New rules with regard to tax avoidance practices were published in the Official Gazette of the Republic of Cyprus on July 03, 2020. These changes (1) are aimed at strengthening the counter tax avoidance practices and (2) are approved at the EU level in accordance with EU Council Directive 2016/1164 of 12.07.2016 (as amended by Council Directive 2017/952 as of 19.05.2017).
This involves such novelties as exit taxation and rules on hybrid mismatches.
EXIT TAXATION
The following legal developments, which come into force retrospectively - from January 1, 2020, provided that the taxpayer (a company or a permanent establishment) must be subject to tax at an amount equal to the market value of the transferred assets, at the time of exit of the assets, less their value for tax purposes, in any of the following circumstances:
- assets are transferred from the Cyprus head office to its permanent establishmentin another EU Member State or in a third country, provided that Cyprus no longer has the right to tax the transferred assets due to the transfer;
- assets are transferred from a Cyprus permanent establishment to its head office in a different EU Member State or in a third country, provided that Cyprus no longer has the right to tax the transferred assets due to the transfer;
- change of tax residence by a Cyprus company to the tax residence of another EU Member State or to a third country, except for those cases when said assets remain effectively connected with a Cyprus permanent establishment;
- relocation of the business activities carried on by the Cyprus permanent establishment to another EU Member State or to a third country, provided that as a result of such a transferCyprus no longer has the right to tax the transferred assets.
If the relocation or transfer as well as the change of tax residence were carried out previously from another EU member state to Cyprus, then the starting point in determining of the value of assets for tax purposes should be the value established at the time of such transfer or change accordingly, except the cases when it does not reflect the market value.
However, if the assets are set to “revert” to Cyprus within 12 months, tax consequences are not to be applied concerning assets posted as collateral, assets related to the financing of securities or where the asset transfer is performed so that prudential capital requirements are met.
HYBRID MISMATCHES RULES
Hybrid mismatch constitutes the situation when the application of the rules of different jurisdictions to the same case results in a double deduction (deduction in both states) or a deduction of the income in one of the states without its further inclusion in the tax base of the other. For example:
- Payment on a financial instrument results in a deduction without inclusion in a taxable income if (a) such payments are not included within a reasonable period of time (the legislator also gives an explicit definition of the term “reasonable period of time” for the purposes and consideration expressed in the said regulation), and (b) the inconsistency takes place due to differences in the legal characterization of the financial instrument itself or the respective payment.
- Payment for a hybrid entity results in a deduction without inclusion in a tax base if such a result takes place due to differences in the attribution of payments made to a hybrid entity in the jurisdiction of such an entity and the jurisdiction of the associated enterprise. The term "hybrid entity" herein means any entity or transaction that is considered taxable in one jurisdiction and the income or expense of which is treated as the income or expense of one (or more) other entities in another jurisdiction;
- The payment to an entity with more than one permanent establishment results in a deduction without inclusion in the taxable base if such an outcome takes place due to differences in regulation in the jurisdiction of the head office and the jurisdiction of a permanent establishment(s).
- The payment results in a deduction without inclusion in a taxable base as a result of the payment to the permanent establishment that is not taken into account, i.e. if the permanent establishment is recognized under the laws of the jurisdiction of the head office but is not considered as such in the jurisdiction of the permanent establishment itself;
- The payment of the hybrid entity results in a deduction without further inclusion in the taxable base and such discrepancy is the result of the fact that the corresponding payment is not taken into account according to the requirements of the legislation of the recipient;
- Deemed payment between the head office and a permanent establishment, or between two or more permanent establishments, results in a deduction without further inclusion if such discrepancy is the result of the fact that such payment is ignored in accordance with the legal requirements of the recipient country;
- Double deduction.
It should be noted that for the cases 5,6,7 the hybrid mismatch arises to the extent that the payer's jurisdiction permits a deduction in respect of an amount that is not the income which is subject to taxation in both jurisdictions as a result of the hybrid mismatch.
At the same time, double deduction or deduction without inclusion should not lead to additional tax implications in the context of hybrid mismatch rules unless it takes place:
- between related companies;
- between the taxpayer and associated company;
- between the head office and the permanent establishments;
- between two or more permanent establishments;
- under the terms of a structured arrangement.
So far as the hybrid mismatch results in a double deduction, (a) the corresponding deduction in Cyprus is not granted to the resident investor and, (b) unless the deduction is prohibited in the investor's jurisdiction, it is prohibited at the Cyprus resident payer`s level.
So far as the hybrid mismatch results in a deduction without further taxation, (a) the deduction is prohibited in Cyprus if the payer is not its resident (b) if the deduction is granted to a payer who is not a resident of Cyprus, then the amount of payment, which would otherwise result in a deduction without further inclusion, must be included in the taxable income of the recipient in Cyprus if it’s a Cyprus resident.
The provisions regarding hybrid mismatches are applicable retrospectively as from 1 January 2020, while those relating to reverse hybrid mismatches will come in to effect on 1 January 2022.
