Understanding tax residency is paramount for international companies operating in Cyprus. Tax residency, pivotal for determining corporate income tax liability at a rate of 12.5%, also shapes worldwide tax obligations and compliance with local tax laws.

Understanding the concept of tax residency

Understanding where your business is considered tax-resident is crucial. Tax residency can vary depending on the country and its tax laws. A company’s tax residency is an important concept with significant implications for its tax liability. A company’s tax residency determines whether it is subject to corporate income tax in a particular jurisdiction. In the case of Cyprus companies’ corporate income tax is subject to a rate of 12.5%.  Also, it is used to determine a taxpayer’s worldwide tax obligations and ensure compliance with the tax laws of its resident country.

Understanding a company’s tax residency is also crucial to prevent double taxation of income. Many countries have double taxation agreements (DTAs) or treaties in place to allocate taxing rights on income earned by companies in multiple jurisdictions. Tax residency helps determine which country has the primary taxing authority. 

Tax residency is also important for countries imposing Controlled Foreign Corporation (CFC) rules primarily to prevent tax avoidance and the erosion of their tax base. Controlled Foreign Corporation (CFC) rules are a set of tax regulations implemented by many countries, primarily to prevent multinational corporations from shifting their profits to low-tax or tax-haven jurisdictions.

Meeting the relevant criteria for business substance purposes

In determining a company’s tax residency, several criteria come into play. To be considered a tax resident, a company typically needs to satisfy one or more of the following conditions:

  • Incorporation or Registration: A company is tax resident if it is incorporated or registered in a country. This is a common criterion, but it may not be the only one.
  • Place of Management and Control: In most jurisdictions, tax residency is determined by the location of the company’s central management and control. This means that the place where key decisions are made, such as board meetings or executive decisions, can establish tax residency.
  • Physical Presence: Most countries may require a company to have a physical presence, such as an office, within their borders to be considered a tax resident.
  • Effective Management: In addition to an office, most developed countries look at where the effective management and control of the company occur. This may involve assessing where most board meetings are held or where some of the company’s top executives are based.
  • Annual Filing and Reporting: Most countries require companies to file annual tax returns and financial statements. Complying with these filing and reporting requirements can also establish tax residency.
  • Ownership or Shareholding: Ownership by residents of a particular country can also trigger tax residency in some cases, especially in the context of controlled foreign corporation rules. This is explained further below.
  • Treaty Provisions: Double taxation treaties can override domestic rules. Companies may rely on the tie-breaker provisions included in treaties to determine their tax residency.
  • Intention of Permanent Establishment: Tax authorities may also examine whether the company’s activities indicate an intention to establish a permanent presence in the country.
  • Establish a Physical Office: Maintain a physical office or place of business in the jurisdiction where the company claims tax residency. This office should be staffed, equipped, and used for the company’s core business activities.
  • Hire Local Employees: Employ local staff in the jurisdiction where the company is claiming tax residency. These employees should be engaged in meaningful work related to the company’s operations.
  • Board of Directors: Ensure that most of the company’s board of directors or key decision-makers are residents or citizens of the relevant jurisdiction.
  • Maintain Bank Accounts: Maintain bank accounts, including the receipt of income and payment of expenses related to the company’s operations performed by the Company’s employees or Directors.
  • Contracts and Agreements: Contracts, agreements, and transactions that are substantially related to the company’s core business activities in the jurisdiction.
  • Keep Records and Minutes: Maintain proper records, minutes of meetings, and financial statements in compliance with local regulations.
  • Obtain Necessary Licences: Where applicable obtain any necessary business licenses, permits, or regulatory approvals required to operate in the jurisdiction.
  • Operational Control: Ensure that the company exercises real operational control and management within the jurisdiction, rather than merely having a passive presence.
  • Local Marketing and Sales: Where applicable conduct local marketing and sales efforts to demonstrate that the company is actively engaged in business activities within the jurisdiction.
  • Compliance with Tax Laws: Comply with all local tax laws and reporting requirements in the jurisdiction where the company claims tax residency.
  • Annual Reporting: File annual tax returns and financial statements in the jurisdiction as required by local authorities. Failure to do so may have adverse effects on tax residency.

 

 

Meeting substance requirements for tax residency (Also applicable for Cyprus tax residency)

Compliance with business substance requirements both in Cyprus and abroad is vital to maintain your company’s tax residency and reap the benefits of an optimal international business strategy. Below, we outline critical actions that showcase business substance: 

  • Maintain a fully-fledged office. Establish and maintain a physical office space in Cyprus that is appropriately equipped for your core business activities.
  • Appoint Active Local Directors: Select local directors who possess a deep understanding of your business and can actively participate in decision-making processes.
  • Record Board Minutes: Keep detailed board meeting minutes at your company’s registered office to demonstrate active corporate governance.
  • Incorporate Directors into Payroll: Ensure that directors are included in your company’s payroll system, reinforcing their direct involvement in the business.
  • Formalize Contracts: Conclude various contracts and maintain records within your company’s office. This includes agreements such as employee contracts, rental contracts, and contracts that underscore the rationale and economic value of your business.
  • Hire Local Employees: Employ local staff in Cyprus, register your company as an employer with Cyprus government authorities, and maintain comprehensive employee records.
  • Localize Financial Records: Store your company’s financial records locally or on a server accessible by employees to facilitate seamless bookkeeping.
  • Manage Bank Accounts: Maintain bank accounts within Cyprus company and execute business transactions under the guidance of your directors.
  • Directors take part in business transactions for example bank transactions either by a way of giving instructions or by a way of execution. 
  • Directors as Bank Signatories: Appoint your directors as authorized bank signatories, further showcasing their active involvement in financial transactions.
  • Secure Local Domains: Obtain and manage local domains, enhancing your company’s online presence and reinforcing its connection to Cyprus.
  • Operational Control via Email Correspondence: Demonstrate operational control through email correspondence, showcasing the day-to-day decision-making process.
  • Localized Website: Develop and maintain a company website with local domains ending in “.cy” to reinforce your company’s presence in Cyprus.
  • Register with Local Professional and Government Bodies: Register your company with local professional and government bodies to solidify its legal standing and credibility.
  • Apply proportionality. As a rule of thumb, the entity owning the most valuable intangibles and performing the most important functions within a corporate structure will typically be entitled to the largest share of the profits or losses.
  • Beneficial Ownership of Income: Cyprus Company should beneficially own the income it receives, aligning with the terms of double tax treaties. The Cyprus Company should beneficially own the income it receives. The Cyprus Company receiving for example foreign dividend income under the terms of a double tax treaty should not receive that income on behalf of another person. The income should accrue to the company itself and be reported in its bank account and financial statements.
  • Transparent Tax Planning: Implement transparent tax planning decisions, such as capitalizing your business with equity and utilizing appropriate foreign or domestic corporations for foreign investments.
  • Avoid Multiple Directorships: Prevent the same directors from serving both your Cyprus International Company and a foreign entity to maintain clear economic substance and independence.
  • Allocate Group Assets: To the extent possible, allocate group assets to your Cyprus company to enhance its economic substance.
  • Utilize a Holding Company: Use a Cyprus Holding Company with multiple investment vehicles in foreign jurisdictions to strengthen economic substance. A Cyprus Holding Company with multiple investment vehicles in foreign jurisdictions is considered to have greater economic substance than a holding company with only one investment vehicle.
  • Proper Management of Interest Income and Dividends: Handle interest income and dividends diligently, ensuring compliance with Cyprus tax regulations and transfer pricing guidelines.
  • Rational Loan Agreements: Structure loan income and agreements rationally to avoid tax implications, including transfer pricing concerns. Transactions are considered to be rational if not made by the same counter-parties, the time of execution of transactions is not the same, Interest rates are at arm’s length and related to commercial rates, adequate returns (profits) are allocated to each company, and in relation to the risk undertaken, dissimilar duration of loans, dissimilar amount of loans received and loans granted.
  • Manage Intellectual Property Rights (IP): License intellectual property rights to foreign companies, ensuring that payments to your Cyprus Company align with commercial justifiability and EU directives. 
  • Utilize Investment Funds: If applicable, set up investment funds subject to local regulations to underscore your company’s business substance.
  • Consider Stock Exchange Listing: Listing your company on a stock exchange or an emerging capital market can further strengthen your business substance, provided it aligns with relevant requirements.

 

In-Depth Inquiries: Additional Documentation Requests by Tax Authorities in Determining Tax Residency and reasons for requesting such documentation.

Tax authorities, in the process of establishing tax residency, may seek additional documentation to delve deeper into relevant details. In specific instances, corresponding tax authorities might request supplementary information. This additional documentation could include:

  • Description of activities and functional analysis. Description of business activities including functional analysis examining the functions, assets, and risks of the entity involved. The goal is to determine the contributions made by an entity to the overall value creation. 
    1. Functional analysis: Includes activities such as manufacturing, marketing, research and development, distribution, and management. 
    2. Assets used: Examining the assets employed by the entity, including tangible assets (such as equipment and inventory) and intangible assets (such as patents, trademarks, and technology), materials, labor used, and possible financial resources are also relevant.
    3. Risks: Analyzing the risks assumed by the entity, such as market risks, operational risks, and financial risks. Understanding who bears the entrepreneurial and financial risks
  • List of Directors and Managers: Certain countries consider the tax residency of a company based on the location of its directors and managers. This is to assess whether the company has a genuine presence and operations in the jurisdiction.
  • Minutes examination: By reviewing board minutes, tax authorities can assess the location of important decision-making processes and, consequently, the company’s tax residency. Tax authorities are interested in understanding where significant business decisions are made.
  • Memorandum of Association: The memorandum of association typically includes information about the company’s objectives and the nature of its business activities.
  • Financial statements. Financial statements, provide a detailed breakdown of a company’s revenue and expenses. Financial statements help tax authorities to calculate the taxable income of a company.
  • Auditors and tax advisors: To verify that the company is working with a qualified tax professional who ensures compliance with tax laws and regulations
  • Employment: If the entity is involved in the hiring of labor, list of names of employees and their functions, level of education, and how their remuneration is calculated: To verify the employment status of individuals associated with the entity.
  • Contracts: Contracts provide insights into the substance and operational presence of an entity in a particular jurisdiction. Further, tax treaties often include provisions regarding the creation of permanent establishments, which can affect tax residency.
  • Lease agreement for the business premises and the amount payable: To determine the establishment of a Fixed Place of Business and to confirm the existence of a physical presence within their jurisdiction, contributing to the entity’s tax residency status
  • Accounts receivable and payable: To assess the entity’s level of economic substance and the nature of its commercial transactions within a jurisdiction. Significant accounts receivable and payable may indicate substance. To understand the financial health of the entity and its ability to meet financial obligations. To assess compliance with transfer pricing regulations. Significant accounts receivable and payable may be relevant to the determination of a permanent establishment (PE) for tax purposes. They can provide information about the entity’s relationships with customers, suppliers, and other business partners with particular jurisdiction.
  • Sales and purchases invoices and receipts and payments including methods involved, place of transactions taken place, number of bank accounts, persons’ bank account names involved: To understand the substance of the entity’s business transactions and the nature of its commercial activities within a jurisdiction. To assess whether the entity’s activities create a PE. To verify the entity’s compliance with VAT/GST regulations. Relevant to the control and management test. Assessing compliance with transfer pricing regulations.
  • Authorized persons for concluding contracts, issuing invoices, and authorizing payments: To determine the entity’s tax residency based on where important decisions are made.
  • The number of bank accounts and bank institution details: To assess the extent to which the entity conducts financial transactions locally and help in understanding the financial control exercised within a jurisdiction thus contributing to the determination of tax residency

 

In Cyprus, tax residency: Understanding Tax Residency for Cyprus Companies

A Cyprus company attains tax residency in Cyprus when its management and control operations are based within the island nation. Furthermore, starting from the year 2023, a Cyprus-incorporated company is automatically regarded as a tax resident of Cyprus by default, provided that it does not hold tax residency in any other jurisdiction. This holds particular significance, especially when a Cypriot company receives income from other companies under its ownership and control.

For Cyprus companies, the vital link between management, control, and tax residency highlights the importance of a well-structured business strategy. The 2023 regulation reinforces the principle that when a Cyprus company’s core functions and decision-making processes are centered in Cyprus, it is deemed a tax resident, reinforcing the country’s position as an appealing destination for international businesses. This is of utmost relevance for Cypriot companies managing income generated from their affiliated entities.

Conclusion

In conclusion, the intricacies of tax residency in Cyprus are fundamental for international businesses seeking to optimize their operations. A clear understanding of these concepts ensures compliance with favorable tax rates and minimizes the risk of double taxation. As Cyprus continues to evolve as an international business hub, maintaining tax residency within its jurisdiction is not only beneficial but also a strategic advantage. Stay informed, meet the criteria for tax residency, and navigate the ever-changing landscape of international taxation to secure your company’s success in Cyprus and beyond.

Unlocking Success: Partner with Us for Your Cyprus and Global Business Strategy

Partner with our firm to ensure your company’s success in Cyprus and worldwide. We specialize in helping clients understand and meet tax residency criteria, optimizing compliance with favorable tax rates while minimizing double taxation risks. Let us guide you through the dynamic international tax landscape and capitalize on Cyprus’s strategic advantages for your business.

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Accordingly, no person, entity, or corporation should act or rely upon any matter or information as contained or implied within this publication without first obtaining advice from an appropriately qualified professional person or firm of advisors, and ensuring that such advice specifically relates to their particular circumstances.