Paper P6 (CYP) Advanced Taxation (Cyprus) Friday 5 June Professional Level Options Module. Time allowed

Transcription

1 Professional Level Options Module Advanced Taxation (Cyprus) Friday 5 June 2015 Time allowed Reading and planning: Writing: 15 minutes 3 hours This paper is divided into two sections: Section A BOTH questions are compulsory and MUST be attempted Section B TWO questions ONLY to be attempted Tax rates and allowances are on pages 2 4 Do NOT open this paper until instructed by the supervisor. During reading and planning time only the question paper may be annotated. You must NOT write in your answer booklet until instructed by the supervisor. This question paper must not be removed from the examination hall. Paper P6 (CYP) The Association of Chartered Certified Accountants The Institute of Certified Public Accountants of Cyprus

2 SUPPLEMENTARY INSTRUCTIONS 1. You should assume that the tax rates and allowances shown below will apply for the foreseeable future unless you are instructed otherwise. 2. Calculations and workings need only be made to the nearest unless you are instructed otherwise. 3. All apportionments should be made to the nearest month. 4. All workings should be shown. TAX RATES AND ALLOWANCES The following rates and allowances for the year 2014 are to be used in answering the questions Income tax 0 19,500 nil 19,501 28,000 20% 28,001 36,300 25% 36,301 60,000 30% Over 60,000 35% Corporation tax All companies 12 5% Special modes of taxation of certain kinds of income Pensions of residents from services rendered outside the Republic (which exceed 3,420) 5% Gross amount of royalties, premiums, compensation, etc 10% Film rental, etc of non-residents 5% Profits of non-resident professionals, artists, etc 10% Capital allowances Annual (wear and tear) allowances Tractors, trenchers, excavators, bulldozers, transcavators, self-propelled shovels and loaders, drums, oil tanks 25% Motor vehicles other than saloon cars 20% Computers and operating software 20% Application software (a) if not exceeding 1, % (b) if exceeding 1, % Agricultural machinery and tools acquired in the years 2012, 2013 and % otherwise 15% Other plant and machinery acquired in the years 2012, 2013 and % otherwise 10% Hotel, industrial and agricultural buildings acquired in the years 2012, 2013 and % otherwise 4% Commercial and other buildings 3% Glass houses, metallic skeleton 10% Glass houses, wooden skeleton 33 3% Amortisation allowance On the cost of purchase or development of intellectual property rights (from 1 January 2012) 20% 2

3 Special defence contribution On dividends received (where applicable) 17% On interest received standard rate 30% reduced rate (applicable under specific circumstances) 3% On rental income (on 75% of the gross rental income) 3% Interest and surcharge on unpaid tax Interest on income and corporation tax assessments (interest is calculated on the basis of completed months. The same rate applies to overpayments of tax) Additional tax PAYE assessments 4 5% p.a. 5% of tax due 4 5% p.a. plus surcharge of 1% per month Value added tax (VAT) Registration limit 15,600 Deregistration limit 13,669 Standard rate: until 12 January % from 13 January % Reduced rates: until 12 January %, 8% from 13 January %, 9% Capital gains tax Rate 20% Life time exemptions (maximum 85,430) General 17,086 Farmer 25,629 Residential dwelling 85,430 Immovable property tax On every Euro not exceeding 40,000 6 On every Euro from 40,001 to 120,000 8 On every Euro from 120,001 to 170,000 9 On every Euro from 170,001 to 300, On every Euro from 300,001 to 500, On every Euro from 500,001 to 800, On every Euro from 800,001 to 3,000, On every Euro from 3,000, Note: If the total value of the property amounts to 12,500 or less, no tax is due. Stamp duty nil for amounts up to 5, for every 1,000 or part of 1,000 for amounts from 5,001 up to 170, for amounts exceeding 170,000 with a maximum amount of stamp duty of 20,000 Land transfer fees 1 to 85,000 3% 85,000 to 170,000 5% Over 170,000 8% 3 [P.T.O.

4 Social insurance Self-employed 14 6% Employer 7 8% Employee 7 8% Maximum annual insurable income of employees 54,396 Other contributions by employers Social cohesion fund 2% Redundancy fund 1 2% Industrial training fund 0 5% Central holiday fund (if not exempted) 8% Retail Price Index for Capital Gains Purposes Year Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

5 This is a blank page. Question 1 begins on page 6. 5 [P.T.O.

6 Section A BOTH questions are compulsory and MUST be attempted 1 You should assume that today s date is 10 November You are waiting for Max, the chief financial officer of Le Romstan Resort Ltd (LRR), a Cyprus tax resident company which owns and runs the Romstan Resort Hotel, located in Limassol, Cyprus. Max has heard about your firm and has requested value added tax (VAT) and corporation and income tax advice. Max enters the boardroom, greets you and opens his notes: As a bit of background, the hotel has not been performing well over the last few years, and is barely turning a profit. In addition, the hotel buildings are in need of a full renovation. The problem is the banks are not willing to extend any further loans beyond the company s existing borrowings, and the owners do not have the funds to invest themselves. The hotel has income from letting rooms, and from the various restaurants located within the hotel. The hotel also has a beauty therapy salon, which has been established as one of the best on the island and is very successful. In addition, there are three shops within the hotel, which are run by Camilla, the daughter of one of our shareholders. Camilla leases the shops from LRR, and runs these shop businesses as a sole trader. We know that the Department of Taxation is examining the hotel industry and that they have already conducted various joint VAT and direct tax audits of similar hotel businesses. We believe that it is only a matter of time before they also audit LRR. We would therefore like to ensure that we are correctly processing transactions in our books for tax purposes, so, if we are not, we can correct any wrongdoings. That is unless you believe it is better to say nothing in case the tax authorities do not find the mistake? Mandatory service charge The first thing on my list is the 10% mandatory service charge. We charge all hotel guests an additional 10% on all of their in-hotel purchases, including restaurant bills, room service bills and any products and treatments purchased from the beauty therapy salon. All of this service charge income is allocated to the employees of the hotel based on the units accumulated in their name. The mechanism for this allocation is as follows: Each department in the hotel is allowed a fixed percentage of the total service charge income earned by the hotel from all of its activities for example, the food and beverages department gets 30%, the accounting department 10% and so forth. The total amount per department is allocated to the employees within that department based on the units they have been allocated personally each employee earns units based on their position and years of experience. This exercise is undertaken monthly, with the amount received by each employee forming part of their salary for that month, and shown separately on their payslip. Because it is not easy to predict the monthly amounts received from the mandatory service charge, we, as employers, do not deduct any tax at source on these amounts through the Pay-As-You-Earn (PAYE) system, as we would do on other remuneration like bonuses, for example. The employees are simply told that they need to pay any tax which arises on this income themselves, through the self-assessment system. In addition, I am not sure of the VAT treatment of the mandatory service charge. Given that it effectively ends up forming part of the employees emoluments, we consider all the income received through the mandatory service charge to be part of salaries and thus do not subject the amounts to VAT. Is this correct? Hotel shops As I said earlier, the shops inside the hotel are run by Camilla. At the end of 2013, we requested tenders for the lease of the shops from 1 January We received three offers, including Camilla s. One was for 10,000 per month, another for 9,000 per month, and Camilla s for 5,000 per month. The board decided to award the lease of the shops to Camilla. We have confirmed with the Department of Taxation that the lease payments will be subject to special defence contribution (SDC). Can you please explain how the SDC should be paid, given that the payments are received quarterly in advance? Loan/guarantee transactions There are also certain loan transactions which we would like you to review: Firstly, Camilla received a five-year, 200,000 bullet loan from LRR to help her make her first purchases of inventory. Under the terms of the loan agreement, she will pay interest annually at the rate of 5%, which is 6

7 around 1% higher than our average borrowing rate from the banks. Full capital settlement will be made in year five. To further help Camilla, the board is considering amending the loan agreement so as not to charge any interest and so effectively make the loan interest free. What are the tax implications, both if the interest rate is kept at 5%, and if it is reduced to nil? Secondly, at the start of 2014, Costas, one of our junior employees who works in the maintenance department, was also provided with a five-year bullet loan for 20,000, with annual interest of 5%. Finally, one of our other employees, Elvira, wanted to buy a house but the developer requested a guarantee, for the amount of 100,000, open for two years until the property was finalised. The bank quoted Elvira fees of 1 5% per year on the capital amount to issue a guarantee letter, so she asked if we could help. Given that she is a key employee in our marketing department, the board agreed to offer the developer a corporate guarantee from LRR, which he accepted. We will not charge Elvira anything for this guarantee as it does not cost us anything to provide it. Can you please advise on any tax consequences resulting from these loan transactions, either for LRR or for each of the other parties? Beauty therapy salon sales We purchase our beauty therapy salon products (essential oils, body scrub creams, etc) from Italy. The hotel s clients like them so much that we have created various sizes of boxes with bundles of several products. Our largest box is very popular but, due to its weight, many clients ask us to ship the boxes direct to their home country, which may be inside or outside the EU. So we have some clients who purchase the products from the beauty therapy salon and take the boxes away with them, and other clients who pay for us to transport the boxes to their home country. We would like to clarify the effect of the various place of supply rules on the VAT treatment of these sales of beauty therapy salon products. Required: Draft a memorandum to Max which addresses the following issues: (i) Whether it could be better not to disclose any of the matters discovered to the tax authorities. (3 marks) (ii) Whether it is correct not to deduct income tax, through the Pay-As-You-Earn (PAYE) process, on the additional mandatory service charge amounts paid to Le Romstan Resort Ltd s (LRR) employees, given that the employees have been told to pay any tax themselves through the self-assessment system; and the actions, if any, which LRR should undertake. (5 marks) (iii) The value added tax (VAT) treatment, including, where relevant, the VAT rate(s) applicable, to the mandatory service charge; and the action, if any, LRR should undertake. (5 marks) (iv) Any tax issues resulting from the tender process for the lease of the hotel shops; and the action, if any, LRR should undertake. (3 marks) (v) The special defence contribution payable on the lease payments and a calculation of the net lease income LRR will receive each quarter. (2 marks) (vi) The tax implications for LRR and/or for Camilla, Costas and Elvira respectively, of the loans and corporate guarantee provided by LRR. (7 marks) (vii) The VAT treatment of the sales of the beauty therapy salon products to the hotel s clients. Note: Calculations are not required except in the case of part (v). (6 marks) Professional marks will be awarded in Question 1 for the appropriateness of the format and presentation of the memorandum, and the effectiveness with which the information is communicated. (4 marks) (35 marks) 7 [P.T.O.

8 2 You should assume that today s date is 16 June Rikos and Kostis are brothers and are both Cyprus tax residents. The brothers are equal partners in Karios Bros Movers (KBM), a partnership registered in Cyprus, and the legal owners of the tradename KBM, which was registered in Cyprus. KBM transports goods between towns within Cyprus and is registered for value added tax (VAT) in Cyprus. Rikos and Kostis have been clients of your firm since they started their business in 2010 and recently requested a meeting to discuss various matters which have arisen. They enter your office, greet you with their typical enthusiasm, and explain the matters on which they need advice. The brothers have recently been contacted by Degas SA (Degas), a French company which sells furniture. Degas has a private customer in Nicosia, Cyprus who has ordered a couch from their French warehouse, which will soon be arriving at the Limassol port in Cyprus. KBM is to transport the couch to the house of Degas customer in Nicosia and raise their invoice for transportation to Degas. The brothers have received a similar request from a furniture manufacturer, OOO Kandinsky (Kandinsky), based in Russia, to transport Russian furniture to Kandinsky s customer in Limassol. The Russian furniture will arrive at the port in Larnaka, Cyprus for transportation and KBM will raise their invoice to Kandinsky. Both Degas and Kandinsky are VAT registered in their respective countries. The brothers want information on the VAT treatment of these transactions. The brothers have accepted an offer from Sorolla SA (Sorolla), a Spanish company involved in the international transportation of goods, to purchase the KBM business, including the tradename. Sorolla has offered the brothers a total price of 500,000, net of VAT, which is broken down as follows: Description Price Original cost to Year of purchase KBM (net of VAT) by KBM 1 KBM tradename 390,000 nil n/a 2 Three vans 100, , Office furniture 10,000 30, ,000 Following the purchase of KBM, Sorolla will continue to undertake business in Cyprus through rented offices in Limassol. However, all invoices will be raised directly by Sorolla in Spain. Following the purchase by Sorolla, Rikos will continue to be involved in the business and will become employed directly by Sorolla to run the Limassol office on a full-time basis. The employment agreement provides for him to be outside Cyprus, delivering Cyprus fruit to mainland Europe, for up to four months in any calendar year. For this four-month period, Rikos will be paid by Sorolla EU Transport SA, another Spanish company in the Sorolla group, which deals with intra-eu transport. Following the purchase by Sorolla, Kostis will cease to be involved in the business. He is considering farming and is interested in purchasing a farmhouse in the village of Kakopetria in the Cyprus mountains. In order to finance this purchase, he will sell his small Limassol beach apartment in June 2014 for 420,000. Kostis has lived in the apartment since he originally acquired it in December 2008 from a developer in exchange for land which he owned in Larnaka. In addition to the land exchanged, Kostis paid the land transfer fees of 21,166, as well as a cash amount of 50,000 to the developer. The land in Larnaka was a gift from Kostis father, who had owned it from The land was valued at 300,000 in December 2008, and has a 1 January 1980 value of 40,000. Kostis has used his general life-time exemption for capital gains in full in a past transaction. Last year, Kostis sold a plot of land he owned in Paphos, Cyprus resulting in a loss for capital gains tax purposes of 23,500. 8

9 Required: (a) Explain how the profits of Karios Bros Movers (KBM) will be taxed prior to the sale to Sorolla. (2 marks) (b) (c) (d) Advise Rikos and Kostis whether KBM should or should not include Cyprus value added tax (VAT) on their invoices to Degas SA and OOO Kandinsky. (5 marks) Calculate Rikos taxable income from the sale of the KBM business to Sorolla SA (Sorolla). Clearly state any assumptions you need to make. (6 marks) Explain how, following the purchase of KBM s business activities, Sorolla will be taxed in Cyprus. (4 marks) (e) Explain how, following the sale of KBM s business activities, Rikos will be taxed in Cyprus. (3 marks) (f) Calculate Kostis capital gain on the disposal of his Limassol apartment. (5 marks) (25 marks) 9 [P.T.O.

10 Section B TWO questions ONLY to be attempted 3 You should assume that today s date is 26 May Marina is a Cyprus tax resident and the owner of the entire share capital of Cyprus Fashion Ltd (CFL). CFL is a Cyprus tax-resident company and is registered for value added tax (VAT) in Cyprus. CFL circulates a monthly fashion magazine and it also has a branch in the United Kingdom (UK) which circulates a UK version of the magazine. CFL s consolidated accounting net profit before tax for the year 2013, from all of its activities (including the UK branch) was 120,000. In 2013, the UK branch alone generated a net profit before tax of 180,000, and paid tax in the UK of 36,000. Christos lives in Ildoria, a country in Asia, where he works as a freelance photographer. Christos is registered for VAT in Ildoria. He has been contracted to come to Cyprus for two weeks to cover the upcoming Cyprus Fashion Show 2014 Festival, on behalf of CFL. Christos will take photographs at the festival, touch up the photos on his laptop and deliver them to CFL on a memory-stick before he returns to Ildoria. Christos will invoice CFL directly for this work. Christos and Marina are discussing the creation of a publication of fashion photos which will be sold in Cyprus. The publication will be a high-gloss booklet with photos from the fashion shows around the world which Christos has covered in the last ten years. CFL will cover the cost of the publication and sell it under its own name. Christos will retain the intellectual property rights of the photos in the booklet, and CFL will pay him gross royalties of 10,000 per year for five years. Ildoria imposes a flat rate tax of 20% on all types of income for both individuals and corporations. The Cyprus Ildoria tax treaty provides for the right of both countries to withhold tax at 15% on royalties and for double tax relief for all income using the credit method. Required: (a) (b) (c) Explain, with supporting calculations, the corporation tax and special defence contribution payable as a result of the profits made by Cyprus Fashion Ltd (CFL) in (4 marks) With regards to Christos coverage of the Cyprus Fashion Show 2014 Festival: (i) Explain how Christos will be taxed in Cyprus and how any tax due will be paid to the Department of Taxation. (3 marks) (ii) Explain the value added tax (VAT) treatment of the invoice raised by Christos to CFL. (2 marks) With regards to the publication of the high-gloss fashion photo booklet, explain, with supporting calculations, how Christos royalty income will be taxed in Cyprus and state the net amount of income he will receive every year after deduction of all taxes. (3 marks) Marina also owns 50% of the share capital of Gabs Gabs Ltd (GGL), an Ildorian tax resident publishing house. GGL operates a branch, Hungry Gabs Cyprus Branch (HGCB), in Cyprus which produces a weekly magazine on Cyprus cuisine and restaurants. HGCB rents a large building where it owns and operates its own printing machines. HGCB s activities have been hugely successful and as a result, GGL has been approached by Themis Stok Leo plc (TSL), a UK based company, with a view to purchasing the activities of HGCB for 2,700,000. If the sale of HGCB goes ahead, GGL has agreed to issue a dividend of the entire amount of the net sales proceeds in three equal instalments over three years. Marina is keen to proceed with the sale, but is concerned about the taxes which will arise as a result, including the risk that the deemed distribution rules will apply and she will have to pay special defence contribution on the entire amount within two years. Ildoria does not impose any withholding tax on dividend payments. 10

11 Required: (d) (e) (f) Explain the tax implications for Gabs Gabs Ltd (GGL) if it were to sell its Cyprus branch to Themis Stok Leo plc (TSL). Note: Calculations are not required for this part. (3 marks) If GGL sells the activities of the branch to Themis Stok Leo plc, advise on the value added tax (VAT) implications. (1 mark) With regards to the profit GGL will derive from the sale of its Cyprus branch to TSL, explain whether Marina s concern over the deemed distribution rules is justified and advise Marina how the dividend income she receives will be taxed and how any tax should be paid to the Department of Taxation. (4 marks) (20 marks) 11 [P.T.O.

12 4 You should assume that today s date is 31 December Evgenia is a Cyprus tax resident and the owner and chief executive officer of Evgenia Electronics Holdings Ltd (EEH). EEH owns 75% of the shares in Barcyprus Holdings Ltd (BCH), BCH owns 100% of the shares in Darsales International Ltd (DSI) and DSI owns 75% of the shares in Farproduction Cyprus Ltd (FPC). All four companies are Cyprus tax resident. The remaining 25% shareholding in FPC is owned by Evgenia personally and the remaining 25% shareholding in BCH is owned by Polar Electrics Inc (PE), a company resident in the United States. The group structure, which has remained the same for several years, is summarised in the following diagram: Evgenia 100% Polar Electrics Inc (PE) Evgenia Electronics Holdings Ltd (EEH) 25% 75% Barcyprus Holdings Ltd (BCH) 100% Darsales International Ltd (DSI) 75% 25% Farproduction Cyprus Ltd (FPC) EEH is just a holding company, holding the shares of BCH. In addition to its ownership of DSI, BCH also owns all the immovable property, including offices and a factory used by the companies in the group. FPC operates the factory, which produces reading tablets. All the reading tablets produced by FPC are sold to DSI, which in turn sells them in the retail market. In 2012, FPC made after-tax profits of 135,000. From these it is expected to declare actual dividends as follows: 70% of its after-tax profit on 31 December 2015, and the remaining 30% of the after-tax profit on 31 December On both dates, DSI will immediately, on the same day, declare the entire amount of the dividend received from FPC as a dividend to BCH. The directors of PE and Evgenia have been discussing floating the shares of BCH on the Cyprus Stock Exchange. They have agreed that the float would be more attractive to investors if there were no minority shareholdings below the level of EEH, i.e. that EEH owned 100% of BCH, which owned 100% of DSI, which owned 100% of FPC. 12

13 Required: (a) (b) (c) (d) Define a tax group for group loss relief purposes and state, with reasons, the tax group(s) which exist within the Evgenia Electronics Holdings Ltd s group structure. (3 marks) With regards to the 2012 after-tax profits made by Farproduction Cyprus Ltd, and the ensuing expected dividend declarations on 31 December 2015 and 2017, explain, with supporting calculations, when and on what basis special defence contribution (SDC), which may arise in any of the tax years 2012 to 2017 inclusive, will be payable by: (i) Farproduction Cyprus Ltd; and (8 marks) (ii) Darsales International Ltd. (3 marks) List ANY FOUR tax exemptions available when using a reorganisation scheme. Note: You are not required to provide details, only to identify the tax liabilities which may be avoided. (2 marks) Advise Evgenia and Polar Electrics Inc on the most tax efficient manner in which to restructure their holdings so as to eliminate the minority holdings in Barcyprus Holdings Ltd and Farproduction Cyprus Ltd. (4 marks) (20 marks) 13 [P.T.O.

14 5 You should assume that today s date is 12 February Ramsy is a Cyprus tax resident and the owner and sole director of Ginger Ltd (Ginger), a Cyprus tax resident company. Ginger trades in high-definition large screens with tele-conferencing facilities and is always in a positive cash position. Ramsy is also the owner and sole director of Gordon Ltd (Gordon), which was incorporated in 2006, so that Ramsy could try something different. Since its incorporation, Gordon has been engaged in a single development project. In 2006, Gordon purchased a parcel of land, using a loan from Ginger to finance the purchase. Also in 2006, Gordon submitted plans to divide the land into five building plots. The permission was granted in 2007 and the five building plots were formed in the same year, again using a loan from Ginger. During 2009, five houses were erected, one on each building plot, this time using funds which were introduced by Ramsy personally, through an increase in share capital. The construction of the houses was completed at the beginning of Two of the houses were kept as non-current asset investments on Gordon s statement of financial position, with the intention that they would not be sold, and for the last five years these two houses have been available for short-term rental as holiday accommodation. The other three houses have been held on Gordon s statement of financial position for the last five years as available-for-sale inventory. Ramsy is now negotiating with an investor who wishes to purchase all five houses from Gordon. Ramsy is happy to proceed as this will result in a good profit. If the sale goes ahead, Ramsy will use the funds from the sale to finance the purchase by Gordon of another piece of land, on which Gordon will then construct three luxury mansions for resale. Required: (a) (b) Analyse the scenario by reference to each of the ten badges of trade and conclude, for each badge and overall, as to whether the transactions of Gordon Ltd will be considered to be of a capital or of a trading nature. (16 marks) Explain the basis on which Gordon Ltd would have paid immovable property tax for each of the tax years 2009 and 2010 and the action, if any, Gordon Ltd should have undertaken. (4 marks) (20 marks) End of Question Paper 14