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With the subject of tax avoidance becoming increasingly prominent both domestically and internationally, and international cooperation to curb the abuse of double tax treaties it is important to consider international tax law developments and initiatives within the context of the Cyprus holding company. It is equally important to consider what measures can be taken to ensure that a company structure is compliant with applicable multilateral tax regulations and that the risk of being found either by domestic or foreign tax authorities to be a ‘sham,’ or more accurately, to be a company/ies without substance, is minimised.
The OECD’s Action Plan to address Base Erosion and Profit Shifting (“BEPS”) is intended to ensure that profits are taxed in accordance with where the relevant economic activity that generates the said profits takes place and where value is created. Under the OECD Model Convention and as reflected in the majority of double tax treaties in order to qualify for the benefits of a double-tax treaty a company must be a resident of one or both contracting states (defined as one who is liable to tax in that state). A company is deemed to have its tax domicile in Cyprus when its management and control are exercised in Cyprus.
For dual resident companies, article 4(3) of the Model Tax Convention prescribes that residence is determined by the ‘place of effective management’ (this is reflected in most of Cyprus Double Tax Treaties such as the Cyprus-Russia double tax treaty, although Russia is not an OECD country).
The OECD’s 2014 deliverables focus on changes to international tax standards based on three core principles:
To ensure compliance with applicable tax regulations Oxford Management offers a wide range of substance solutions. It is important to note, however, that each company and each set of circumstances are different and solutions are tailor made for our clients incorporating some or all of the below as required.
1. Appointment of qualified directors: Appointing appropriately qualified directors to make decisions in relation to the company having regard to the business of the company.
2. Office presence: Establishing a physical presence through the maintenance of office premises in Cyprus with dedicated telephone and fax lines, preparation of Logo and Stationary, web presence as well as part-time or full-time employees to manage the day to day administration of a company.
3. Business records: Maintaining accounting and corporate records such as minutes etc, at the Cyprus company’s offices.
4. Multiple directorships: Implementing appropriate mechanisms to avoid multiple directorships (ie where the director of a Cyprus company is also the director of a parent or source company), as tax authorities may consider this an indication that the company does not operate independently but rather under the direction of another company.
5. Rational agreements: Arm’s length principles are applied to all loan agreements, and considerations such as whether the counter-parties are the same are taken into account and appropriate safeguards are subsequently put in place.
6. Beneficial ownership: Structurally designed to ensure that beneficial ownership is reflected in the Cyprus Company. In this way the income received by the Cyprus Company shall be reported in its bank account and financial statements.
7. Listing on Cyprus Stock Exchange: This is another option to consider as listing a Cyprus Company to the Cyprus Emerging Capital Market is a viable and cost effective solution. There is no minimum share capital requirement to be disbursed to the general public.
8. Establishment of a Cyprus International Trust: The Trust can become the shareholder of the Cyprus Company. In case where a discretionary Trust is being established the beneficiaries of such Trust will not have ownership and or control over the Trust Property (i.e. shares of Cyprus Company).
9.Continually develop the Company: It is very important to continuously demonstrating Cyprus economic substance throughout the Cyprus Company’s lifetime.
10.Accounting Records: accounting records should be prepared and kept in Cyprus;
11.Cyprus Alternative Investment Funds (AIFs): use the AIFs for major investments. Shares or units of an AIF are held by a custodian bank, administered by the administrators and regulated by Securities and Exchange Commission.
12.Operation of Bank Accounts: The bank accounts of the company, regardless of whether they opened in or outside Cyprus, should be operated from Cyprus as it can be argued that the effective management and control of the company is where its bank accounts are managed from.
13.Hold international assets to the Cyprus Company: A Cyprus holding company with various investments in foreign companies is considered to have greater economic substance than a holding company with only one investment.
In light of the international relevance of this concept the definition of the term can be found in international law and OECD commentary to the OECD Model Tax Convention. Furthermore, according to UK case law, which retains a persuasive influence in Cyprus, the common law test of ‘central management and control’ can be applied to determine effective management as set out in Wensleydale’s Settlement Trustee v IRC  STC (SCD) 241.
This common law concept sees the place of ‘central management and control’ as being where a company’s Board of Directors meet and the place of strategic management, rather than the place of day-to-day management. This principle, however, is displaced where the Board of Directors is not exercising their powers and/or functioning as such, which also goes to substance and the role of directors in contributing to the assessment of a company as having real substance.
Where a Cyprus company, incorporated for example as a subsidiary is wholly managed from abroad in the sense that all key relevant decisions are made by a parent company or ultimate beneficial owner overseas, then the tax residency of that company in Cyprus could be brought into question. One of the possible means of avoiding the loss of residency on this basis is to ensure that qualified personnel with the ability to make strategic decisions concerning the particular business of the company and who are also tax residents of Cyprus, are appointed as directors. Along these lines, multiple directorships should also be avoided.
Effective management is closely tied to substance while the issue of substance is not only relevant in a European and OECD context but is also provided in most Double Tax Treaties.
What the concept of substance entails has been challenged in the Russian courts by the Russian tax authorities as for example in the case between the Russian tax authorities and the Russian branch of the Cyprus company Eastern Value Partners Ltd whereby the tax authorities denied the applicability of the Cyprus – Russia Double Tax Treaty on the grounds that the conditions for economic substance were not satisfied. According to the double tax treaty between Cyprus and Russia a company is not entitled to the benefits of the treaty where the said company’s main purpose or one of its main purposes is to obtain the benefits of the agreement.
Another matter which is considered by tax authorities when evaluating the status of a company is that of beneficial ownership. The OECD Model Convention specifies that in certain circumstances such as dividend, interest and royalty articles, a receiving company must be the ‘beneficial owner’ of income to obtain the reduced rates of source withholding tax.
Despite the absence of definitive guidance as to what constitutes beneficial ownership the OECD’s Conduit Companies report in 1986 suggests that nominee companies, bare trustees, custodians and conduit vehicles with narrow administrative powers over income cannot claim to be beneficial owners.
Further international law commentary indicates that beneficial ownership is constituted when income is received for the ‘person’ (which definition includes a company) or person’s own benefit and is not intended to pass through a person on its way to another destination or any direct or indirect obligation to pay forward any benefits received to a party outside the jurisdiction of the company.