Bricks and mortar operations in Cyprus

Cyprus’ economic strength has traditionally been founded on three main pillars; financial services, tourism and real estate (although the latter two are obviously intertwined and the first one has always been the most important of the two). The financial services industry has diversified in recent years.

Originally, Cyprus’ financial services industry was almost exclusively a ‘’trust industry’’, ie holding- and finance companies (a slightly derogatory term for these companies being ‘’letterbox companies’’) and all the support these companies (hereafter HFCs) required, including but not limited to company administration (directors- and secretarial services), legal services (contract drafting etc.), accounting & audit services and banking. In the last decades, a slow but steady diversification could already be identified. The Cypriot investment fund industry grew significantly and a forex industry developed even more quickly.

Nevertheless, the main focus remained on services to HFCs.

The advantages used to be pretty straightforward.

An investor in (for example) the US that wanted to make an acquisition in India and wanted to benefit from tax exemption for a future sale, could set up a Cypriot holding company (CHC). CHC would use the registered address of a local service provider and staff from that provider acting as company secretary and directors. The bookkeeping would also be outsourced to Cypriot third party professionals. CHC would neither have full time staff employed nor identifiable business premises of any significance at its exclusive disposal in Cyprus.

CHC could acquire the Indian target company (ITC). At a later stage CHC could sell the shares in ITC without any taxation. There would be no taxation in Cyprus based on Cyprus’ broad (by far the broadest in the EU) tax exemption system for gains upon the sale of shares in other companies and there would not be any taxation in India either because the double tax treaty between Cyprus and India assigned the right to levy tax over the gain to Cyprus. Cyprus would obviously not materialize this right.

Or take another investor from (for example) Hong Kong who wanted to make an acquisition of an EU company (EUC) and was looking for tax optimization of the expected annual dividend flows. He/she could set up a Cyprus holding company (CHC) that would make the acquisition of EUC. EUC could then pay annual dividends to EUC free of withholding tax, based on the (in certain cases generous) implementation of the so-called EU Parent Subsidiary Directive, the latter under circumstances providing for withholding tax exemption for dividend payments between EU companies. There would be no tax over the dividends at CHC’s level, based upon Cyprus’ domestic tax system. Based upon the same tax system, there would be no withholding tax in Cyprus over dividend payments to the Hong Kong investor either.

Or take one more example; an Israeli investor who wanted to make an acquisition in Russia (pre sanctions era) and also expected a steady dividend flow that needed to be optimized from tax point of view. That investor could also set up a CHC that would acquire the Russian company (RC). RC could then make dividend payments to CHC that could qualify for the reduced dividend withholding tax rate of 5% under the double tax treaty between Cyprus and Russia. Cyprus would not levy any (withholding) tax over incoming and (possible) outgoing dividends.

To put it bluntly; those days are gone. With respect to the example of the US investor; the applicable double tax treaty has changed to India’s benefit, but even if it hadn’t, so-called BEPS (Base Erosion and Profit Shifting) provisions (see also hereafter) implemented in the double tax treaty between Cyprus and India would have made it much more difficult for the investor in question to achieve the desired tax optimization.   

With respect to the example of the Hong Kong investor; in 2015 already, the so-called ‘’EU Parent Subsidiary Directive general anti-abuse rule’’ was included in the EU Parent Subsidiary Directive (PSD). The practical consequence of this rule is that it has become much more difficult (and costly) for HFCs (companies like CHC in the example) with no significant presence in its country of domiciliation (jn this case Cyprus) such as staff, premises and activities in general, to enjoy the tax benefits of the PSD. In order to enjoy these benefits, CHC’s operations in Cyprus have to expand. Office space must be leased, staff must be hired/assigned.

With respect to the (outdated but for our purposes useful) example of the Israeli investor, the following must be noted. As a result of the OECD’s so-called BEPS project (BEPS standing for Base erosion and profit shifting, and basically referring to tax planning strategies), it has become (much) more difficult for HFCs to qualify for benefits of double tax treaties as well. By means of the so-called ‘’principal purpose test’’, being part of the BEPS project, for example, the tax administration of a country (in this case Russia) can deny the tax treaty benefit if one of the principal purposes of the action undertaken by the taxpayer (in our case the use of CHC) is to obtain a treaty benefit. Again, the practical consequence of this rule is that it has become much more difficult (and costly) for HFCs (companies like CHC in the example) with no significant presence in its country of domiciliation (jn this case Cyprus) such as staff, premises and activities in general, to be eligible for the benefits of double tax treaties. Again, in order to enjoy these benefits, CHC’s operations in Cyprus have to expand. Office space must be leased, staff must be hired/assigned.  

The above developments have led to a significantly decreased demand for HFCs or ‘’letterbox companies’’, traditionally the Cypriot financial services industry’s bread and butter. It necessitated the Cypriot Government to abandon its traditional policies of ‘’solely’’ creating an attractive environment for such companies.

The Cypriot Government had to attract more companies that wanted to conduct genuine business operations on the island, ‘’bricks and mortar operations ’’, including the assignment of employees from abroad to Cyprus.

By (sometimes literally) nature, Cyprus already has a lot to offer to (employees of) such operations. To name a few advantages; office space is broadly available and relatively affordable, the country offers 325 days of sunshine per year, offers low criminality rates, excellent medical services and school system and a beautiful, varied landscape comprising beaches, mountains, forests, picturesque and/or bustling cities etc. 

But, as said, Cyprus had to make its jurisdiction not just attractive for letterbox companies but also, and especially, for ‘’bricks and mortar operations’’ and it has done so by introducing several new measures in the field of taxation, including salary taxation (to be discussed later), but also through introduction of a legislative framework to implement a rapid strategic investment licensing process for companies that want to set up operations in Cyprus, creating the so-called ‘’one-stop shop’’.

The Cypriot economy is now at a transitory stage towards attracting genuine business operations to the island. But the efforts of the Cyprus Government to attract these operations are already paying off as more and more (big) companies decide to start genuine operations in Cyprus and hire/move staff in/to the country.    

It is obviously important to know what are the relevant tax aspects in case business operations are set up in Cyprus. It is also relevant to know what are the tax consequences for a business owner who moves to Cyprus (together with his business operations).

Below this will be discussed in more detail.

Residence

First of all (in case of business owners but also employees moving to Cyprus) one has to ask when a person will be regarded as resident of Cyprus according to Cypriot tax laws.

A person is regarded as resident of Cyprus in the following situations;

• Either he/she spends more than 183 days in any one calendar year in Cyprus, without any further additional conditions/criteria being relevant, or;
  
  He/she;
   
• spends at least 60 days in Cyprus in a calendar year;
• does not reside in any other single state for a period exceeding 183 days in aggregate;
• is not considered tax resident by any other state, and
• has other defined Cyprus ties.

A person can be considered to have other defined ties in the above sense if he/she carries out any business in Cyprus and/or is employed in Cyprus and/or holds an office (directorship) of a company in Cyprus at any time in the tax year. The individual must also maintain a permanent residential property in Cyprus that is owned or rented by him/her.

Needless to say, however, especially in case of temporary assignments, that it is still possible that other countries are able to successfully claim that these persons are still residents of their own jurisdictions. This has to be looked at on a case by case basis, in cooperation with local tax experts.

Personal taxes

In case of relocation of a business owner to Cyprus, his/her main income will usually be salary and dividends (and interest income).

Salary

In case of relocation of an employee to Cyprus, usually the main income will be salary income.

Income tax

Salary is subject to income tax. The applicable tax brackets are as follows.

From                                   To                                                     Tax rate               Accumulated                        

0                                                        19,500                                0%                        0

19,501                                              28,000                                20%                      1,700

28,001                                              36,300                                25%                      3,775

36,301                                              60,000                                30%                      10,885

60,001 and higher                                                                      35%

However, based upon recently implemented changes, the Cyprus law provides for a 50% income tax exemption for salary received by any person;

- employed for the first time in Cyprus who was previously not resident in Cyprus for a period of at least 10 consecutive years;
- receiving an annual salary of at least EUR 55,000;
- for a period of 17 years.

So, the above brackets can be ‘’cut in half’’, meaning that the maximum net effective income tax rate is 17.5%.

Social security

In addition, there are social security premiums that must be paid by employers and employees over paid/earned salaries.

The rates are as follows.

Employee contributions

• First of all employees are liable to pay social security premiums at a rate of 8.3% with an annual salary cap of € 60,060 above which no premiums are due;
• Furthermore, employees are liable to pay contributions to the National  Health Service at a rate of 2.65% rate, with an annual cap of € 180,000 above which no such premiums are due.

Employer’s contributions

• Employers must pay contributions at total rate of 10% (represented by obligatory contributions to the social security fund, redundancy fund and industrial training fund) with an annual salary cap of € 60,060;
• Employers also must pay contributions at 2% rate to the so-called ‘’cohesion fund’’, without applicable cap.
• Finally, employers must pay NHS contributions at 2.9% rate (taking into account the aforementioned € 180,000 cap).

Dividends, gains and interest income

Dividends

Dividends received by residents of Cyprus are not subject to income tax. However, they are subject to a so-called special contribution for defence (defence tax) over their gross amount, at a rate of 17%.

Nonetheless, people who are resident of Cyprus but cannot be regarded as so-called ‘’domiciled in Cyprus’’ will be exempt defence tax.

So, it is important to observe what the ‘’domiciled’’ concept means.

The domicile concept assumes that every person has either:

1. the domicile received at birth (‘domicile of origin’), or
2. the domicile (different from the concept of domicile of origin) acquired by his/her own act (‘domicile of choice’).

The domicile of origin of a person as per i. is normally that of the father.

A person may acquire a domicile of choice by establishing his/her home in Cyprus with the intention of permanent or indefinite residence as per ii.

A person moving to and becoming resident of Cyprus (see hereafter) whose father was not domiciled in Cyprus at birth, can for the first 17 years of his/her stay be regarded as non domiciled resident of Cyprus. As a result, any dividends received by this person will not be subject to defence tax (or other taxes).

Keep in mind though that such dividends will be subject to a National  Health Service levy at a rate of 2.65% rate (with an annual cap of € 180,000 above which no such premiums are due; other income subject to such levy may be taken into account for the determination of whether the cap has been reached).

Gains

The tax treatment of gains realized by individuals depends on the type of gain in question.

Any gains upon the sale of securities is fully exempt from income tax (or other taxes). Securities are defined as ‘shares, bonds, debentures, founders’ shares and other securities of companies or other legal persons, incorporated under a law in Cyprus or abroad, including options thereon.’

This exemption is a standard feature of Cyprus’ income tax system (and is regardless of the domiciled status of a Cyprus resident).

In case of other gains (in practice other gains will mainly be represented by gains from the sale of real estate), it has to be determined on a case by case basis whether (income) tax is payable (usually there isn’t, unless Cypriot real estate is involved, see hereafter). In case of the sale of foreign real estate, if such gain is taxable in Cyprus (which would only be the case if it qualifies as so-called ''trading gain'' and gains after 3 years of acquisition without significant refurbishment of the estate in question in the meantime usually don’t qualify as such in any case), tax payable in the country where the real estate is located may be offset against Cypriot tax due and can already lead to effective tax exemption.        

Also a gain upon the sale of Cypriot real estate will only be subject to income tax if it qualifies as trading gain. However, if it does not qualify as trading gain and no income tax is due, Cypriot capital gains tax at a rate of 20% will still be due.

Also keep in mind that gains upon securities and real estate, if qualifying as trading gains in the aforementioned sense, will be subject to a National Health Service levy at a rate of 2.65% rate (with an annual cap of € 180,000 above which no such premiums are due; other income subject to such levy may be taken into account for the determination of whether the cap has been reached). 

Interest

Interest income received by individuals is usually not subject to income tax but to defence tax. Defence tax is due over the gross amount of the interest at a rate of 30% (a lower rate of 3% applies to interest income earned from Cyprus government bonds, Cyprus and foreign corporate bonds listed on a recognised stock exchange, or bonds issued by Cyprus state organisations or Cyprus or foreign local authorities listed on a recognised stock exchange).

However, interest earned by a non domiciled resident of Cyprus is also exempt from defence tax. 

This means that non domiciled residents can earn interest income without any tax payable.

Again one also has to keep in mind that interest income will in ANY case be subject to a National Health Service levy at a rate of 2.65% rate (with an annual cap of € 180,000 above which no such premiums are due; other income subject to such levy may be taken into account for the determination of whether the cap has been reached).

Company taxes

The general corporate income tax rate in Cyprus is 12,5%. So, usually profits generated by companies resident in Cyprus are subject to 12.5% tax.

Special provisions and reduced effective tax rates may apply to income from shipping operations, income from exploitation of intellectual property and profits realized by companies that have received capital injections. The latter may apply for the notional interest deduction facility, which may bring down the effective tax rate for profits realized by capitalized companies to as low as 2.5%.      

Furthermore, gains realized by Cypriot companies holding shares in other companies (whether as portfolio investments or larger participations) will always be exempt from income tax, based on the aforementioned income tax exemption for profits from the sale of securities, and dividends will normally be exempt from any taxation as well.

CONCLUSION

Cyprus is an excellent place to relocate or set up business operations and to move your personal residence. It offers a friendly personal and corporate tax system and the living- and business conditions are very attractive.

Are you thinking about moving your residence and/or business operations and you need assistance in the field of company administration, tax advice, legal services or any other services to make this plan work, please contact Rutger Kriek at rutger.kriek@equationcs.com

We will be more than happy to assist.