Cyprus’s Controlled Foreign Corporation (CFC) rules are instrumental in regulating income generated by foreign subsidiaries of domestic entities. These rules predominantly target passive income sources like dividends, interest, royalties, rents, and capital gains.
In general, controlled foreign corporation (CFC) rules
Controlled Foreign Corporation (CFC) rules are a set of tax regulations implemented by usually developed countries, primarily to prevent multinational corporations from shifting their profits to low-tax or tax-haven jurisdictions. These rules aim to ensure that income earned by foreign subsidiaries of a domestic company is properly taxed by the country where the parent company or the beneficial owner is based. The specific details and application of Controlled Foreign Corporation (CFC) rules can vary from one country to another, but the core principles are similar. Similar rules are also included in most countries’ double tax treaties. These rules are designed usually to tax the passive income generated by foreign subsidiaries of domestic entities. Below are key aspects of Controlled Foreign Corporation rules set by most countries:
- Ownership Threshold: Controlled Foreign Corporation (CFC) rules typically apply when a domestic entity, such as a corporation or individual, owns a certain percentage (often more than 50%) of the voting shares or value of a foreign corporation. This level of ownership gives the domestic entity control over the foreign corporation’s operations.
- Types of Income: CFC rules target specific categories of passive income, such as dividends, interest, royalties, rents, and capital gains, earned by the foreign subsidiary. These types of income are often subject to special taxation when earned by a Controlled Foreign Corporation (CFC). Usually, income derived from active business operations in the Controlled Foreign Corporation’s (CFC’s) home country may be exempt from Controlled Foreign Corporation (CFC) rules
- Taxation of Shareholders: Under Controlled Foreign Corporation (CFC) rules, the shareholders of the domestic entity that owns the Controlled Foreign Corporation (CFC) are typically subject to tax on their pro-rata share of the Controlled Foreign Corporation’s (CFC’s) income, even if the income is not distributed. This can result in the taxation of income that remains within the foreign subsidiary.
In Cyprus, controlled foreign corporation (CFC) rules
In Cyprus, controlled foreign corporation (CFC) rules stand as a cornerstone of the country’s tax framework. These regulations play a pivotal role in ensuring that income earned by foreign subsidiaries of domestic entities is managed efficiently and subject to relevant tax provisions. In this section, we delve into the intricacies of Cyprus’ CFC rules.
Dividends distributed from the foreign company to the Cyprus company
- Irrespective of the existence of a double tax treaty, Cyprus tax legislation does not impose income tax on dividends received by a Cyprus company
- Dividends received by a Cyprus company are subject to defence tax contribution at the rate of 17% if the companies paying the dividend
- have activities the nature of which amount to more than 50% of investment income and
- their country of residence imposes corporation tax which is less than 6.25% per annum. Both criteria must apply for the tax to apply.
For operating companies’ the first criterion applies and there will be no tax on dividends received by a Cyprus company
- Anti-Avoidance Tax Directive (ATAD) provisions have been transposed into domestic tax legislation regarding Controlled Foreign Corporation (CFC) rules. As of 1 January 2019, an entity or a permanent establishment of which the profits are not subject to tax or are exempt from tax in Cyprus is treated as a Controlled Foreign Corporation (CFC) where the following conditions are met:
- In the case of an entity, the taxpayer by itself, or together with its associated enterprises holds direct or indirect participation of more than 50% of the voting rights, or owns directly or indirectly more than 50% of the capital or is entitled to receive more than 50% of the profits of that entity; and
- The actual corporate tax paid on its profits by the entity or permanent establishment is lower than 50% of the corporate tax that would have been charged to the entity or permanent establishment under the applicable corporate tax system of Cyprus.
Where an entity or permanent establishment is treated as a Controlled Foreign Corporation (CFC), Cyprus shall include in the tax base the non-distributed income of the entity or the income of the permanent establishment which is derived from mostly passive income which includes the following categories: i) Interest or any other income generated by financial assets; ii) Royalties or any other income generated from intellectual property; iii) Dividends and income from the disposal of shares; iv) Income from financial leasing; v) Income from insurance, banking and other financial activities; vi) Income from invoicing companies earning sales and services income from goods and services purchased from and sold to associated enterprises, adding no or little economic value.
Ultimate beneficial owner tax implications if the beneficial owner is a tax resident in another country.
Irrespective of the existence of a double tax treaty, Cyprus tax legislation does not impose withholding tax except for certain royalty payments if the IP is utilised in Cyprus. Non-resident companies have no obligation to withhold taxes on any payments they make. Dividends paid (directly or indirectly) to non-resident shareholders and interest paid to non-residents are not subject to withholding tax.
As of 31 December 2022, Cyprus applies a withholding tax of 17% on dividends paid by unlisted companies, 30% on passive interest payments (excluding payments from natural persons), and 10% on royalty and similar payments (excluding payments from natural persons) if the recipient of the payment is a company in a jurisdiction on the EU’s list of non-cooperative tax jurisdictions (commonly referred to as the EU “blacklist”).