Публикация посвящена схемам оптимизации налогообложения компаний на Кипре. В публикации детально рассматриваются схемы одноуровневого и двухуровневого финансирования.
Provisions of the Law
Article 33 of the Income Tax Law 2002 (the “Law”) gives the Inland Revenue Department the power to adjust transactions between connected companies, entities and individuals on an arm’s-length basis and to tax the resulting deemed profits, gains or benefits.
The Income Tax Office (ITO) was invoking Article 33 when a loan from a Cyprus company to a related party was considered below market rates and imposing a deemed interest income on the Cyprus company which it sought to tax at, at the applicable income tax rates at that time.
For example, if a Cyprus company had provided a loan of 0% to a related party then the ITO was imposing tax on the deemed interest as if that Cyprus company had given a loan at market rates (i.e. 5%).
In relation to back-to-back loans there was an uncertainty as to which was the minimum margin which would be acceptable by the ITO as being at arm’s length and, therefore, complying with Article 33 of the Law.
In 2011 after numerous requests by members of the Institute of Certified Public Accountants in Cyprus ( ICPAC) to address the issue of the back-to-back loans with the Income Tax Office and formalise what was by that time an unofficial common practice as to the minimum acceptable margins on the back to back loans, the ICPAC sent a letter to the ITO requesting an official guidance.
On 27 June 2011 the ITO has responded to the request of ICPAC officially setting the definition of the back to back loans as well as the detailed guidance on these loans.
The guidance provided is set out below:
Guidance on back-to-back loans
Minimum profit margins have been confirmed as acceptable from the tax year 2008 onwards:
|Amount of loan in EUR||Profit Margin|
|Interest bearing loan||interest-free loan|
|Less than 50m||0.35%||0.35%|
|50m – 200m||0.25%|
|More than 200m||0.125%|
In relation to years 2003 – 2007 which are still open, the minimum profit margin to apply is 0.30% regardless of the loan amount and whether the loan is interest bearing or not.
Calculation of the spread
- The minimum acceptable spreads are calculated after the deduction of all expenses directly or indirectly related to the financing transaction (i.e., net spreads).
- Any foreign exchange differences (either realised or unrealised) should not be included in the taxable profit calculation of the Cypriot company. That is, foreign exchange gains should not be taxable and foreign exchange losses will not be deductible.
- Loans receivables that are written-off cannot be deducted from the taxable profits of the Cypriot company. Likewise, loans payable that are waived will not be included in the Cypriot company’s taxable profits.
Application of the above spreads
- A Cypriot tax resident company borrows from a related party and uses the funds to on-lend to another related party within a six month period. The funds borrowed and on-lent by the Cypriot company may be interest-free or interest bearing.
- The Cypriot company obtains one loan in order to finance a number of loans or where the Cypriot company obtains a number of loans in order to finance a single loan. The spreads apply to each separate financing transaction.
- The Cypriot company obtains a bank loan (subject to guarantees from another company in the same group) to on-lend to its related parties. Subject to certain conditions, the spread may also apply in cases where credit instruments other than loans are used.
This development presented an opportunity for taxpayers to review their financing arrangements and benefit from the certainty offered.
DEVELOPMENTS ON BACK TO BACK LOANS
TWO TIER FINANCING COMPANY
Provisions of the Law
In accordance to the change in the Income Tax Legislation (Income Tax Law, Law 118 of 2002 – Section 9(15)) as published in the Official Gazette of the Republic of Cyprus 6 July 2012 and effective from 1 January 2012, if a Cyprus parent company incurs an interest expense on the acquisition of shares of a company that is a 100% owned subsidiary (whether directly or indirectly and irrespective of whether the subsidiary is a Cyprus or foreign company), the interest expense will now be deductible for tax purposes by the parent company.
In accordance to the Law full deduction will only apply if the subsidiary does not own assets that are not used in the business. In case the subsidiary holds such assets, the deductibility of interest expense will be limited to correspond to the amount of assets used in the business.
Note that the above relates only to purchases of shares effected after 1 January 2012.
Previous provisions of the law
In accordance to the law applicable before the above amendment (Income Tax Law, Law 118 of 2002 – Section 9(15)), it was stated that interest expense relating to the cost of an asset which was not used in business was not allowable.
Circular 2010/8 issued in June 2010, clarifies that assets not used in business include shares in public and private companies, land and buildings, recreational vessels, art etc.
Note that the circular states that the non-deductibility of interest expense stops after the lapse of 7 years from the purchase of the asset.
Reasoning behind the changes of the new law
The reasons of the amendment of the law, was to facilitate the two tier Cyprus financing company and tackle concerns (mainly from Russia) relating to the Beneficial Ownership principle which was assessed following the Eurobond issue and whereby the benefit of the non-deductibility of withholding tax would depend on the beneficial owner of the interest rather than the vehicle used to issue the debt.
Under the two tier Cyprus financing structure the risk of the intermediate Cyprus financing company being considered as a Conduit/Pass through vehicle is reduced since it is no longer a company that receives financing from related parties (usually BVI) and provides financing to related parties (usually Russia/Ukraine) keeping a very small margin taxable in Cyprus but rather a holding company.
Benefits from the changes in the above legislation
The above legislation enhances the tax benefits of using a two tier Cyprus financing structure since:
- The risk of the Cyprus financing company being considered a conduit is reduced as it is no longer a vehicle of the BVI company used in financing the Russian company providing an additional layer of protection of the Russian tax authorities considering the BVI company as the Beneficial Owner and thus withholding tax on interest paid.
- The benefits of the tax on the very low interest margin kept in the Group are maintained (due to the Group losses relief).
It is important to note that the Law refers to i) direct or indirect wholly owned subsidiaries and ii) owning assets that are used in business.
“Assets that are used in business” importance: This would avoid the abuse of the legislation whereby a Cyprus company uses financing to purchase shares in a company that has the sole purpose of gaining interest from fixed deposits, simply remaining dormant and using the tax losses to offset gains in the parent , using the funds for the purchase of land or building or in general for the non-business benefit of the shareholder .
“Directly or indirectly wholly owned subsidiaries” importance: This removes the disadvantage of having a two tier Cyprus holding company structure (i.e. a Cyprus holding company holds the shares of another Cyprus holding company which then owns shares of a Russian company).