The Cyprus Ministry of Finance has presented a draft bill implementing the EU Anti-Tax Avoidance Directive (ATAD) which aims to combat corporate tax avoidance and create a level playing field for businesses operating within the EU. The draft legislation contains five anti-abuse measures relating to controlled foreign companies (CFC), interest limitation, a general anti-abuse rule (GAAR), exit taxation and hybrid mismatches. Once ATAD is implemented, the first three measures will apply retroactively as from 1 January 2019 whereas the latter two are expected to enter into force on 1 January 2020.
Currently, interest expenses are deductible if the arms’ length principle is adhered to and if the income in question is not tax-exempt. ATAD introduces an interest deductibility rule which limits the deductibility of borrowing cost to 30 per cent of the taxable earnings before interest, tax, depreciation and amortisation or €3 million, whichever is higher. For a group of Cyprus companies, the deductibility limit applies for the total borrowing cost of the group. Financial institutions and public infrastructure projects are exempted and there is a grandfathering clause under which loan arrangements entered into before 17 June 2016 (and not thereafter amended) are also exempted. “Standalone entities” (an entity which is not part of a consolidated group for financial accounting purposes and has no associated enterprise) also fall outside the scope of the interest limitation rule. An equitable allowance is permitted allowing full deduction if the taxpayer can demonstrate that the ratio of its equity over its total assets is not more than two percentage points lower than the equivalent ratio for the group as a whole.
Unused interest costs may be carried forward for up to five years.
General anti-abuse rule
The GAAR is introduced as a general catch-all provision aimed at disregarding artificial arrangements (or series of arrangements) which have been put into place for the main purpose of obtaining a tax advantage that defeats the object or purpose of the applicable tax laws and which having regard to all relevant facts and circumstances, are not genuine. The Cyprus Assessment and Collection of Taxes Law already contains a GAAR so introduction of this provision is not expected to impact Cyprus laws.
Controlled foreign companies
A CFC is defined as a company or a permanent establishment directly or indirectly controlled by a Cyprus tax resident company, the corporate profit tax burden of which is less than half of what it would be under the Cyprus tax system. The CFC provisions in ATAD aim to allocate income at the Cyprus level if the CFC of the Cyprus entity is not taxed or is taxed at a very low rate, even if the subsidiary income is not in fact distributed to Cyprus. Under this rule, the income of the qualifying subsidiary which is not distributed must be included in the tax base of the Cyprus parent if the income arises from non-genuine arrangements which have been designed with an aim to obtain a tax advantage, unless the subsidiary is resident in the EU/EEA and is engaged in substantive economic activity.
The draft provisions relating to exit taxation provide that taxpayers shall be liable to tax at an amount which is equal to the difference between the market value and the value for tax purposes of the assets to be transferred outside the net of Cyprus tax while remaining under same ownership. The exit taxes may be paid in instalments over a period of five years.
A hybrid mismatch is an arrangement which aims to exploit differences between tax systems so as to obtain an advantage. The effect of a hybrid mismatch is usually a double deduction (a deduction in both Member States) or a deduction of the income in one Member State without inclusion in the tax base of the other Member State (a deduction without inclusion). ATAD contains provisions to counteract cross-border hybrid mismatches so that the deduction of a payment leading to the double deduction or inclusion is denied in one of the two jurisdictions. So if a hybrid mismatch occurs, the operating expenses in relation to the mismatch will not be deductible to the extent that they are deductible in another Member State where their source is located and are not taxable in another Member State receiving the income.
Clients should assess the practical impact of the implementation of the new ATAD measures on their Cyprus entities or groups, particularly with respect to financing structures, identifying entities that may exceed the 30 per cent limit, and with respect to Cyprus holding companies, where subsidiaries under the new legislation may be construed as CFCs.
The foregoing is for general information only and not intended to be relied upon for legal advice in any specific or individual situation.