The Anti-Tax Avoidance Directive (ATAD) – Tax

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A taxpayer will be subject to corporate tax on an amount equal
to the market value of the transferred assets at the time of exit,
less their value for tax purposes.

Is it justifiable that Cyprus has been considered by European
authorities of acting as a tax haven? All the below actions taken
by the Cyprus Authorities, which have been adopted into the Cyprus
law, should be considered before this question is answered.

Cyprus has incorporated into its tax legislation the automatic
exchange of information with all European tax authorities and it
has also adopted and incorporated into legislation the relevant
OECD guideline, known as Common Reporting Standard, through which
automatic exchange of information is extended to all contracting
parties.

Further, Cyprus has adopted all of the European Tax Directives
(ATAD).

The Anti-Tax Avoidance Directive (ATAD), is effectively the
action taken by the Council in response to the recommendations of
the Base Erosion and Profit Shifting (BEPS) Action Plan of the
OECD. The main objective of the ATAD is to ensure that tax is paid
where the profits and value are generated.

On the 5 April 2019, the Cyprus House of Representatives adopted
the law implementing the provisions of the ATAD. The measures which
were incorporated being:

  • Controlled Foreign Company (CFC) rules
  • Interest limitation rule
  • General anti-abuse rule

The provisions of the law apply retrospectively, as of 1 January
2019.

Controlled Foreign Company (CFC) rules

An appealing tax planning tool is to shift profits from
companies based in high-tax jurisdictions to their subsidiaries
based in low-tax jurisdictions. The aim of the CFC rule is to
combat this deferral and to tax such income in the jurisdiction in
which the parent company is tax resident.

Member States are allowed to choose between two options. The
first option is generally applicable to predefined passive income
of a CFC (option A) while the second option is applicable to income
arising from “nongenuine arrangements” put in place
essentially to obtain a tax advantage (option B). Cyprus has
selected option B. The CFC rules apply to both Cypriot tax resident
companies and non-Cypriot tax resident companies which have a
permanent establishment (PE) in Cyprus.

Cyprus considers a CFC as a company which is tax resident
outside of Cyprus and is controlled by a company or companies’
tax resident in Cyprus. A CFC is a low taxed non-Cyprus tax
resident company in which,

  • A Cypriot resident company, either by itself or together with
    its associated enterprises, holds an interest either directly or
    indirectly of more than 50% in a non-Cypriot tax residency
    company.
  • Where by the actual corporate tax paid on the profits of the
    foreign entity or foreign PE is lower than 50% of the tax that
    would have been imposed, if such profits were subject to tax in
    Cyprus in accordance with the provisions of the Cyprus Income Tax
    Law.

The CFC rule does not apply to non-Cyprus tax resident companies
if a CFC has either:

  • Accounting profits that do not exceed €750 000 and
    non-trading income which is not more than €75 000; or
  • Accounting profits that do not exceed 10% of its operating
    costs for the tax year.

The non-distributed income of a CFC which is the result of
non-genuine arrangements is added to the taxable income of the
Cyprus tax resident controlling company.

It is clarified that non-distributed income is the income that
has not been distributed within the year in question.

There should be no CFC charge if there are no significant people
functions in Cyprus that are instrumental in generating the income
of the CFC. A Transfer Pricing Study will be required in this
respect.

It is possible for the Cypriot controlling entity to claim
credit for any overseas tax imposed on the CFC profits which are
included in its tax base. The Law does not limit the credit to the
tax imposed in the jurisdiction of the CFC.

Interest limitation rule

Another common and appealing tax planning tool is for companies
based in low tax jurisdictions to provide financing to related
companies based in high tax jurisdictions. The interest expense at
the level of the borrowing entities could effectively reduce the
overall tax liability.

In order to avoid this before mentioned practice, the interest
limitation rule was introduced which restricts exceeding borrowing
costs deductible in the tax period in which it is incurred to 30%
of the tax payers EBITDA (earnings before interest, tax,
depreciation and amortization), subject to a threshold of
€3,000,000. For the purpose of calculating a company’s
EBITDA, any income that is not taxable and any tax losses brought
forward are not taken into consideration.

Exceeding borrowing costs refer to net interest expense, being
mainly interest income less interest expense on all forms of debt,
including other costs similar to interest and expenses incurred in
connection with the raising of finance.

Standalone entities (not part of a consolidated group) and
financial undertakings (such as credit institutions and investment
firms) are excluded from the limitation rule. Moreover,
grandfathering has been provided for loans concluded before 17 June
2016. Finally where the Cyprus resident company is part of a
consolidated group for financial reporting purposes, the taxpayer
may fully deduct its Exceeding borrowing cost, provided that the
ratio of its equity over its total assets is equal to (or no more
than 2% lower) than the equivalent group ratio.

Any unused exceeding borrowing costs and interest capacity which
cannot be deducted in the current tax period, may be carried
forward for the next five years.

The interest limitation rule is applicable to financing with
both related and non-related parties.

General Anti-Abuse Rule (GAAR)

The Cyprus Income Tax Law provides that for the purpose of
calculating the corporate tax liability, any arrangement or series
of arrangements should be ignored if they have been put in place
with the main purpose of obtaining a tax advantage that defeats the
purpose of the applicable tax law and which are not genuine and do
not display any economic substance, always having regard to all
relevant facts and circumstances. Where such arrangements are
disregarded, the tax liability will be calculated in accordance
with the provisions of the Income Tax Law. This is aimed at all
non-genuine transactions performed whether domestically or
cross-border.

Following the partial adoption of the EU Anti-Tax Avoidance
Directive in 2019, on 19 June 2020, the Cyprus Parliament voted
into law the remaining provisions of the ATAD.

The anti-tax avoidance measures that have further been
incorporated into law are the following:

  • Exit taxation rules
  • Hybrid mismatch rules

The provisions of the law apply retrospectively, as of 1 January
2020.

Exit taxation

Exit taxation rules are designed to prevent taxpayers from
avoiding tax by transferring their activities or assets out of the
country in which the specific activities or assets had gained their
value in. Based on these rules, Cyprus will have the right to tax,
subject to the provisions of the Cypriot Income Tax Law any
unrealized gain created in Cyprus at the time a taxpayer transfers
its activities, or assets out of Cyprus. The value of the gain
should be based on the arm’s length principles.

A taxpayer will be subject to corporate tax on an amount equal
to the market value of the transferred assets at the time of exit,
less their value for tax purposes.

Under certain circumstances, a taxpayer has the right to pay the
exit taxation in instalments over a period of five years and any
existing tax deductions or exemptions regarding corporation tax
rules will continue to be applicable.

Hybrid mismatches

Hybrid mismatches occur due to the different tax treatments of a
payment of a financial instrument from one jurisdiction to another.
Hybrid mismatches usually have the following tax effect, being a
double deduction in both jurisdictions or a deduction in one
jurisdiction without being taxed in the other.

The objective of the hybrid mismatch rules is to neutralize the
tax effects of hybrid mismatch arrangements. So in order to avoid
any double deduction, when the receiver of such is a Cyprus tax
resident, the deduction will not be accepted in Cyprus and when the
payer of such is a Cyprus tax resident and where the deduction is
not denied by the foreign jurisdiction then the deduction will be
denied in Cyprus.

The hybrid mismatch rules deal with the following types of
arrangements:

  • A payment from a financial instrument were the mismatch is
    attributed to the difference in characterization of the financial
    instrument or the payment and when the payment is not included in
    the jurisdiction of the payee within a reasonable time frame.
  • A payment to a hybrid entity were the mismatch results from
    differences in the allocation of payments made to the hybrid
    entity;
  • A payment to an entity with one or more PEs were a mismatch
    results from differences in the allocation of payments;
  • A payment to a disregarded PE;
  • A payment by a hybrid entity whereby the mismatch results from
    the fact that the payment is disregarded under the laws of the
    payee jurisdiction;
  • Situations with double deduction outcomes.

The Directive provides for the following two measures to correct
and to neutralize the effects of hybrid mismatch arrangements:

  • The primary rule, whereby if there is a deduction on the income
    on the level of the recipient, the payer will be denied a deduction
    on the payment; and
  • The secondary rule, whereby if the payment is deductible at the
    level of the payer, the income will be included at the level of the
    recipient.

The law provides the following measures regarding the treatment
of hybrid mismatch outcomes: To the extent that a hybrid
mismatch results in a double deduction, the deduction will be
denied in Cyprus under the primary rule, if Cyprus is the receiver
jurisdiction. Where Cyprus is the payer jurisdiction, the deduction
will be denied in Cyprus if it is not denied by the investor
jurisdiction.

Brexit

The UK’s exit from the EU changes the world balance within
both political and economic systems.

International companies seem to have initiated a relocation of
financial resources and employees to other EU countries.

Those businesses trading mainly with the EU countries are
subject to the greatest risk and expected to suffer the most. Those
companies that trade with companies outside the EU bear less risk,
though it exists too. A car dealership may serve a good example:
cars produced in the UK may contain parts produced in the EU and
vice versa. In turn, this will mean an increase in prices of end
products and services, which will definitely influence the entire
supply chain. This is one of the reasons why some UK based
companies are moving to the EU.

Further, the UK may adopt a decision to stop complying with the
rules and regulations of the EU. The country may decide on an
individual basis what is of benefit to its economy and vice versa.
The British authorities are expected to maintain existing EU rules
and regulations, however this cannot be guaranteed.

With respect to taxes it should be mentioned that an increase in
existing taxes and/or introduction of new taxes is a possible
scenario in the future. In particular, with respect to VAT as the
UK currently operates in accordance with the European standard, it
is uncertain whether the country will preserve it or implement its
own new standard.

Some UK citizens have already applied for second passports in
other European countries and also in Cyprus.

It seems that Brexit may also benefit the Cyprus shipping sector
as there are numerous shipping companies that have set up
subsidiaries in Cyprus and transferred part of their business so as
to enjoy the benefits provided.

In addition, Cyprus has recently attracted a number of
investment fund managers from the United Kingdom.

There are many undeniable advantages which make Cyprus an
excellent destination to relocate from the UK and to avoid any
possible negative implications of Brexit.

  • At the moment in the UK uncertainty prevails and different
    possible scenarios for the future. On the other hand in Cyprus due
    to all the above implementations it can be considered as a possible
    reliable jurisdiction that offers the stability of its financial,
    law and political system, reliable legislative and regulatory
    framework, providing a wide range of possibilities for efficient
    tax planning.
  • Tax legislation in Cyprus is simple and predictable, provides
    for one of the lowest taxes rates in Europe.
  • The country has a stable, growing economy and easy access to
    countries of the European Union, Africa, Middle East and Asia.
  • Cyprus enjoys the privilege of being a member of the European
    Union and is subject to the EU legal framework, which guarantees
    uniformity and a coherent approach to all regulated relationships
    within the EU.
  • The legal and judicial systems of Cyprus and the UK are quite
    identical due to history and the close relationships between the
    countries. For instance, corporate rules are mainly adopted from
    English company law and the legislative system in Cyprus is based
    on English common law.
  • The other advantages offered by Cyprus are the favourable
    climate, multicultural population, high standards of living, safety
    and good ecological situation and fairly low living expenses, which
    make the country not only a good place for doing business but also
    a decent place for a comfortable life.

Just because Cyprus has one of the lowest tax rates in the EU
does not make it a Tax Haven by default and although there are
still many changes which need to take place, it is without a doubt
that Cyprus is moving in the right direction.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.