The Tax Therapy Of Curiosity – Tax

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A. INTRODUCTION

With this publication we outline the main provisions of the
Taxation Laws in relation to the tax treatment of interest income
and interest expense and we elaborate on the various financing
schemes available.

B. THE BASIS OF TAXATION OF INTEREST INCOME

Generally, the Taxation Laws in Cyprus are applicable
only to tax residents of
Cyprus, both individuals and companies, on their
world-wide income.

(I) Definition of tax resident

In the case of an individual – means an
individual who stays in Cyprus for one or more periods exceeding,
in aggregate 183 days in the year of assessment.
In the case of a company – means a
company whose “management and control” is
exercised in Cyprus.

The management and control of a company is exercised by its
board of directors. The nationality or the residence of the
shareholders is irrelevant. It is also irrelevant where the company
was registered, whether in Cyprus or abroad. Incorporation in
Cyprus is not sufficient to qualify the company as a tax resident
of Cyprus. There is no definition in the Law as to the meaning of
“management and control”.

The main factors that will identify this issue are: –

The place of directors’ meetings. Where board decisions are
taken. This factor is treated as being the most crucial;
The residence of the directors or at least the majority of
them;
The degree of control exercised by the directors on company
decisions;
Whether the directors think and decide on the crucial
management decisions affecting the business of the company or they
simply follow instructions and rubber stamp;
Where the general policy of the company is formulated and by
whom.

Non-residents of Cyprus are not taxable in Cyprus. Despite this
general rule, non – residents having income from within Cyprus
(Cyprus source income) i.e., through a permanent establishment are
taxable in Cyprus only as to this Cyprus source income.

For a detailed analysis as to the applicability of the taxation
laws, kindly see our publication “The Management and
Control Test – Taxation of Cyprus and Foreign
Companies” as well as our publication
“Immigration and Retirement in Cyprus – The Tax
Aspect”.

(II) Taxation of Interest Income

Taxation on interest income is imposed according to: –

The “Income Tax Law”; or
The “Special Defence Contribution for the Republic
Law”.

The applicability of each of the above laws (herein referred to
as the “Law”) depends on the type of interest income a
person will acquire which is divided into two main categories:
–

Interest income acquired from the ordinary
activities of the business or closely connected
with those activities.
- In this case the interest is treated as active interest and is
  regarded as trading income and taxed according to Income Tax Law at
  the rate of 12.5% on any resulting net taxable profits, and
Interest income not acquired from the
ordinary activities of the business or closely connected with those
activities.
- In this case the interest is considered as passive interest and
  is taxed under Special Defense Contribution Tax at the rate of 30%
  on the interest income accrued or credited.

(III) Interpretation of “ordinary activities” and
“activities closely connected with ordinary
activities”

As the definition of what is regarded as “ordinary
activities” or activities closely connected with ordinary
activities” is not clearly identified in the Law, The
Commissioner of Income Tax, has interpreted the above provisions of
the Law in a separate circular as follows: –

1. Interest that is acquired “from the ordinary
activities of the business”: –

This type of interest is considered to be: –

a) The interest of banking businesses.

This category includes all the banks, co-operative credit
institutions and enterprises that have as their main purpose the
granting of loans such as the Housing Finance Corporation.

b) The interest that is acquired by
financing companies.

These are the companies which provide finance by the method of
hire – purchase or leasing agreements or any other type of
financing.

In effect, the interest that the banks and financial
institutions or financing companies receive or credited, is
considered as trading income and is NOT liable to Special Defence
Contribution Tax but only liable to Income Tax at 12.5% on any
resulting net profits.

2. Interest that is acquired from “activities
closely connected with the ordinary activities of the
business”:-

This type of interest is considered to be:-

a) The interest received or credited
from trade debtors:

For example, the interest received or credited by companies or
individuals when their normal business activity is the buying,
selling or development of immovable property, or the interest
received or credited by companies or individuals that are selling
or re-selling cars or other vehicles or machinery or other
products.

In effect, the interest that companies or individuals receive or
credited from their ordinary trading activities with their debtors
is considered as interest closely connected with the ordinary
activities of the business and is not subject to Special Defence
Contribution Tax but only to Income Tax.

b) Interest on current
accounts

The interest that companies or individuals receive from banks in
their commercial banking accounts (current accounts) used for their
ordinary trading activities.

c) The interest of Insurance
Companies;

d) The interest that companies receive
or credited when they act as the vehicle through which the
companies of the group are financed.

In effect, companies which are used as a financing vehicle of
their group, i.e. financing a mother, subsidiary or other related
company (associate), then the interest received or credited is
considered as trading income and is not subject to Special Defence
Contribution Tax, but only subject to Income Tax at a rate of 12.5%
on any resulting net profits.

The meaning of “group companies”

The meaning of group of companies is defined in the
Companies’ Law Cap. 113, where according to Art. 2 of this law,
“group of companies” means the whole body of companies
which consists of the mother and its subsidiary or its
subsidiaries.

Further, according to Art.148 of the Companies’ Law Cap.
113, the meaning of subsidiary and holding companies is defined as
follows:-

A company is deemed to be a subsidiary of another if, but only
if,

that either –
1. is a member of it and controls the composition of its board of
  directors; or
2. holds the majority of the voting shares (rights) ; or
3. is its member and controls the majority of the voting shares
  (rights) by agreement which has been signed with other
  members.
the first mentioned company is a subsidiary of any company
which is that other’s subsidiary.

A company controls the composition of the board of directors if,
but only if, that other company can appoint or remove the holders
of all or the majority of the directorships without the consent or
concurrence of any other person.

For the purposes of the Companies Law, a company shall be deemed
to be another’s holding company if, but only if, that other is
its subsidiary.

Further, according to International Financial Reporting
Standards applicable in tax audit matters, an associate is an
enterprise in which the investor has significant influence and
which is neither a subsidiary nor a joint venture of the
investor.

Significant influence is defined as the power to participate in
the financial and operating policy decisions of the investee but
without being able to exercise control over those policies. If an
investor holds, directly or indirectly through subsidiaries, 20% or
more of the voting power of the investee, it is presumed that the
investor does have significant influence, unless it can be clearly
demonstrated that this is not the case. Conversely, if the investor
holds, directly or indirectly through subsidiaries, less than 20%
of the voting power of the investee, it is presumed that the
investor does not have significant influence, unless such influence
can be clearly demonstrated. A substantial or majority ownership by
another investor does not necessary preclude an investor from
having significant influence.

The commissioner of Income Tax considers within the definition
of a “group of companies”, any parent or subsidiary
company as specified in the Law as well as any associate company
(holding more than 20% of the voting shares).

In view of the above, full disclosure as to the group structure
will need to be provided to the company’s auditors in order to
be able to assess the correct tax treatment of the interest
income.

3. Interest received or credited liable to Special Defence
Contribution Tax

Examples of interest liable to Special Defence Contribution Tax:
–

Interest received by the resident company/individual from fixed
deposit accounts and bonds that are not held as a trading
activity;
Interest received or expected to be received from loans granted
by companies that do not qualify as an ordinary activity or an
activity closely connected with the company’s ordinary
activities.

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The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.