Application of the Anti-Tax Avoidance Directive (ATAD) in Cyprus
The ATAD aims to implement the recommendations arising from the OECD/G20 Base Erosion and Profit Shifting (BEPS) Project and also introduce a general anti-abuse rule which is not BEPS related.
The ATAD includes anti-avoidance measures in the following areas:
- A General Anti-Abuse rule to counteract aggressive tax planning;
- A Controlled Foreign Company (CFC) rule to deter the shifting of profits to low/zero tax jurisdictions (BEPS Action 3);
- An interest limitation rule to discourage artificial debt arrangements (BEPS Action 4);
- Exit taxation rules designed to prevent taxpayers from avoiding tax, by transferring their residence out of the country in which economic value has been created.
- Hybrid mismatch rules aiming to neutralise the tax effects of hybrid mismatch arrangements.
The above provisions numbered 1-3 have entered into force as of 1 January 2019, whereas items 4&5 apply as from 1 January 2020.
GENERAL ANTI-ABUSE RULE (GAAR)
The purpose of the general anti-abuse rule is to discourage artificial arrangements and counteract aggressive tax planning not yet been dealt with through specifically targeted provisions (SAARs). Even though most EU countries already have a form of a general anti-abuse rule in their legislation, the aim of the directive is to create a uniform approach amongst the EU Member States.
In simple terms, the Cyprus tax authorities can disregard any arrangement or scheme created with the main aim to minimize taxes and although the scheme seems legal on paper, is abusing the spirit of the law and does not have any commercial rationale.
CONTROLLED FOREIGN COMPANY (CFC) RULES
Controlled Foreign Company (CFC) rules have the effect of re-attributing the income of a low-taxed controlled subsidiary to its Cypriot parent company. Then, the Cypriot parent company becomes taxable on this attributed income in Cyprus.
INTEREST LIMITATION RULE
The interest limitation rule aims to discourage the financing of companies based in high-tax jurisdictions through subsidiaries based in low-tax jurisdictions. The rule focuses on limiting the deduction of ‘excess’ interest arising from the above practices. The interest limitation rules restrict the tax deductibility of borrowing costs (interest) that exceed 30% of the tax-adjusted earnings before interest, taxes, depreciation and amortization (EBITDA). The most important aspects of the interest limitation rules are:
• The interest limitation rules are applied at a Cypriot group level (75% criterion).
• De minimis exception for exceeding borrowing costs up to EUR 3 million.
• An exemption applies to stand-alone entities and to financial institutions.
• Grandfathering rules apply to loans concluded prior to 17 June 2016.
• Exclusion of long-term public infrastructure loans.
• Equity-escape clause provisions.
• Carry-forward provisions for unused interest capacity and for exceeding borrowing costs whose deductibility is restricted.
EXIT TAXATION
The exit taxation rule is designed to prevent taxpayers from avoiding tax, by transferring their residence, activities or assets out of Cyprus. In accordance with the provisions of the Cypriot Income Tax Law, Cyprus will have the right to tax any unrealised gain created in Cyprus at the time of the exit. The value of such gain should reflect the arm’s length principles.
HYBRID MISMATCHES
A hybrid mismatch is the consequence of differences in the tax treatment of a payment or an entity, under the laws of two or more jurisdictions.For example, in some jurisdictions a payment is treated as interest which is tax deductible, whereas in Cyprus such payment is treated as a dividend which is tax free. This results into a double tax saving based on the same item. Thus, the objective of the hybrid mismatches rules is to neutralise such differences on hybrid mismatch arrangements.
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