Cyprus: The Role Of Cyprus On International Tax Planning

Last Updated: 10 September 1999
INTRODUCTION

Cyprus' strategic geographic location, excellent commercial infrastructure political stability, favourable tax incentives and high European life-style are among the factors which have contributed to the development of the island as an important financial and business centre in the Middle East.

Foreign participation in the Island's economy has always been encouraged and endorsed by all official bodies and authorities as well as by the Cypriot people themselves. This generous and liberal approach is already paying dividends and has successfully generated a growing awareness amongst foreign corporations and individuals of the unique advantages of using Cyprus as a business base.

Today the authorities are demonstrating more clearly than ever before that they are seriously committed to refining and expanding the legislation and regulations in terms of which foreign involvement in the island's economy is secured. Therefore, an extremely favourable environment for all forms of offshore business activities and onshore foreign investment has been specifically structured to ensure that they enjoy an infrastructure which has the maximum potential for success and growth. Cyprus is considered to be a low tax jurisdiction and not a zero tax jurisdiction or a tax haven.

In contrast to many countries commonly used for offshore structures, Cyprus has concluded a number of double tax treaties with many developed countries as well as with Russia, the CIS and all the other Eastern European countries.

THE DOUBLE TAX TREATIES OF CYPRUS

The impressive number of the double tax treaties of Cyprus, combined with the very low taxation of offshore entities, and the nil withholding tax rates on dividends, interest and royalties paid by such entities make the Republic a tax incentive country, offering real possibilities for international tax planning. The primary purpose of these treaties is the avoidance of double taxation of income earned in any of the treaty countries. This is usually achieved, either through the allowance of a tax credit against the tax levied on the taxpayer by his country of residence or through tax exemption in one contracting state of the income taxed in the other contracting state. Normally, the result is that the taxpayer pays no more than the higher of the two rates.

Cyprus has double tax treaties with the following countries:

- Austria               - Ireland
- Bulgaria              - Italy
- Canada                - Kuwait 
- China                 - Malta 
- Czech Republic        - Norway 
- Slovak Republic       - Poland
- Denmark               - Romania 
- Egypt                 - Russia and CIS Republics
- France                - Syria (as from 1/1/1996)
- Germany               - Sweden
- Greece                - UK
- Hungary               - USA
- India                 - former Yugoslavia.
The tax treaties with Belgium and South Africa are signed and await ratification while the treaty with Finland awaits signature. New treaties with Thailand and Singapore are currently being negotiated.

All the double tax treaties of Cyprus are drafted on the basis of the OECD treaty model. As with all double tax treaties, their primary objectives are firstly, to clarify and determine the taxing rights of each contracting state, secondly, to reduce or avoid the impact of international juridical double taxation, and thirdly, to introduce anti-avoidance provisions and mechanisms to prevent tax evasion.

Cyprus is perhaps the best example of a "low tax jurisdiction" country or as it is better defined a "treaty haven" since it combines a low tax regime with an extensive network of double tax treaties and only a few anti-treaty shopping provisions. Out of all the treaties now in force, only the treaties with Canada, Denmark, Germany, France, UK and USA have some anti-avoidance provisions. Even so, these countries, with the exception of Canada and the USA provide tax sparing credits to Cypriot offshore entities.

Cyprus has a clear advantage when compared with other low or no-tax jurisdictions because of the extensive double tax treaty network. Cyprus is relatively unusual in the extent of its treaty network in that, although there are limitation provisions in some of its treaties its double tax treaties in combination with the low tax concessions given by Cyprus to offshore entities offer many possibilities for international tax planning. Moreover, the high esteem and reputation enjoyed by Cyprus with foreign tax jurisdictions means that tax screening requirements normally relevant to tax havens and low tax countries may not be relevant to payments to Cyprus legal entities, whilst the anti-avoidance legislation of high tax countries aimed at clawing back benefits derived through tax havens and low tax countries may be less significant with regard to Cyprus. At this point it should be noted, by way of illustration, that the most recent and perhaps the most appropriate example of the use of the "limitation of benefits" article is the new USA/Netherlands double tax treaty whose 27 pages long limitation of benefits article literally reduces to the minimum the tax potentials of Dutch companies as investment vehicles in and out of the USA.

In conclusion it can be stated that the wide network of Cyprus double tax treaties, combined with the tax and other incentives afforded to Cyprus offshore companies, renders Cyprus a particularly attractive place for the establishment and operation of an offshore entity. For a foreign corporation, whose activities and investments are situated on an international level, Cyprus is amongst the very few locations that combine benefits in the country where the investment is made, by eliminating or substantially reducing withholding taxes, in Cyprus itself, by avoiding or paying tax at a low rate of 4.25% and in the home country of the organisation by avoiding or reducing tax and in some cases even enjoying tax sparing credits.

THE TAX REGIME OF CYPRUS

The tax system of Cyprus is administered by the Director of Inland Revenue, who is also the Commissioner of Income Tax and who is also responsible for tax policy and tax collection.

Since 1 January 1991, Cyprus has used the "classical" system of taxation under which corporate income is subject to corporation tax and also to withholding tax on distribution by way of dividends. The corporation tax is based on "taxable trading" profit which is the accounting profit, as disclosed by the company's income statement, as adjusted for tax purposes. The corporate tax rate is 20% in respect of profits up to the first CYP40,000 and 25% on profits in excess of this amount.

Cyprus incorporated offshore companies (i.e. companies totally owned by non-residents and conducting their business activities outside Cyprus) are subject to tax on their taxable profits at the reduced rate of 4.25%, and are not subject to any withholding tax on distributions by way of dividends.

The income of individuals is subject to tax as follows:

- up to CYP 5000 :NIL
- from CYP 5001 - CYP 8000 :20%
- from CYP 8001 - CYP 11000 :30%
- more than CYP 11001 :40%

The personal income tax provides for certain allowances or deductions such as the deduction on rent, the deduction for interest paid on housing loans, the deduction on insurance premia etc., and tax credits such as credits for spouse, children etc.

The emoluments of foreign employees of offshore entities are either taxed at reduced rates or are exempt from tax, depending on where the employment is exercised and how such emoluments are paid. The term "emoluments" includes salary and other allowances such as housing, cost of living, school fees etc.

  • the emoluments out of services rendered inside Cyprus are taxed at half of the normal personal tax rates.
  • the emoluments out of services rendered outside Cyprus are taxed at one-tenth of the personal tax rates.
  • the emoluments out of services rendered outside Cyprus but received in Cyprus or through Cyprus are exempt from tax.
Where the expatriate employee renders services both in Cyprus and abroad, his salary is apportioned between the time spent in Cyprus and abroad and then taxed accordingly.

CASE STUDIES

The easiest way of comprehending some of the principles outlined above, is through practical examples and considerations. The following examples should be noted:

Tax Planning Opportunities With Russia

As a result of the excellent double tax treaty which Cyprus concluded with the USSR in 1982 and which is still in force, not only with Russia but also with most of the CIS countries, Cyprus is the jurisdiction which is probably most associated with Russian investments. The Cyprus/Russia double tax treaty provides for complete exemption from Russian withholding tax on dividends paid from a Russian entity to its Cypriot parent. This nil rate also applies to interest payments.

The most beneficial feature is however that Cyprus offshore companies, which are taxed at the favourable rate of 4.25%, are not excluded from enjoying the benefits of the treaty. Furthermore, Cyprus offshore companies do not pay capital gains tax on the sale of shares in underlying subsidiaries. Unlike many other jurisdictions Cyprus does not impose capital duty on the share capital of Cypriot companies. Also under unilateral Cyprus law, dividends paid to a Cypriot holding company may be remitted to the ultimate shareholders free from Cypriot withholding tax.

Tax Planning Opportunities With China

Although Hong Kong is probably considered to be the most favourable jurisdiction for routing investments in China, other jurisdictions may be of particular use especially where royalty or interest payments extract income before the local profits are subject if relevant to Chinese taxation. It should be noted that there is no need for double tax treaty protection to route investments in China in the case where the expected profits are to be remitted overseas in the form of dividends, since no Chinese withholding tax is imposed on dividends earned by foreign companies investing in China.

In order to channel the flow of interest and royalty payments with the minimum of foreign taxation, it may be necessary to seek protection under one of the so far 30 double taxation agreements concluded by China. One of the most useful treaties for such purposes is the treaty with Cyprus. Under the Cyprus/China double tax treaty, the maximum withholding tax rate on royalties and interest is 10%. Of particular importance is the fact that the treaty contains no limitation of benefits provisions so that a Cyprus offshore company paying tax at just 4.25% on its income will nevertheless be able to benefit from the treaty provisions. Such Cyprus companies may therefore not only be useful as intermediary companies but indeed as the ultimate financing or licensing entities used for investment in China.

Tax Planning Opportunities With India

The best way of comprehending the tax planning potentials of Cyprus with India is through a comparison with the Mauritius/India double tax treaty. Mauritius although a newcomer in the offshore financial world, has achieved considerable success to date, mainly due to the absence of competition in the Indian Ocean and also due to the cultural links between Mauritius and India.

Under the Mauritius/India treaty, withholding tax rates on dividends, interest and royalties derived under the treaty by a Mauritius company from India are:

dividends: 15% (on a shareholding of less than 10%) 5% (in all other cases)
interest: (in the case of interest derived by a bank in Mauritius) 20% (in all other cases)
royalties: 15%

The equivalent rates of Indian withholding taxes under the newly ratified India/Cyprus treaty:

dividends: 15% (on a shareholding of less than 10%) 10% (in all other cases)
interest: 10%
royalties: 15%

There is no doubt that Mauritius is a very tax effective jurisdiction for companies holding substantial participation (a shareholding of more than 10%) in Indian companies. However, Cyprus has equal treatment on portfolio dividends and, given that it enjoys a lower rate of Indian withholding tax on interest, could be, under these circumstances, a better location for portfolio investment companies. Moreover, Cyprus might be considered to be a more convenient jurisdiction from a geographical aspect and as having a much more developed commercial infrastructure.

Routing Through Austria/Cyprus

Austria's domestic tax legislation provides for a tax free receipt of dividends and other income by Austrian holding companies. Cyprus offshore companies may be the parents of Austrian holding companies and therefore could in certain circumstances provide a suitable alternative to the present popular Netherlands/Netherlands Antilles holding structure. Under the Austrian/Cyprus double tax treaty the Austrian dividend withholding tax is reduced to 10% and there is no further taxation in Cyprus for offshore companies holding the Austrian company's shares.

Alternatively, Cyprus offshore companies may be used as intermediaries for converting certain types of income such as royalties and interest into dividends which can be received by Austrian holding companies tax free. So, for example, royalty and interest payments may be received by the Cyprus offshore companies from other countries under reduced treaty withholding tax rates and they may then be paid in the form of dividends to the Austrian holding companies. No tax would be due in Cyprus since the 4.25% corporate tax rate on offshore companies will be reduced to zero through the foreign tax credit scheme provided under the terms of the Austrian/Cyprus double tax treaty.

Routing Through Ireland/Cyprus

Ireland is another favourable jurisdiction for international tax planning, so that the combination of Irish tax concessions with the favourable Cyprus/Ireland double tax treaty may provide an excellent means of structuring investments or business opportunities in high tax jurisdictions. This is especially so where Cyprus' treaties with such countries contain limitations on benefits provisions, such as the UK and US. For example, financing UK activities through an Irish company may enable interest to be received gross under the UK/Ireland double tax treaty with limited Irish taxation and paid to the ultimate Cyprus parent company without any further Irish taxation under the Cyprus/Ireland double tax treaty.

Conclusion

The Cypriot authorities are only too well aware of the need to maintain a high reputation if Cypriot entities are to be used in international tax planning. Thus Cyprus is one of the few low tax countries that require disclosure of beneficial interests before such entities are formed, although this information is treated with utmost confidentiality. The authorities are determined to impose whatever regulations are required to prove that the political and economic stability enjoyed by the island for the past 23 years provides a secure environment for companies and individuals with international business.

This information was correct in June 1997.

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