Cyprus: Measures to tackle tax evasion

IFLR briefing firm Elias Neocleous & Co explains what market participants need to know about new tax initiatives in Cyprus

Cyprus is committed to staying abreast of all international and EU initiatives aimed at tackling tax evasion. To this end, Cyprus is making significant efforts to upgrade its tax legislation, in order to comply with both the guidelines of the OECD and the legislation of the EU.

It has already adopted general anti-abuse rules at a domestic level, and amendments to the relevant legislation are expected to provide increased, and more specific, powers to the tax authorities by giving them the power to impose tax liability, calculated in accordance with income tax legislation, to those who do not adhere to, and/or fail the valid commercial and economic reality test.

As part of this continuous effort, Cyprus has already incorporated into its domestic law (effective as of January 2016) the anti-avoidance provisions of the EU Parent – Subsidiary Directive (Directive 2015/121/EU – PSD GAAR). Cyprus has never applied withholding tax, so the amendments included in the directive did not have a direct effect in Cyprus.

BEPS/EU anti-abuse initiatives

On April 5 2019, the House of Representatives also approved legislation implementing the EU Anti-Tax Avoidance Directive (2016/1164/EC), (ATAD) in Cyprus with the aim of improving the internal market's ability to deal with cross-border tax avoidance practices.

The provisions relating to interest deductibility rules, controlled foreign companies (CFCs) and general anti-abuse rules (GAAR), as included in ATAD, entered into force on January 1 2019. GAAR rules only apply to corporate transactions.

On July 3 2020, the remaining two amendments for full implementation of the ATAD were published in the Official Gazette of the Republic.

The first concerns the introduction of an exit tax regime (ATAD I), which applies retroactively from January 1 2020. As exit taxes affect taxable assets and, given that certain assets are specifically exempt from the imposition of any Cypriot tax (e.g. securities), the imposition of exit tax is not expected to have material consequences.

The second is related to hybrid mismatches (ATAD II) and also applies retroactively from January 1. The so-called reverse hybrid mismatches rule will apply from January 1 2022. Issues of hybrid mismatches arise, for example, in cases where an entity or arrangement is regarded as a taxable entity under the laws of one jurisdiction and whose income or expenditure is treated as income or expenditure of one or more other persons under the laws of another jurisdiction.

At present, the only segment of Cypriot tax legislation that targets hybrid mismatches concerns dividends and income funds. According to this, dividends received by a Cyprus tax resident entity are subject to corporate tax if a tax deduction has been claimed for them at the level of the payer. The relevant amounts will not be tax exempt, and will be taxed as normal corporate income at a rate of 12.5%.

Tax treaty instructions/MLI

Furthermore, on January 22 2020, the ratification document of the Multilateral Convention on the Implementation of Tax Treaties (MLI) was published in the Official Gazette, together with the position of Cyprus and an explanatory statement.

Cyprus has approved the minimum actions as defined by the MLI, including Article 7 (on abuse of the Treaty). Article 7 contains a GAAR based on the Principal Purpose of Transactions or Arrangements (PPT) as well as an additional option to supplement the PPT with a simplified Limitation on Benefits (LOB). In addition, Cyprus has chosen to apply paragraph 4 of the same article, in cases where the competent authority determines that such benefits would have been granted in the absence of the transaction or arrangement.

With the above legislative actions, Cyprus demonstrates its commitment to support international efforts to tackle tax evasion practices. Existing and new structures will need to ensure and display the by now well known, globally accepted substance requirements. Failure to adhere to these requirements may result, inter alia, in the recharacterisation of incomes, double taxation, monetary penalties/prosecutions, and the application of controlled foreign corporation rules. Therefore, clients are advised to review their structures and seek to understand how these developments may affect them.