Lowtax Cyprus International Focus
By the Lowtax Team
28 September, 2011
Cyprus may no longer be offshore, and it may currently be suffering more than its fair share of the slings and arrows of outrageous fortune, but the islands tax and legal framework remains an attractive proposition for international corporate investors and individuals looking to escape the fiscal and meteorological gloom of the high tax European countries, and in this feature we examine some of the key attributes of the islands business and tax offering.
Over the years, Cyprus has developed an excellent business infrastructure, and this, coupled with the widespread use of the English language, a legal system largely based on English law, and relatively light taxation, makes the island a very convenient and effective international base.
The government's successful encouragement of the offshore sector has led to the development of a European-standard commercial and financial infrastructure, although there is no longer any distinction between domestic and offshore companies. International links are particularly strong in the shipping and banking sectors. The island is a popular base for holding company activities and as a route for investment into and out of Eastern Europe, Russia and the so-called CIS.
Cyprus has been a member of the European Union (EU) since 2004, and in 2008 the country joined the eurozone. As a condition of its entry into the EU the government had to discard many of the tax laws which had encouraged tens of thousands of offshore companies to register in Cyprus. However, the tax regime which replaced it remains one of the most favourable in the EU. Both onshore and offshore companies pay corporate income tax at 10% - the lowest rate among the 27 EU member states and in 2009, Cyprus was rated as the most attractive tax regime in Europe by a 2009 KPMG poll, ahead of Ireland, Switzerland and Malta.
As a result of these tax reforms, from 2003 Cyprus has applied a residence-based taxation regime, under which profits from activities of a permanent establishment situated outside Cyprus are completely exempt from tax. This exemption will not apply to a Cyprus company if its foreign permanent establishment directly or indirectly engages in more than 50% of its activities in producing investment income and if its foreign tax burden is substantially lower than that in Cyprus. In these tests are not met, a Special Defence Contribution (SDC) becomes payable on dividends received at a rate of 15% (soon due to rise to 17%). The SDC is also payable on deemed dividend payments made to individuals at 15% (also due to rise to 17%), and on certain domestic inter-company interest payments not received in the ordinary course of business at a rate of 10% (soon to rise to 15%). Relatively few international companies are subject to these imposts, however.
Many international investors choose Cyprus as the location for financial holding and investment companies, due to the island's low-tax regime and network of tax treaties, which include most of the major European countries and the United States. In 2011, new DTAs have been signed with Armenia and the UAE, and an updated agreement was signed with Germany. Cyprus also announced its intention to launch tax treaty negotiations with Luxembourg in July 2011. By far the most important tax treaty for Cyprus, however, has been that with Russia, which has contributed to the huge flow of Russian investment through the Mediterranean island in recent years. In 2006, it was said that more than one-fifth, or USD28bn, of the USD130bn total accumulated investments in Russia came via Cyprus, while Russian deposits in Cypriot banks are said to exceed USD26bn. The Russian government has, however, been keen to combat tax treaty abuse, and the terms of the Cyprus/Russia DTA have been tightened, which, in the process, led to Cypruss removal from the Russian tax authoritys black list of tax havens last year.
As stated, banking plays a major role in the financial services industry of Cyprus, and there are currently 15 banks incorporated in the island, of which eight are subsidiaries of foreign banks. In addition, there are 25 branches of foreign banks, of which nine are branches of banks of EU countries. There is also one representative office. Cypriot law offers investors a moderate degree of confidentiality, although, since 2005, information about savings returns received in Cyprus by nationals of other EU countries is being passed to the tax authorities in the individuals' home countries under the EU Savings Tax Directive.
Ship management and maritime operations have become an important part of the Cypriot economy, and the government has in recent years developed a maritime policy which is highly favourable for ship owners. Shipping companies owned by non-residents and deriving their income from sources outside Cyprus are not subject to Cypriot taxation. Cyprus has also extended its tonnage tax regime for companies engaged in international maritime transport and liable to corporate tax in Cyprus. The new tonnage tax system was approved by the European Commission on March 24, 2010 under state aid rules for maritime transport. The Merchant Shipping (Fees and Taxing Provisions) Law was then enacted in May 2010 and extends the favourable benefits available to owners of Cyprus flag vessels and ship managers to owners of foreign flag vessels and charterers. As of December 31, 2010, there were 1,862 ships on the Cyprus register, with a gross tonnage of more than 22 million.
Tourism remains a major pillar of the Cypriot economy, thanks to the islands near-perfect Mediterranean climate, which offers year-round sunshine and short winters. The weather, combined with a cost of living below the EU average and relatively low rates of personal taxation, has encouraged many western Europeans, and particularly the British, to winter in the island, or to make it their permanent home.
Tax residence in Cyprus is defined as presence in the country for more than 183 days in a calendar year (which is the tax year), and then applies to the whole year. Resident individuals are subject to tax on their world-wide income; non-residents are taxed only on certain types of income arising in Cyprus. As of 2011 income tax rates are progressive up to a maximum of 30% on income above EUR36,600, and SDC is due on dividends and certain interest payments received by Cypriot residents Pensioners, however, pay only 5% tax on their incomes.
Taxes are, however, on the rise for some. In August 2011, the Cypriot government was forced to propose a number of tax-raising measures in an attempt to plug a growing budget deficit and prevent the country from being sucked into the vortex of the Eurozone crisis. These proposals, approved by the Cypriot parliament later the same month, once enacted, will create a new top rate of personal income tax of 35% on annual income over EUR60,000 and increase property tax. As mentioned, the SDC rate on dividends will increase by 2% to 17%, and on interest by 5% to 15%. A EUR350 annual charge on all Cypriot-registered companies will also be introduced, the first payment of which will fall due on December 31, 2011. A proposed 2% increase to the 15% value-added tax was dropped from package of measures approved by parliament, however.
Earlier in the year, the government looked to the banking sector in order to boost its tax take, and on April 14, 2011, legislation was enacted to introduce a special bank levy under which financial institutions operating in Cyprus will be required to pay 0.095% on the total amount of deposits held at the end of each calendar year, up to a maximum of 20% of banks' total taxable profits.
Although a further wave of austerity measures is expected to ensure that Cyprus meets its fiscal targets, there are few signs yet that this is damaging Cyprus as an international business and financial centre. But it remains to be seen how investor confidence will be affected in the months and years ahead.
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