On February 18, 2011, after lengthy negotiations, Cyprus and Germany signed the new Agreement on the Avoidance of Double Taxation, which will replace the existing agreement of 1974.
The main changes are outlined below:
The Agreement's appliance on taxes has been expanded to include further forms of tax such as the Cyprus corporate income tax and the capital gains tax.
A new definition is also provided on the Protocol to the Agreement according to which the 'place of effective management' will be considered as the place where the key management decisions are taken, that is where the senior partner/s make such decisions.
Article 5 (Permanent Establishment): In relation to permanent establishments (PE), a building site or construction or even any supervisory activities in connection with the aforementioned will be considered as a PE when it lasts more than 12 (previously six) months. Furthermore, the term PE is further restricted by the exclusion of any preparatory or auxiliary activity as PE.
Article 6 (Income from immovable property): The two countries have, further, decided to include income of agriculture or forestry as an income of immovable property but to exclude income from immovable property used for the performance of professional services, which was included on the 1974 Treaty.
Article 8 (Shipping, inland waterways transport and air transport): Significant additions have been established on shipping. Profits from the operation of boats engaged in inland waterways transport are going to be taxed in the Contracting State in which the enterprises' effective management is situated. Profits have also been extended to include profits from rentals of ships, aircrafts, the use or rental of containers, as well as tasks performed for the operation of the ship.
Moreover, the new Agreement completely abolishes the provision according to which Germany could tax profits of a Cyprus resident company or partnership, owed more than 25% by a non-Cypriot-resident, if it could not prove that the tax appropriate is equal to Cyprus tax .
Article 9 (Associated enterprises): A new provision has been introduced according to which adjustments on tax imposed on an enterprise need to be made when an associated enterprise has been taxed in the other Contracting State, and those profits would have accrued to the first enterprise if they were not associated.
Article 10 (Dividends): An amendment on
dividends has been established according to which, where the
dividends are taxed in the State in which the company paying the
dividends is a resident and the beneficial owner of those dividends
is company and a resident of the other State, then the charge
should not exceed 5% of the gross amount of the dividends
(before 10%) if the Beneficial owner holds directly at least 10%
(before 25%) of the capital of the company paying the
dividends.
Moreover, a new restriction is introduced. A State will not impose tax on dividends paid where a resident-company of a Contracting State derives income or profit from the first State, unless dividends paid to a resident of the other Contracting State or the holding in respect of which the dividends are paid is effectively connected with a PE in that other Contracting State.
The limitation on the German tax on dividends paid to a Cyprus-resident-company by a Germany-resident-company is abolished. This is due to the change from imputation system to the so called partial income procedure for corporate income tax purposes. The tax rate for companies is the same regardless whether the profits are kept within the company or issued to the shareholders as dividends.
Article 11 (Interest):
The provision on interest is made absolute by stating that interest derived from a Contracting State shall only (previously may) be taxed in the other Contracting State where its beneficial owner is a resident. The exemption from tax on interest paid to governmental institutions is abolished. The term interest is slightly extended but the penalty charges for late payment are excluded for interest purposes.
Article 12 (Royalties):
The term royalties has been slightly extended to include new provisions, while the special case of royalties taxed from the right to use cinematograph films is abolished. Furthermore, a specification is introduced on which royalties shall be taxed in the Contracting State of which a PE related to the royalties paid is established, irrespectively of whether the person paying the royalties is a resident of a Contracting State or not.
Article 13 (Capital Gains):
According to the new Agreement, gains of a resident of a Contracting State from alienation of shares, which derive more than 50% of their value from immovable property, may be taxed in the State where the property is situated. It is, also, provided that gains from the alienation of boats in inland waterways transport shall be taxable in the State where the enterprises' place of effective management is situated.
Article 25 (Exchange of information): The new Agreement gives a wider power on the two countries to exchange information on a tax payer when it is foreseeably relevant (previously necessary) for the purposes of the Agreement or for the purposes of domestic laws (previously only for the purposes of the Agreement). Furthermore, even though the confidentiality condition is still applicable, the new Agreement allows the use of such information for any purpose if the Competent Authority of the Contracting State, giving the information, expressly allows it.
Both Contracting States are obliged to give requested information even if they are not required for their tax purposes and they cannot decline to provide them on the reason that they are held by financial institutions, by agencies, as a fiduciary capacity or for ownership interests.
Finally, the Protocol to the new Agreement states that in the case where a State receives irrelevant data of a tax payer, it shall erase or correct them and inform the supplying State. If a person suffers unlawful damage as a result of the exchange of information, then the receiving State will be held liable under its domestic laws.
Conclusion
The concept of beneficial owner, originating from the common law environment, is introduced in the present Agreement. The concept is used more and more in the Double Tax Treaties text and it raises discussions within the tax, legal and economic fora. Already, there have been numerous reactions as to the interpretation of the term based on the source country and its legal system. The big issue is its understanding and interpretation by each Contracting State. Currently, there is a misunderstanding between civil law and common law jurisdictions on the approach that shall be given to the term. Does it have a legal or an economic connotation? The introduction of the beneficial ownership connotation indicates a shift to the substance over form approach and shows the attempt of the States to prevent economically unrealistic tax structures. Although this approach seems in line with OECD, not all countries follow this approach in their national tax laws resulting in differences when interpreting the beneficial ownership. If at some time there is a common understanding and an international fiscal meaning of the term, among the contracting states, we will be in a better position to understand, which country taxes the dividends, royalties and interest paid, as in practice, under the new approach, a recipient does not necessarily mean that will also be the beneficial owner of the income. Finally the introduction concerning the exchange of information is characteristic for Agreements concluded by Germany in the recent past. In the absence of a level of information exchange as provided for by the OECD Model, Germany may deny tax benefits to tax payers. Exchange of information clauses also appear more and more often in agreements concluded by Cyprus too. Exchange of information is becoming a standard practice across the Globe in bilateral agreements.
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