Major amendments to the Cyprus tax legislation

Tax law amendments were adopted in December 2015.

The amendments made to the Income Tax Law, the Capital Gains Tax Law and the Assessment and Collection of Taxes Law mainly aim to improve Cyprus’ competitiveness in attracting foreign investments, enhance business development and harmonize the Cyprus tax laws with EU legislation.

The main amendments to the tax legislations concern:

Offshore activities of Cyprus
The definition of the term “Republic of Cyprus” has been extended to include the territorial waters, the contiguous zone, the exclusive economic zone and the continental shelf of Cyprus.
The definition of the term “permanent establishment” has been amended to include all activities pertaining to the exploration and exploitation of the seabed in the exclusive economic zone.
The gross income earned from sources within Cyprus by a person who is not tax resident of Cyprus or who does not have a permanent establishment in Cyprus in consideration for providing ancillary services related to such exploration or exploitation activities is subject to tax at the rate of 5%. If the payment is made by a person who is not a tax resident of Cyprus or who does not have a permanent establishment in Cyprus, but the cost is borne by an associated person in Cyprus, the Cyprus-resident associate is responsible for withholding this tax and paying it to the Cyprus tax authorities by the end of the following month.
All these changes are effective from 1 January 2016.
The neutral tax treatment of foreign exchange (FX)
With retrospective effect from 1 January 2015 profits and losses arising from (FX) tat fluctuations will be disregarded for tax purposes apart from gains or losses arising from trading in foreign currencies or foreign currency derivatives. Entities trading in foreign currencies or foreign currency derivatives may irrevocably elect to be taxed on the basis of only realised profits or losses.
These provisions apply retrospectively from 1 January 2015.
Implementation of the new provisions of the EU Parent-Subsidiary Directive
The introduction of anti-hybrid and general anti-avoidance measures in relation to dividend distributions within the EU.
Dividends received by Cyprus-resident companies from abroad will no longer be exempt from corporate income tax if the payment of the dividend is a tax-deductible expense for the company paying the dividend under the laws of the country in which it is resident. In addition, there is no longer any exemption from corporate income tax for dividends received under an arrangement that has been put in place with the main purpose of obtaining a tax advantage and that is not based on valid commercial reasons reflecting the underlying economic reality.
With effect from 1 January 2016 such dividends will be taxed as normal business income subject to income tax and will be exempt from Special Contribution for Defence.
Exemption of income from first employment in Cyprus
Individuals becoming tax-resident and taking up employment in Cyprus were previously entitled to an exemption of 20% of their annual income from employment in Cyprus for the first three years of residence. The exemption was limited to €8,550 per annum. With effect from the 2015 tax year onward, the exemption is extended to five years, but it will be available only until the year 2020.
In 2012 a further exemption was introduced, exempting 50% of the first five years’ income from employment in Cyprus of a person who was not previously resident in Cyprus, provided the income from employment in Cyprus exceeds €100,000 per annum. The period of five years has now been extended to ten years. In respect of employments that started on or after 1 January 2015, the exemption is not available to anyone who was resident in Cyprus in any three of the five tax years preceding the year in which the employment in Cyprus began, or to anyone who was resident in Cyprus in the year preceding the year in which the employment began.
The exemption is available in respect of any tax year in which income from employment exceeds €100,000 per annum, irrespective of whether the income falls below that amount in any year, provided that when the employment started the income exceeded €100,000 and the tax authorities are satisfied that the variations in the annual income are not made for the purpose of obtaining this tax benefit.
It has now been made clear that the two exemptions are mutually exclusive, and that only one of them can be claimed by a particular taxpayer.
Losses arising from the licensing and /or sale of intellectual property rights.

Cyprus’s IP regime allows an 80% deduction from the net profit generated by the use or disposal of IP rights.  If a loss is made from such activities, only 20% of the resulting loss can be offset against income from other sources or carried forward to be offset against income of subsequent tax years.
This amendment applies retrospectively to all tax years from January 2012 onwards.
Extension of ‘accelerated’ capital allowance
The increased tax writing-down allowances of 20% on expenditure on plant and machinery and 7% on new industrial and hotel buildings will be extended until 31 December 2016.
Group relief of taxable losses
Previously group loss relief was available only for losses incurred by Cyprus tax resident companies. The law has been amended to harmonise with the European Directive 2011/96/EU (Parent-Subsidiary Directive) so that a subsidiary company which is tax resident in another EU member state can surrender its taxable losses to another group member company tax resident in Cyprus, provided the subsidiary has exhausted all means of surrendering or carrying forward the losses in its member state of residence or to any intermediate holding company.
The amount of taxable losses must be calculated on the basis of the Cyprus tax laws.
In order to determine whether two companies are members of a group the law has also been amended to allow the interposition of holding companies established in another EU member state, in a state with which Cyprus has concluded a double tax treaty or in a state which has signed the OECD multilateral convention for exchange of information.
These provisions apply to 2015 and later tax years.
Anti-avoidance provisions for re-organizations
Corporate reorganisations are exempt from all forms of tax in Cyprus. In accordance with the amended law, the tax authorities allow to withhold the exemption if they have sufficient reason to conclude that the reorganisation is not based on valid commercial or financial considerations and that the main purpose or one of the main purposes of the reorganisation is the reduction, avoidance or deferment of payment of taxes. Any such decision is open to objection and appeal in accordance with the provisions of articles 20 and 20A of the Assessment and Collection of Taxes Law.
The tax authorities will also have the right to impose conditions on the number of shares which can be issued as part of any reorganization and the minimum period for which such shares should be held (up to a limit of three years). These restrictions do not apply in the case of publicly listed companies and transfers of shares on death.
These provisions apply with effect from 1 January 2016.
Arm’s length adjustments – Downward transfer pricing
Cyprus does not have specific transfer pricing rules in its domestic legislation, but the arm’s length principle is incorporated into the Income Tax Law, allowing the tax authorities to impose additional taxes on profits or benefits arising from related party transactions. Before the current amendment, the only adjustments that could be made were to increase profits, and there was no provision for the corresponding expenses and losses to be compensated. For the 2015 and later tax years the Income Tax Law as amended allocates the profit arising from transactions between related parties onto an arm’s length basis and, in the event of one party’s profit being increased, allows a corresponding deduction for the counterparty to the transaction.

Amendments to tax-exempt income
With retrospective effect from 1 January 2015 local authorities are no longer exempt from taxation on rental income from immovable property.
Capital gains from sale of shares in property companies
Prior to the amendment capital gains tax was charged only on disposal of immovable property located in Cyprus or on disposal of shares of companies that directly owned immovable property located in Cyprus. It was therefore very straightforward to avoid tax on disposal of the shares of a property-holding company by interposing an intermediate holding company and disposing of the shares in that company, rather than the property-owning company itself. The amendment closes this loophole by providing that gains from the disposal of shares in companies that indirectly own immovable property in Cyprus by directly or indirectly holding shares in a company that owns immovable property located in Cyprus will also be subject to capital gains tax, if the value of the immovable property represents more than 50% of the value of the assets of the company whose shares are sold. The gain to be taxed will be calculated on the basis of the market value of the immovable property.
Trading gains from sale of shares of property companies
If a company’s business is dealing in shares of companies, any sale of shares is treated as a transaction of a trading nature, and exempt from income tax under article 8 of the Income Tax Law, which exempts profit on the sale of shares and other securities. As profits of a trading nature, these gains would not fall within the scope of the Capital Gains Tax Law. This provided a further simple means of gaining complete exemption from tax on disposals of shares in companies owning immovable property located in Cyprus.
The Capital Gains Tax Law has now been amended to close this loophole by providing that trading gains on disposal of shares in property-owning companies are subject to capital gains tax.
Transactions between related parties
In any transaction between related persons the tax authorities may substitute the market value of the property for the contract price if they consider that the contract price is less than the market value.
Conclusion

The tax reform maintains and strengthens the Cyprus competitiveness as an international centre by simplification of the tax regime, clearer definition of tax elements and complete harmonisation with EU directives.

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