Substance, tax residency of companies and beneficial owner of income

The most important issue faced by companies NOT only in Cyprus but all over the world is Substance. Substance is required by the new EU Parent / Subsidiary directive, the EU anti-tax avoidance directive, the OECD’s BEPS action plan, by various tax authorities on treaty shopping and in the context of exchange of information by foreign tax authorities.

 

Substance can be separated into:

1. Statutory – Company prepares audited Financial Statements, files and pays its taxes and meets its statutory obligations.
2. Physical – It includes all mentioned under statutory substance and in addition the company must maintain a fully-fledged office, employing full-time or part-time employees, having an operational website, having qualified directors and senior executives preferably relocated from the home country who can also benefit from the 50% allowance provided to individuals. The directors should not be the same as the ones of the source company or be Nominees who are directors in many other companies.
3. Economic – Company must have economic activities, maintain local bank accounts, performs accounting and HR functions and is not a Dormant or Pass through entity.

Holding companies in Cyprus must meet the above provisions in order to have valid substance and be considered a Cyprus Tax Residence company. Cypriot Tax Authorities will issue tax residency certificates only to those companies which meet the tax residency criteria and that fulfill all the above mentioned in regard to substance.

 

Beneficial Ownership

Beneficial owner is the person who has the actual benefit from the income received and takes the final decisions on how this income will be utilized.

Beneficial ownership issues affects income such as:

– Dividends

– Interest

– Royalties and

– Capital Gains

Russia applies the Beneficial ownership of income to Dividends, Interest and Royalties and seeks to tax the person who has the right to income in Russia. The Double Tax Treaty benefits for any company will be available provided that the company receiving the income submits to the person paying the income a confirmation stating that this company has the right to receive that income. The Russian tax law does not have any specific test for determination of beneficial ownership but companies that want to avoid this rule must:

1. Have economic presence in country of residency.
2. Use the income received in their business activities, have economic benefit from it and have the authority to dispose it.
3. Take their own decisions.
4. Have substance.
5. Have no legal or actual obligations to transfer the income to 3rd parties.

Under the Double Tax Treaties agreements, the following will be some of the information to be requested in order to determine whether Beneficial ownership issues exist:

– Does the company grant loans?

– Have the payments being made under the loan agreement?

– Who provided the funds to facilitate the loan transactions?

– Rate of interest charged on the loans.

– Was interest received transferred to another party.

In order to overcome beneficial ownership issues in Cyprus you must:

1. Increase substance in Cyprus.
2. Replace back to back loans with loans out of equity and claim the Notional Interest Deduction (NID) that has yet to be challenged.
3. Replace back to back licensing with owning the IP and claim the IP regime.
4. Utilize funds for business activities instead if transferring them to low tax jurisdictions.

It is very important to take these factors into consideration when registering and establishing a company in Cyprus in order to avoid issues that will challenge the residency status of the company. The rules of substance are the same in ALL jurisdictions that act as financial centers but the main difference is the quality of services provided in Cyprus and the low operating costs in regards to substance.