A. Introduction

Amendments to the Income Tax Law for the implementation of the EU Anti-Tax Avoidance Directive Issue N-7-2019, 9 April 2019.

The House of Representatives on 5 April 2019 voted into law the provisions of the European Council Directive for the adoption of rules against tax avoidance practices that directly affect the functioning of the internal market (known as Anti-Tax Avoidance Directive – ATAD).

These rules apply to all companies as well as other entities that are subject to tax in Cyprus in the same manner as companies, including entities that are not Cyprus tax residents but that have a Cypriot permanent establishment.

The anti-tax avoidance measures provided by the Directive are the below:

These measures are included in the Directive published on 12 July 2016 (known as ATAD I), while the provisions on hybrid mismatches are extend in a second Directive adopted on 29 May 2017 (known as ATAD II).

B. Interest limitation rule

The interest limitation rule provides that the excess borrowing cost (EBC), which exceeds 30% of adjustable taxable profit (taxable EBITDA), is not deductible for the purpose of calculating the taxable income of a company.

Exceeding borrowing costs are deductible up to the higher of 30% of taxable EBITDA or €3 million. This means that EBCs up to and including €3.000.000 is in any case not restricted by this rule (the €3.000.000 threshold would apply in cases where ‘30% of taxable EBIDTA’ results to an amount below €3.000.000).

In the case where the company is a member of a Cyprus group, the limit of €3 million applies for the total borrowing costs of the (1).

(1)  Exclusions from the interest limitation rule

The interest limitation rule does not apply to:

• Financial undertakings (Credit institutions, investments firms, alternative investments funds managers (AIFMs) and management companies of undertakings for collective investment in transferable securities (UCITS), Insurance and reinsurance undertakings)
• standalone entities (5)
• loans used to fund long-term public infrastructure projects where the project operator, borrowing costs, assets and income are all in the European Union.
• loans which were concluded before 17 June 2016, but the exclusion shall not extend to any subsequent modification of such loans.

(2)  Equity escape clause

Where the company is a member of a consolidated group for financial accounting purposes, it may choose for each tax year to deduct the whole amount of the EBC if it can demonstrate that the ratio of its equity over its total assets is equal to or higher than the equivalent ratio of the group, subject to the following conditions:

1. the ratio of the taxpayer’s equity (means the share capital, share premium and reserves) over its total assets is considered to be equal to the equivalent ratio of the group, if it is equal to or at lower by 2% of the group ratio,
2. all assets and liabilities are valued using the same method as in the consolidated financial statements prepared under accepted accounting principles

(3)  Carry forward of EBC and unused interest capacity

EBC which cannot be deducted in the year in which it was incurred may be carried forward and be deducted from future taxable income of the company for the next 5 years. For the calculation of the unused interest capacity (the difference between 30% of EBITDA 3 and EBC) the €3.000.000 threshold mentioned above is not taken into consideration.

In case where the same three year period there is both a change in the ownership and a substantial change in the activities of the business, EBC prior to the change cannot carried forward.

(4)  Reorganizations

In case of a reorganization, any accumulated EBC and unused interest capacity will be transferred to the transferee company in accordance with the relevant provisions of the legislation regarding the reorganization of companies.

C.  General anti-abuse rule (GAAR)

Cyprus Income Tax Law has been amended introducing the EU Anti-Tax Avoidance Directive (ATAD) GAAR in the Cyprus tax legislation.

The Law provides that for the purposes of calculating the corporate tax liability, any arrangement or a series of arrangements which are non-genuine and have as a main purpose the obtaining a tax advantage, should be disregarded. In such a case the tax liability is calculate I accordance with the Cyprus income tax law.

An arrangement or a series thereof shall be regarded as non-genuine arrangements to the extent that they are not put into place for valid commercial reasons which reflect economic reality.

(1)        Controlled Foreign Companies (CFC) Rules

A CFC is defined as a non-Cypriot tax resident company or a foreign permanent establishment (“PE”), the profits of which is not taxable or exempt from tax in Cyprus if the following conditions are met: 

• Where the Cyprus tax resident company by itself or together with its associated company, holds alone or together participation of more than 50% of the voting rights or of capital, or is entitled to receive more than 50% of the profits of such company, and
• the actual corporate tax paid on the profits of non-Cypriot tax resident company or the foreign PE is lower than 50% of the Cypriot corporate income tax that it would have paid by applying the provision of the Cypriot income tax law if it were resident in Cyprus.

(2)  Income to be included

When a foreign company it is determined that is a CFC, the tax base of the Cypriot controlling taxpayer shall include the non-distributed income of a CFC which result from non-genuine arrangements that have been put in place in order to obtaining a tax advantage are added to the taxable income of the Cyprus tax resident company.  

Non-distributed income is considered the accounting profit after tax which has not been distributed to the controlling Cyprus tax resident company during the tax year in which the profit is derived or within a period of seven (7) month after the year end.

(3)  Exemptions from the CFC rule

The CFC rule is not applied where non-Cypriot tax resident company or the PE has:

• accounting profits do not exceed €750.000, and the passive income does not exceed €75.000 or
• the accounting profits do not exceed the 10% of its operating costs for the tax period.

(4)  No double taxation of the same profits

As required under the Directive, the Law includes provisions aiming to avoid double taxation of the same profits if a CFC distributes profits (or if there is a sale of a CFC) and the resulting dividend income (or profits from the disposal of the CFC) are taxable. In such a situation, the dividend income (or profit from disposal) to be included in the tax base shall be reduced by the amount of the underlying profits that had been previously caught under the CFC rules and included in the tax base as CFC income. 

(5)  Foreign tax relief

The controlling Cyprus tax resident company can claim credit for any overseas tax imposed on the CFC profits which are included in its tax base.  

(6)  Avoidance of double taxation

Rules have been put in place in order to avoid double taxation of the same profits. Where a CFC distributes profits or a sale of a CFC and the resulting dividend income or profits (from the disposal of the CFC) are taxable then the controlling Cyprus tax resident company tax base should be reduced from the divided income or the profit from disposal that had been previously included in the tax base as CFC income. 

(7)  Calculation of CFC income

• The income or loss to be included in the tax base of the controlling Cyprus tax resident company shall be calculated in proportion to the company’s effective participation in the CFC.
• The income or loss shall be limited to the amounts generated through assets and risks in relation to which the significant people functions are carried out by the controlling Cyprus tax resent company.
• The attribution of income shall be calculated in accordance with the arm's length principles and is limited to the amount of the non-distributed income of the CFC.
• The non-distributed income or loss shall be included in the tax period of the controlling Cyprus tax resident company in which the tax year of the CFC ends.

D. Definitions of the relevant terms

1. Borrowing costs is broadly defined and covers interest expenses on all forms of debt, other costs economically equivalent to interest expenses as well as expenses incurred in connection with the raising of finance
2. Exceeding borrowing costs is defined as the excess of borrowing costs over interest income and other economically equivalent taxable revenues.
3. Taxable EBITDA is defined as the total of net taxable income (calculated as per the Cypriot income tax laws) increased by the exceeding borrowing costs, the depreciation and amortization of fixed assets and intangibles and the notional deduction of 80% on the gross profit as a result of the Intellectual property (IP) Box regime. Losses brought forward from prior years are not taken into account in determining the EBITDA. Thus exempt income such as dividends, capital gains and their relating costs are not taken into consideration. at your disposal to discuss whether and how you are affected by the above developments.
4. Cyprus Group, as this is defined in the Income Tax Law (75% participation group), including permanent establishments in Cyprus.
5. A standalone entity means a taxpayer that is not part of a consolidated group for financial accounting purposes and has no associated enterprise (minimum 25% participation).