clearly that the company is, in reality, operating in itself and not under the supervision or control of the company of the source country.
21. Allocate Group Assets to the Cyprus Company to avoid “thin capitalisation threads”
To the extent feasible, allocate to Cyprus 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.
22. The allocation of assets and business risks of the Group to the Cyprus Company
To the extent practicable, the allocation to the Cyprus Company of business risks and assets. Sometimes it is very important to demonstrate that the Cypriot entity is able to generate the income it presents by examining the assets it uses and the business risks it incurs. It may sometimes be necessary to prove that the entity owns the assets and assumes the appropriate risks that generate all or part of its revenue as if it were not controlled by another company and that significant employee actions are critical to generating its income.
23. Exercise adequate control over business risks by the Company itself and its Management
In some cases, it might be important to demonstrate that the Directors and staff of the Cyprus Company exercise adequate control over business risks.
Control over risks might comprise:
• The capability to make decisions, to take or decline risk-bearing opportunities, together with the actual performance of this decision- making function.
• The ability to make decisions about whether and how to respond to opportunity-related risks, along with the actual performance of this decision-making function.
• Sometimes the question should be asked: Is this a simple formal decision made through the practices of a properly convened board of directors that exercises risk control?
• Financial risk-taking capacity includes access to adequate financing to take on the risk and bear the consequences of implementing the risks
• The allocation of funds from the company’s own funds
24. Cyprus holding company, the holding of valuable assets
Holding valuable assets by a Cyprus holding company, such as investing in equities, intangibles or other assets, including real estate or ships, might be enough to demonstrate business in Cyprus.
25. Cyprus companies established for a 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.
26. The holding of multiple investments by a Cyprus Holding Company
A Cyprus Holding Company with multiple investments in foreign companies is considered to have greater economic / business substance than a Cyprus holding company with only one investment.
27. Multiple ownership of the Cyprus Company
The multiple ownership of the Cyprus Company, ie the ownership of a Cyprus Company with multiple holders/shares enhances Cyprus business substance since such a company is not managed by only one foreign entity. In such a shareholding scheme, it appears that the control and management of the Cyprus Company are carried out by Cyprus.
28. Proper management of a Cyprus Holding company
Proper management of a Cyprus Holding company by demonstrating business and strategic reasons for its existence for example parent company’s activities to manage and control its subsidiaries’ assets and income cannot necessarily indicate the existence of a wholly artificial arrangement having no economic character. Only a wholly artificial arrangement which does not reflect economic reality” would create issues (2017 ECJ Case Law (Marks and Spencer Case/ Juhler Holdings and Deister Holdings)
29. 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 the form of a dividend, might be considered a form of unrelated payment received.
30. 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:
• Both transactions shouldn’t be made by same counter-parties;
• Time of execution of transactions should not be the same;
• Interest rates should not be similar but instead should be at arm’s length and related to commercial rates;
• Adequate returns (profits) allocated to each company and in relation to risk undertaken;
• The same duration of loans might not be the same;
• The number of loans received and loans granted might not be the same.
• If loans granted to related parties have been given out of the Cyprus company’s own funds
31. Cyprus company capital adequacy
Capital adequacy of the company in Cyprus means that the Cypriot Company has sufficient capital to take on the risks of its operations, and consequently profits or losses from its activities are wholly owned by the Cyprus Company.
32. 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 of 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 a real presence in Cyprus
33. 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.
34. 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.
35. Consider a Cyprus Stock Exchange listing
Listing the Cyprus Company to the Cyprus Emerging Capital Market demonstrates the Cyprus Company is actively doing business in Cyprus. History requirements are minimum; listing and maintenance costs are not restrictive; no minimum share capital must be dispersed among the general public.
36. 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 to develop value-adding, real solutions using Cyprus as their international business headquarters. Many investors prefer cheap solutions, to set 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 provide fully-fledged offices and part-time or full-time staff that can be employed by Cyprus Companies.
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.
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.
PKF Cyprus firms are member firms of the PKF International Limited network of legally independent firms and do not accept any responsibility or liability for the actions or inactions on the part of any other individual member firm or firms.