The purpose of the general anti-abuse rule (GAAR) is to discourage artificial arrangements and counteract aggressive tax planning not yet been dealt with through specifically targeted provisions (SAARs). It applies from 1 January 2019 and is in line with the European Anti-Tax Avoidance Directive (ATAD).
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.
Generally, the ATAD’s GAAR is designed to be compliant with the freedoms of the European Union by applying only to arrangements that are not genuine, in line with the interpretation of the European Court of Justice in various cases.
In the recitals of the Directive, it is stated that taxpayers should have the right to choose the most tax efficient structure for their commercial affairs and the ATAD’s GAAR should be applied to non-genuine arrangements.
The text of the ATAD’s GAAR as implemented into Cypriot Income Tax Law reads as follows:
|For the purposes of calculating the corporate tax liability, Cypriot income tax law shall ignore an arrangement or a series of arrangements which, having been put into place for the main purpose or one of the main purposes of obtaining a tax advantage that defeats the object or purpose of the applicable tax law, are not genuine having regard to all relevant facts and circumstances. An arrangement may comprise more than one step or part.|
For the purposes of paragraph 1, an arrangement or a series thereof shall be regarded as non-genuine to the extent that they are not put into place for valid commercial reasons which reflect economic reality.
Where arrangements or a series thereof are ignored in accordance with paragraph 1, the tax liability shall be calculated in accordance with national law.
Following the definition of the ATAD, the general anti-abuse rule is applicable when:
- there is an arrangement or series of arrangements;
- that are put into place for the main or one of the main purposes of obtaining a tax advantage;
- that defeat the object or purpose of applicable law;
- which are not genuine once considered all the relevant fact and circumstances.
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.
What is an arrangement or series of arrangements
The directive does not include a definition of the term but from an EU perspective it has a broad interpretation and it consists of any contract, transaction, scheme, action, operation, agreement, promise, undertaking or event.
Calculation of tax liability in accordance with national law
Assuming an arrangement falls under ATAD’s GAAR, tax authorities can ignore any kind of legal arrangement with the aim of assessing the true tax position of the taxpayer. In some cases this might be easy, however in complicated arrangements there is a question what would be the alternative position arrived by the Tax Authorities by what guidelines would this ‘true’ tax position be found.
The only guideline here seems to be the intent of the law. It is noted that under Cypriot law, the Assessment and Collection Law includes a provision which already provides that the Tax Commissioner may disregard any non-genuine transaction
Main or one of the main purposes of obtaining a tax advantage
In order for an arrangement to be captured by the ATAD’s GAAR, its main purpose or one of its main purposes must be the achievement of a tax advantage. A tax advantage could arise by increasing deductions or losses, decreasing income or gains, obtaining timing advantages, and ensuring a potential tax charge does not arise (or is reduced).
The wording used – main or one of the main- is a subjective test and seems to allow some flexibility according to which the abuse threshold can be met in the presence of a range of motives underlying an arrangement, provided that at least one of these main motives is tax related.
In practice, tax is another business cost that needs to be managed, and virtually all companies consider tax implications when transacting/ investing etc, thus any tax-efficient legal structuring could indicate the presence of a tax purpose and maybe even a main purpose. One could argue then, that the subjective test in the ATAD will always be met since tax considerations always are made.
Valid commercial reasons – ECJ Case
In an ECJ case (Fogia – relating to cross border mergers) the ECJ concluded that in order for there to be valid commercial reasons, a merger must be motivated by more than purely tax advantages. If several objectives are involved, tax considerations should not predominate. In the particular case, the ECJ concluded that the group’s cost savings from the merger were marginal when compared to the level of tax benefits, and therefore the cost savings did not constitute a valid commercial reason.
Thus, tax authorities should evaluate the purposes of an arrangement and weigh the tax benefits obtained vs any other non tax related benefits. In certain cases, non tax benefits may not be obvious, thus the taxpayer may point them out as a defence, however, those other considerations should not be minimal or negligible.
Since motives may be difficult to establish, taxpayers should look at other factors (e.g. existence of economic substance, transactions at arm’s length conditions) that may indicate the taxpayer’s intention.
Defeats the object or purpose of the applicable tax law
Non genuine arrangements that achieve a tax advantage in a way that defeat the object or purpose of the applicable tax law fall under ATAD’s GAAR.
To determine whether an arrangement defeats the object or purpose of the applicable tax law, it’s necessary to carry out a detailed assessment to consider the object and purpose of the tax provision at stake, and then determine if the tax advantage obtained, although observing the law, frustrates the intent of the legislator.
For example, various jurisdictions including Cyprus have enacted a favorable IP Tax Regime to attract R&D centers. One of the basic conditions for qualification under the IP Regime is the development of the IP by the company itself (via its employees) or by outsourcing its development to non-related parties. If the tax authorities would discover that the development of the IP is not made by totally independent related parties, but rather a connected company, they could invoke the GAAR and deny the benefits of the IP regime to the said company.
The ATAD’s GAAR provides that ignoring legal arrangements may occur only if these arrangements “are not genuine having regard to all relevant facts and circumstances” and that “an arrangement or a series thereof shall be regarded as non-genuine to the extent that they are not put into place for valid commercial reasons which reflect economic reality”. A similar wording is used in the general anti-abuse rule of the Parent Subsidiary Directive.
Multilateral Instrument (MLI) and Parent-Subsidiary Directive
It is noted that a similar anti-abuse provision is included in the MLI signed by Cyprus on 6 July 2017 and become effective from 1 January 2020 as well as on the Parent-Subsidiary Directive.
The MLI was signed by 87 countries and will amend the bilateral tax treaties mainly to implement agreed minimum standards to combat treaty abuse.
Impact of GAAR on Cypriot structures
Effectively the General Anti Abuse Rule gives tax authorities more power to challenge artificial tax structures. Having relevant substance at the level of a Cypriot structure is becoming more important than ever. Generally however, we do not expect the Cypriot tax authorities to attack non agressive Cypriot structures owned by non-residents.