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.