Tax competitiveness of Cyprus enhanced by recent amendments

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1 from International Tax Services Tax competitiveness of Cyprus enhanced by recent amendments August 7, 2015 In brief Amendments to the Cyprus corporate and personal tax laws that will enhance the country s tax competitiveness were published in the Cyprus Government Gazette on July 16, Key amendments include: a tax deduction on corporate equity in the form of a notional interest deduction (NID) a tax exemption for personal investment income (dividends and interest) of non-domiciled (non-dom) individuals. The NID amendment aims to reduce corporate debt by increasing the attractiveness of equity from a tax perspective. The non-dom provisions aim to further encourage high-net-worth individual investors to reside and invest in Cyprus. The NID amendment is retroactively effective on January 1, The non-dom provisions took effect July 16, Another bill containing additional tax amendments has been sent to Parliament for discussion and voting. We expect Parliament to consider these additional proposals in September, following the Summer recess. The main proposals in this bill include: neutral tax treatment for foreign currency exchange differences (forex) that do not relate to trading in forex extension of the arm s-length principle to include arm s-length downward adjustments extension of the employment income exemption period for expatriates earning over from five to 10 years In detail Enacted amendments Tax deduction on corporate equity notional interest deduction (NID) This amendment to the Income Tax Law aims to reduce corporate debt and encourage new equity (share capital and share premium) by introducing an annual tax deduction for corporate equity. New equity introduced to a company beginning January 1, 2015, in the form of paid-up share capital or share premium is eligible for the annual NID. New equity may be contributed in cash or in assets-in-kind. For the latter, the amount of new equity may not exceed the assets market value, which taxpayers must substantiate.

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3 Similar to how the interest expense on debt financing is generally calculated as an interest rate on loan principal, the NID is calculated as an interest rate on the eligible share capital / premium. The NID interest rate is the yield on 10-year government bonds at December 31 of the prior tax year of the country where the funds are employed in the business of the company, plus a 3% premium, subject to a minimum amount that is the yield of the 10-year Cyprus government bond at the same date, plus a 3% premium. The NID is tax deductible similar to actual interest expense. Accordingly, the NID is available when new equity is used to finance most types of business assets. The NID cannot exceed 80% of taxable profit as calculated prior to applying the NID. A taxpayer may elect not to claim part or all of the NID available in any tax year. NID not used because of the 80% cap or the taxpayer s election may not be carried forward to future tax years. To prevent possible abuse of the NID, the amendment introduces a general anti-avoidance provision for noncommercial transactions. The amendment also contains a number of specific anti-avoidance provisions that may restrict the NID as well. These include: New equity that comes from reserves existing at December 31, 2014, cannot qualify for the NID unless the new equity is financing new business assets. New equity that comes from share capital / premium existing at December 31, 2014, cannot qualify for the NID. New equity that comes from revaluations of assets cannot qualify for the NID. Companies benefiting from the reorganization provisions of the tax law will have their new equity calculated as if the reorganization had not taken place. To avoid duplication of the NID, it will be available only to one company when the new equity of a company is derived directly or indirectly from the new equity of another. The NID will be reduced to the extent that another entity has claimed an interest deduction in Cyprus with respect to certain funds if the new equity comes directly or indirectly from such funds. We expect the Cyprus tax authorities to issue a clarifying circular on the practical application of the NID. The NID applies to Cyprus taxresident companies and to permanent establishments (PEs) in Cyprus of non-resident companies. It took effect retroactively on January 1, Observation: The amendment s aim is to encourage new equity, which in turn should increase the economic robustness of Cyprus companies by allowing them to reduce reliance on debt financing while keeping their competitiveness. Exemption from taxation for personal investment income (dividends and interest) of non- Cyprus domiciled (non-dom) individuals Before this amendment, Cyprus taxresident individuals earning Cyprussource or foreign-source income in the form of dividends or passive interest were subject to Cyprus Special Defence Contribution (SDC) at the rate of 17% on dividends and 30% on interest, regardless of their domicile status. With this amendment, individuals with non-dom status no longer are subject to SDC. Coupled with the income tax exemptions existing for such income, this amendment means that nondoms are exempt from taxation in Cyprus on their dividends and passive interest, regardless of whether such income is earned in Cyprus or abroad. Regarding rental income, whether Cyprus- or foreign-source, Cyprus taxresident individuals with non-dom status are now subject only to income tax on rental income; previously, Cyprus-resident non-doms also were subject to SDC on passive rental income. For purposes of the SDC Law, the following individuals are domiciled in Cyprus: individuals who have a domicileof-origin in Cyprus, as defined in the Wills and Succession Law, with the exception of: individuals who have acquired and maintain a domicile-ofchoice outside Cyprus based on the provisions of the Wills and Succession Law and were not tax residents of Cyprus under the Income Tax Law (ITL) for any period of at least 20 consecutive years prior to the tax year of assessment; or individuals who were not residents of Cyprus under the ITL for a period of at least 20 2 pwc

4 and consecutive years immediately before these amendments entered into force; regardless of the preceding conditions, individuals who have been residents of Cyprus under the ITL for at least 17 of the 20 years prior to the tax year. Domicile-of-origin under the Wills and Succession Law is acquired at birth and generally is the same as the father s domicile at the time of birth; in exceptional cases it is the mother s domicile. Regarding the first exception above, the Wills and Succession Law provides that a domicile-of-origin may be changed to a domicile-of-choice if in actual fact the individual permanently establishes himself or herself in another country with the intention to permanently live and die there. The amendment also introduces antiavoidance provisions that restrict its application when domiciled individuals transfer assets to nondoms to take advantage of these provisions of the SDC law. This amendment took effect July 16, Observation: In addition to the above-noted income exemptions, Cyprus tax laws also provide an unconditional exemption from tax for gains on disposals of shares and bonds issued by companies and other corporate titles, except in certain cases in which the company holds immovable property in Cyprus. (Note: The ITL defines titles as shares, bonds, debentures, founders shares and other securities of companies or other legal persons, incorporated under a law in the Republic or abroad and rights thereon. ) Combined with the existing exemptions, the new amendment to the SDC law makes Cyprus a very taxefficient location for non-doms to hold investments in shares, bonds and other interest-earning assets. Amendments expected to be discussed and voted on in September Tax-neutral treatment for foreign currency exchange differences (forex) that do not relate to trading in forex Under these provisions, all forex would be treated on a tax-neutral basis from a Cyprus income tax perspective (i.e., gains not taxable, losses not deductible) with the exception of forex arising from trading in forex (that is, from transactions for which the primary purpose is to create a forex gain), which would remain taxable and deductible. The definition of forex includes gains and losses on foreign currency rights or derivatives. Regarding trading in forex, which remains subject to tax, this proposal would introduce an option for taxpayers to make an irrevocable election whether to be taxed only upon realization of forex rather than on an accruals/accounting basis. This amendment would take effect retroactively from January 1, Observation: Businesses with crossborder transactions usually incur forex. Forex is often difficult to predict, especially in the current global economic climate. The proposal aims to simplify the income tax treatment of forex. Extension of the arm s-length principle to include arm s-length downward adjustments The ITL currently provides only for upwards adjustments to profits when taxable profits earned on related-party transactions are below an arm slength (i.e., market value) amount. The bill would amend the ITL by introducing the possibility of downward adjustment when expenses or losses incurred with related parties are not at arm s length. The amendment also would provide that when two related Cyprus taxpayers enter a transaction and the Cyprus tax authorities make an upwards arm s-length adjustment to one of the taxpayers, there would be a corresponding downward adjustment for the other taxpayer. This amendment would take effect retroactively to January 1, Observation: This proposal is designed to increase fairness to businesses with respect to their related-party dealings. Extension of the employment income exemption for expatriates earning over 100,000 from five to 10 years The ITL currently provides a 50% exemption from income tax for remuneration from any employment exercised in Cyprus by an individual who was not a resident of Cyprus before commencement of the employment. The exemption applies for five years, beginning in the year that the employment begins, provided the annual remuneration exceeds 100,000. The bill would extend the period for which the exemption is available from five to 10 years. For employment commencing on or after January 1, 2015, there would be 3 pwc

5 an additional requirement that the individual was not tax resident in Cyprus for any three (or more) tax years in the five years immediately before the tax year in which the employment begins and was not a tax resident in the tax year immediately prior to such tax year. The ITL also currently provides a 20% exemption from income tax for any remuneration from any employment exercised in Cyprus by an individual who was not a resident of Cyprus before commencement of the employment, subject to a maximum exemption of 8,550. This 20% exemption applies for three years beginning with the tax year following commencement of the employment. The bill proposes that for employment commencing during or after 2012, the three-year period would increase to five years and that the last year for which the 20% exemption would be available is The bill also provides that those individuals eligible for the 50% exemption could not claim the 20% exemption as well. These amendments are proposed to take effect retroactively to January 1, Observation: The maximum income tax rate on personal income in Cyprus currently is 35%. The 50% exemption reduces the effective income tax rate on eligible employment income for highly paid individuals to approximately 8% to 17.5%, depending upon personal circumstances. Extension of the exemption period would further enhance the attractiveness of this measure. The takeaway These enacted and proposed amendments aim to make the Cyprus tax system more fair and competitive, and should ultimately contribute positively to the local economy. The enacted NID, together with the proposals for neutral treatment of forex and extension of the arm slength principle, should have a positive impact for businesses. For individuals, the enacted and proposed amendments relate to the most common forms of personal income (employment income, dividend income, and passive interest income) and should encourage more high-net-worth individual investors and high-earning employees to reside, work, and invest in Cyprus. Let s talk For an in-depth discussion of how these proposals might affect you or your business, please contact: International Tax Services, United States Jovanna Tannousis jovanna.m.tannousis@us.pwc.com International Tax Services, Cyprus Theo Parperis theo.parperis@cy.pwc.com Stelios Violaris stelios.violaris@cy.pwc.com Marios Andreou marios.andreou@cy.pwc.com Nicos Chimarides nicos.chimarides@cy.pwc.com 2015 PricewaterhouseCoopers LLP, a Delaware limited liability partnership. All rights reserved. PwC refers to the United States member firm, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see for further details. SOLICITATION This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors. 4 pwc

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