The European Union has enforced new rules designed to further combat tax avoidance across the European Union.
The provisions of the Anti-Tax Avoidance Directive are effective from 1 January 2019 and refer to the following areas:
- Controlled Foreign Company (CFC)
- Limitations of interest deductibility (LoID)
- General anti-abuse rule (GAAR)
- Controlled Foreign Company (CFC)
The particular provisions of the law impact Cyprus tax-resident companies and permanent establishments of non-Cyprus tax resident companies.
For starters, the first measure contained in the new Directive refers to the Controlled Foreign Company (CFC) rule aiming to deter profit shifting to no-, or low-, tax countries, since parent companies in a high tax country often control their subsidiaries in a no-, or low-, tax country in order to reduce the Group’s tax liability. The CFC rule should discourage them from doing so, by ensuring that the member-state where the parent company is located will tax certain profits that the company registered in no-, or low-, tax country. The CFC rule will be triggered if the tax paid in the third country is less than half of that which would have been paid in the member-state in question. The company will be given tax credit for any taxes that it did pay abroad. This will ensure that profits are effectively taxed, at the tax rate of the member-state in which they were generated.
When a non-Cyprus tax-resident company (or an exempt foreign Permanent Establishment (PE) meets the definitional criteria of CFC, the Cyprus CIT taxpayer must include in its taxable profit the non-distributed income (including interest, royalties and dividends) of the CFC to the extent that such income arises from non-genuine arrangements which have been put in place for the essential purpose of obtaining a tax advantage.
Failure to comply with the EU directive:
If a member-state fails to comply with the EU directive, the European Commission may open an infringement procedure, and if necessary, it may bring the case before the Court of Justice of the European Union.
- Interest Limitation Rule
Interest payments are generally tax deductible in the EU. Some companies arrange their inter-company loans so that their debt is based in one of the group’s companies in a high-tax country where interest payments can be deducted. Meanwhile, the interest on the debt is paid to the group’s “lender” company which is based in a low-tax country where interest is taxed at a low rate. In this way, the Group reduces its overall tax burden.
The Directive proposes to limit the amount of net interest that a company can deduct from its taxable income, based on a fixed ratio of its earnings. This should make it less attractive for companies to artificially shift debt in order to minimise their taxes.
In Cyprus, the interest limitation rule limits the otherwise deductible exceeding borrowing costs (hereinafter “EBCs”) of the Cyprus CIT taxpayer/Cyprus group up to 30% of the adjusted taxable profit (taxable EBITDA) with the aim to discourage a group of companies from providing financing facilities to companies based in high-tax jurisdictions through subsidiaries based in low-tax jurisdictions.
The interest limitation rule contains an annual €3.000.000 safe-harbour threshold. This means that EBCs up to and including €3.000.000 is in any case not restricted by this rule (the €3.000.000 threshold would apply in cases where ‘30% of taxable EBIDTA’ results to an amount below €3.000.000). In the case of a Cyprus group the €3.000.000 applies for the aggregate EBCs of the Cyprus group and not per taxpayer.
- General Anti-Abuse Rule (GAAR)
The Directive sets out a General Anti-Abuse Rule, which will tackle abusive tax arrangements if there is no other anti-avoidance rule that specifically covers such an arrangement. The GAAR acts as a safety net in cases where other anti-abuse provisions cannot be applied. It will allow tax authorities to ignore abusive tax arrangements and tax on the basis of the real economic substance.
The Cyprus Income Tax Law has been amended introducing the ATAD GAAR in the Cyprus tax legislation under which Cyprus shall ignore an arrangement or a series of arrangements which -the main purpose, or one of the main purposes, of their having been put into place being to obtain a tax advantage that defeats the object or purpose of the applicable tax law- are not genuine (i.e. are not put into place for valid commercial reasons which reflect economic reality) having regard to all relevant facts and circumstances,. The GAAR will therefore target all non-genuine transactions performed in a domestic or a cross-border situation.
The draft law adds a new Article 33(6) to the Income Tax Law which reproduces the provisions of Article 6 of ATAD, allowing the tax department to disregard artificial arrangements the main purposes of which include obtaining a tax advantage that defeats the object or purpose of the tax laws.