Recent Tax Treaty Developments In Cyprus

Proposed Amendments To Cyprus’s Assessment And Collection Of Taxes Law

The Cyprus Government has published a draft law amending the Assessment and Collection of Taxes Law (Law 4 of 1978) in order to facilitate implementation of agreements for automatic exchange of information with other countries.

When it is enacted, the Assessment and Collection of Taxes Law (Amendment) Law of 2015, which was published in the Official Gazette of the Republic No. 4159 on March 23, 2015, will add two new subsections, numbered 15 and 16, to Article 6 of the Assessment and Collection of Taxes Law. The new subsections regulate the arrangements under which the Commissioner of Taxation may provide information obtained from any person to implement agreements for automatic exchange of information between the Republic of Cyprus and another country, whether an EU member state or a third country.

The proposed provisions are similar to existing provisions relating to information exchange except in one important regard. The prior approval of the Attorney General is required for information exchange under double taxation agreements (DTAs) and existing legislation, but there is no requirement for prior approval under the new provisions.

Cyprus has not entered into any bilateral agreements for automatic exchange of information, but automatic exchange of information does take place already under the laws implementing the EU Savings Tax Directive (Council Directive 2003/48/EC of June 3, 2003), similar arrangements with Switzerland, the Channel Islands and other jurisdictions, and Council Directive 2011/16/EU as regards administrative cooperation in the field of taxation, which provides for mandatory automatic exchange of information between EU member states with effect from January 1, 2015, in respect of income from employment, directors’ fees, life insurance products not covered by other Directives, pensions, and ownership of and income from immovable property.

In addition, under the Model 1 inter-governmental agreement between Cyprus and the US under the Foreign Account Tax Compliance Act (FATCA), which was signed in December 2014, the Cyprus tax authorities are responsible for forwarding information reported to them by Cyprus-based financial institutions subject to FATCA to the US Internal Revenue Service.

The New Cyprus – Iceland Double Taxation Agreement

Many DTAs seem to spend an eternity in limbo between signature and entry into force. With less than seven weeks between signature on November 13, 2014 and entry into force on December 22, 2014, the new DTA between Cyprus and Iceland set a new standard for timeliness.

Like most of Cyprus’s recent DTAs, the Cyprus– Iceland DTA closely follows the form of the 2010 OECD Model Convention. Its key features are summarized and explained below.

Taxes Covered

The DTA covers the following categories of taxes:

The Cyprus income tax, corporate income tax, the special contribution for the Defence of the Republic (commonly referred to as SDC tax), and capital gains tax;
The Icelandic state income tax and municipal income tax.
It will also apply also to any identical or substantially similar taxes that are imposed in future in addition to, or in place of, the existing taxes.

Residence

Article 4, which deals with residence, replicates the provisions of the OECD Model. The residence of dual-resident individuals is settled by the closeness of an individual’s ties to the respective states or, failing that, by agreement between the two states. Legal persons are resident in the state in which their place of effective management is situated.

Permanent Establishment

Article 5 contains the usual list of activities that do not give rise to a permanent establishment, namely storage and display of goods, maintenance of stocks for processing by a third party, maintenance of a purchasing or information-gathering facility, or for preparatory or auxiliary purposes.

A building site, a construction, assembly or installation project, or a supervisory or consultancy activity connected with it will be deemed to be a permanent establishment only if it lasts for more than 12 months.

If an enterprise has a representative in a contracting state that has, and habitually exercises, authority to conclude contracts in the name of the enterprise, the enterprise concerned is deemed to have a permanent establishment in respect of any activities which the person undertakes for the enterprise.

Taxpayers need to be aware of the potential adverse consequences of unintended creation of a permanent establishment. Particular care needs to be taken regarding the issuing of general powers of attorney.

Hydrocarbon Exploration And Exploitation

Most of the DTAs that Cyprus has concluded since gas reserves were discovered in its exclusive economic zone in 2008 have included an article dealing with off shore hydrocarbon exploration and exploitation activities, usually requiring a much shorter period (generally three months) than the usual 12 months to trigger the creation of a permanent establishment.

The Cyprus–Iceland DTA does not include a separate article of this kind, but instead adds exploration facilities to the standard list of locations giving rise to a permanent establishment. As noted above, it provides that a building site, construction or installation project or any supervisory activities in connection with such site or project constitutes a permanent establishment only if it lasts more than 12 months, but it does not set any minimum duration for exploration activities to constitute a permanent establishment. It is not clear whether this exclusion is intentional or whether exploration activities will be treated in the same way as others.

Income From Immovable Property

Income from immovable property may be taxed in the contracting state where the property is situated.

Business Profits

Profits are taxable only in the contracting state in which the enterprise earning them is resident unless it carries on business in the other contracting state through a permanent establishment there, in which case the profit attributable to the permanent establishment may be taxed in the contracting state in which it is located.

The agreement includes detailed rules for apportionment of profits to permanent establishments, which are to be applied on a consistent basis over time.

International Transport

Profits from the operation of ships (including ancillary equipment such as barges, containers, and trailers) or aircraft in international traffic are taxable only in the contracting state in which the enterprise is resident, determined by its place of effective management.

Dividends

Withholding tax on dividends paid by a company resident in one state to a company (but not a partnership) resident in the other is limited to 5 percent of the gross dividend as long as the recipient is the beneficial owner of at least 10 percent of the shares in the company paying the dividend. Otherwise, the maximum rate of withholding tax is 10 percent.

As Cyprus imposes no withholding tax on dividends paid to non-residents, in practice this provision applies only to dividends paid from Iceland to Cyprus.

Interest

Interest paid by a resident of one state to a resident of the other is taxable only in the state of residence of the recipient, subject to safeguards against abuse ( e.g. , the exemption does not apply to any excessive interest above interest on an arm’s length basis).

Royalties

The maximum withholding tax on royalties is limited to 5 percent.

Capital Gains

Gains derived by a resident of one contracting state from the alienation of immovable property situated in the other may be taxed in the contracting state in which the property is situated. Gains on disposal of shares or similar interests in a company or other entity deriving more than 50 percent of its value from immovable property may also be taxed in the contracting state in which the immovable property is situated. Gains arising from the disposal of immovable or movable property associated with a permanent establishment, or from the disposal of movable property used in connection with the performance of independent personal services, may be taxed in the contracting state in which the permanent establishment is located or the services are performed.

Gains derived from the alienation of all other property (including ships or aircraft operated in international traffic) are taxable only in the contracting state in which the alienator is resident. However, gains from the disposal of shares in a company resident in one contracting state derived by an individual who is resident in the other contracting state but who was a resident of the first-mentioned state in the course of the five years preceding the disposal may be taxed in the first state (the state in which the individual was previously resident).

Elimination Of Double Taxation

Elimination of double taxation is achieved by the credit method. The credit is limited to that part of the income tax in the state of residence as computed before the deduction is given that is attributable to income that is subject to tax in the state of residence.

The growing importance of substance over form also needs to be taken into account. While there is no explicit limitation of benefits or other anti-abuse provision, there are clear signals that artificial structures and transactions which have tax avoidance as their sole purpose will not be tolerated. Careful planning and implementation are essential in order to obtain the full benefits of the agreement.

Mutual Agreement Procedure

The article replicates the corresponding article of the OECD Model, except there is no facility for unresolved issues to be referred to arbitration. They are therefore to be resolved by the contracting states.

Exchange Of Information

The exchange of information article reproduces Article 26 of the OECD Model Convention verbatim.

The usual Protocol that is included in many of Cyprus’s recent agreements, which sets out detailed requirements regarding information exchange, is absent. However, Cyprus’s Assessment and Collection of Taxes Law provides the same robust safeguards against abuse of the exchange of information provisions. Requests for exchange of information are dealt with solely by the International Tax Relations Unit (ITRU) of the Department of Inland Revenue. Exchange of information may take place only via the ITRU: direct informal exchange of information between tax officers bypassing the competent authority is prohibited.

A request must be much more than a brief email containing the name and identifying information of the individual concerned. Rather, a detailed case must be made, with the criteria set out in a lengthy legal document. In effect, this means that the authorities requesting the information must already have a strong case even before they request the information. Accordingly, it will not be possible to follow up a suspicion without first gathering significant evidence. As a final safeguard, Cyprus’s Assessment and Collection of Taxes Law requires the written consent of the Attorney General to be obtained before any information is released to an overseas tax authority.

Entry Into Force And Termination

The agreement entered into force on December 22, 2014, and its provisions are effective in respect of amounts paid or credited on or after January 1, 2015 with regard to taxes withheld at source, and in respect of taxable years beginning on or after January 1, 2015 with regard to other taxes.

Termination of the agreement will require written notice by either contracting state given no later than June 30 in any year from 2019 onwards, whereupon the agreement will cease to have effect from the beginning of the following year.

Conclusions

The new agreement with Iceland completes Cyprus’s double tax treaty coverage of the prosperous Nordic markets. Cyprus and Iceland share many common characteristics: both are islands; both have a relatively small population and a services-based economy; and both are recovering from a painful banking crisis.

The new agreement aims to strengthen their trade and economic relations, in line with the Cyprus Government’s continuing efforts to update and extend its network of double taxation treaties so as to attract foreign investment and promote Cyprus as an international business hub.