Proposed changes to the Cyprus Tax Legislation
Proposed changes to the tax legislation enacted by the House of Representatives on 9th July 2015
In order to attract foreign investments, the Government of Cyprus proposed new tax legislations. These new tax rules are very beneficial for international investors who wish to do business through Cyprus and they create a new dynamic for the Cyprus economy.
In an effort to improve Cyprus’ tax system and make it more attractive to both the local and international business communities, in cooperation with all stakeholders of the professional services sector, the House of Representatives has made amendments in the tax legislation of the country. The bills incorporating these changes have been sent to the Parliament for review and voting in order to come in to effect the soonest possible.
The most important amendments to the laws are as follows:
A. Changes related to the Income (including Corporation) Tax Laws
1. Foreign Exchange Differences
As of 1st of January 2015, any foreign exchange (FX) gains or losses will be exempt from taxation irrespective of whether they are realised or unrealised. This will not apply to companies trading in foreign currencies and related products. Such companies can make an irrevocable election not to be taxed on unrealized gains or losses, as it was the case so far for all companies.
2. Anti-avoidance provisions for hybrid instruments and artificial transactions for dividends
Under current law, dividends are exempt from Income Tax, but individuals (and on some occasions companies) are subject to Special Contribution for Defence.
When a Cyprus company receives dividends from a foreign participation, these are recorded as dividends (income) in the hands of the Cyprus Company and are treated as an expense by the paying company. The shares/securities to which such payments are associated are known as “hybrid instruments”. An example of such instruments is preference shares, which in some countries are considered as shareholders’ equity, whereas in some other they have the same treatment as debt.
The EU Parent/Subsidiary Directive was amended last year to exclude hybrid instruments from the provisions of the Directive since they result to double non-taxation. The Directive has also been amended so that it does not apply in cases where there is an arrangement between the parent and the subsidiary companies, the main (or one of the main) purpose of which is to result to a tax advantage. Such cases are described as not genuine, since they are not put into place for valid commercial reasons, which reflect economic reality.
The Cyprus tax laws are amended, so that dividends received by a Cypriot company which fall under the above provisions will no longer be exempt from Income Tax, but instead will be considered as normal business income. At the same time and since such transactions will not be considered as dividends, they will be exempt from Special Contribution for Defense, where applicable. This amendment will be put in to effect as of 1 January 2016.
3. Exemptions of income from first employment in Cyprus
Currently, 20% of the income from employment in Cyprus of a person who was not a tax resident of Cyprus during the previous tax year is exempt from taxation for a period of three years starting from the 1st of January of the year following the year or employment. The exemption is capped at €8.550 per annum.
This exemption will be extended from three to five years. It will be abolished by 2020.
There is also an exemption equal to 50% of the income from employment in Cyprus which is effective for income received after the 1 January 2012, for a person who was not tax resident of Cyprus during the previous tax year provided that the income from employment in Cyprus exceeds €100.000 per annum. The exemption is applicable for a period of five years.
This exemption will be extended from five to ten years.
It will no longer be possible to benefit from both exemptions, where applicable.
4. Notional interest deduction on equity
A deemed interest deduction will be allowed on funds introduced into a Cyprus tax resident company in the form of shareholders equity which is termed as “new equity” and which funds are used for the operations of the company.
The deemed interest will be calculated at a rate equal to the effective interest earned on the 10 year government bonds of the country where the funds are invested, plus 3%, with the minimum rate considered being the effective interest earned on 10 year bonds issued by the Republic of Cyprus, plus 3%.
“New equity” is defined as share capital and share premium to the extent that it has actually been paid in cash or in kind (for the latter at market value), introduced into the business after 1 January 2015. It does not include revaluation or any other reserves converted in to share capital.
A number of anti-avoidance provisions are included in the legislation, including a provision that, as with actual interest expense, deemed interest will be tax deductible only if it is used for financing assets used in the business. Another provision is that the deemed interest is capped at 80% of the taxable income of the company during the year before the deduction of the deemed interest expense.
5. Extension of period of accelerated depreciation for tax purposes
Under the existing provisions, increased annual allowances are granted for new assets acquired in the years 2012, 2013 and 2014 if they relate to plant and machinery (20% instead of 10%) and industrial buildings and hotels (7% instead of 4%).
The period of accelerated depreciation is extended to cover 2015 and 2016 also.
6. Group loss relief
Under the current provisions of the law, group loss relief can only be claimed by Cyprus tax resident companies. This means that both the surrendering and the claimant companies must be tax residents of Cyprus during the year in which the claim is made (only current year claims are permitted).
Based on the amendment, a company tax resident in an EU member state can surrender its taxable losses to another group company tax resident in Cyprus and vice versa, provided all the chances of surrendering or carrying forward the losses in the member state of residence of the surrendering company have been exhausted.
Losses surrendered to a Cyprus company must be calculated based on the provisions of Cyprus laws.
7. Anti-avoidance provisions for re-organizations
A number of anti-avoidance provisions are introduced, which will give the right to the Tax Commissioner to refuse to accept tax-free reorganizations, if the Commissioner can determine that the main purpose or one of the main purposes of the reorganization is the reduction, avoidance or deferment of payment of taxes.
8. Limitation of loss carried forward on IP activities
The Cyprus IP tax Regime provides that 80% of statutory deduction for intellectual property profit will be regarded as deemed expense. Therefore only 20% of royalty profit will be taxed at 12.5% corporation tax setting the maximum effective tax rate to 2.5%. The law did not specify if the provision of 80% deemed deduction applied when a company had taxable losses. With the proposed law as of 1st of January 2015 only 20% of taxable losses will be carried forward.
B. Introduction of “Domicile” concept in Special Contribution for Defense
Special Contribution for Defense is payable only by tax residents of Cyprus (as defined in the income tax laws), which, in the case of individuals, means persons who spend at least 184 days in Cyprus in a tax year. The tax is charged on dividends, interest and rental income.
The law will be amended so that individuals who are tax residents of Cyprus but are not considered to be “domiciled” in Cyprus would be exempt from payment of Special Contribution for Defense on related income.
An individual can be considered as domiciled in Cyprus either (i) by domicile of origin or (ii) by domicile of choice, as defined by the Wills and Succession Law of Cyprus.
The term "Domiciled in Cyprus" is defined as an individual who has a Domicile of Origin, in accordance with the Wills and Succession Law, in Cyprus but it does not include:
•An individual who has obtained and maintains a Domicile of Choice outside Cyprus in accordance with the Wills and Succession Law, provided that the individual was not a Cyprus tax resident for a period of 20 consecutive years preceding the tax year under examination.
•An individual who has not been a Cyprus tax resident for a period of at least 20 consecutive years before the commencement of the law.
In addition, individuals who are considered as Cyprus tax residents as defined by the Income Tax Law for at least 17 years from the last 20 years before the year of assessment are considered as "Domiciled in Cyprus" for SDC purposes and will therefore be subject to the relevant taxation if and when this condition will be met.
C. Changes in taxes related to Immovable Property
1. Capital gains tax
(a) Capital gains from sale of shares in property companies
Currently, Capital Gains Tax is charged on disposal of immovable property located in Cyprus or on disposal of shares of companies, which own immovable property located in Cyprus.
Under the proposed legislation, gains from the sale of shares in companies which indirectly own immovable property in Cyprus by holding shares in a company which owns immovable property located in Cyprus, will also be subject to capital gains tax. This will apply only in cases where the value of the immovable property represents more than 50% of the value of the company whose shares are sold.
(b) Exemption from Capital Gains Tax related to properties acquired until 31 December 2016
With this proposed amendment any gains on disposal of properties acquired between the date on which the provision comes in to effect and 31 December 2016, will be completely exempt from Capital Gains Tax.
2. Immovable property tax law
(a) Abolition of the Immovable Property Levy payable to Municipalities
The municipality and community levy payable to the Municipalities will be abolished.
(b) Immovable Property Tax Law
A new Immovable Property Tax Law will be introduced which provides for the imposition of tax, based on a single tax rate of 1‰ on the value of the property based on the latest General Valuation by the Department of Lands and Surveys (currently that of 31 December 2013).
3. Land registry fees
From the 2 January 2011 up to the 31 December 2016, no transfer fees will be payable if the property to be transferred falls within the scope of VAT. If it does not, the transfer fee will be reduced to 50%.
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