The lack of definition of the terms “management and control” and “place of effective management”, terms used in respect of legal bodies in the D.T.Treaties, as well as the reference in Art. 4.1 of the O.E.C.D. Model Treaty (included in practically all Cyprus Treaties) to the laws of the respective Contracting State in order to determine the tax status of legal bodies on the basis of ‘place of management or other similar criterion” leads to the consideration of the Cyprus law in order to establish the residence of a legal body under such law for tax purposes and, consequently for Treaty purposes as well.

In the interpretation of the term management and control the English law will be looked to as the Cyprus legislation is similar to the English in this respect, as it were prior to recent changes shifting the criterion for tax purposes to registration insofar as English companies are concerned.

Under English law, residence of a company for tax purposes was not dependant on registration. In the words of an English judge,

“the place of registration… although it may be a factor in deciding where control is, is no more conclusive as to a company’s place of residence than is the place of birth of an individual”.

Well-established case law in England, dating back to the last century, has laid down that a company resides for tax purposes where its real business is carried on and the real business is carried on where the central management and control actually abides.

Without entering into more detail, the essential criteria of ‘central management and control” under English law and consequently under Cyprus law are:
1. Where the majority of the directors reside;
2. where the board meetings are held;
3. and where the general policy of the legal body is formulated.

Majority in equity capital has no practical relevance.

The co-existence of all three of the above criteria is essential. The first criterion may be satisfied even if the directors, in the case of Cyprus, are not locally residing Cypriots so long as they are local residents for the time being – Cypriots or not as, for example, foreign employees of a Cyprus legal entity.

Some recent English cases may appear to throw some doubt on the validity of the above criteria, but in reality this is not the case. It is on matters of evidence or the lack of evidence, proving or disproving these criteria, that the findings in these cases are based. It is true, of course, that in the face of so many tax avoidance schemes, depending on residence of a company in a given country or not, English courts, like so many others are particularly cautious and are apt to scrutinize more the existence of all three of the above criteria, especially of the third one, which after all is not so clear cut as the first two. Sometimes the third criterion goes hand in hand and is merged with the second, but this is not always the case, especially in tax avoidance schemes, and although disproving it is not an easy thing, in the absence, which is not easily forthcoming, proving it as well is not always practicable.

In view of the tax advantages offered by Cyprus in conjunction with Cyprus double tax treaties, management and control from Cyprus of IBCs acquires a foremost significance.

To fortify the above criteria, especially the third one, in the case of treaty countries, (as well as other countries with anti-avoidance provisions) the formal approach of merely having a majority of locally residing directors and of the holding of board meetings in Cyprus must be further extended, both in a positive and in a negative manner.

In a positive manner it may be strengthened by creating a Cyprus operation as genuine and as real as possible. An office in Cyprus as such, where business is apparently conducted, contracts entered into, employees employed and paid, is indicated, together with letter headings with the local business address, bank accounts in Cyprus in addition to those abroad, and other similar outward indications of local presence and activity.

In a negative manner it may be protected by avoiding the appointment of even one director from the country from which income is expected to arise or in which tax incidence is sought to be avoided. The signing of contracts outside Cyprus, the granting of general powers of attorney to persons who are not directors, the exclusion of Cyprus resident directors from the operation of bank accounts, especially Cyprus ones, are also matters, which must be avoided.

Thus, a Cyprus set-up, carefully planned and carried out, has much more chance to pass the test of genuineness, as Cyprus is not an exotic tax haven with no other justification.

Depending on the circumstances of every specific case it is usually advisable to seek tax residency in Cyprus. This way you limit to 10% your tax exposure and you take advantage of Cyprus double tax treaty network. Further details about taxation are provided in the related single page leaflets and structures of our firm.

Cyprus Nominees should be able to demonstrate that board meetings are being made in Cyprus, minutes are kept showing that as well as showing that management is exercised and dividends are declared for example.

Power of Attorney, if it has to be used, better be used for short period of times so as to demonstrate just temporary management transfer and not complete transfer of management (and possibly tax domicile).

One is driven back to the “place of management” test-choosing directors who will be assiduous with meetings and minutes, and can be relied on to be sufficiently well informed about the company’s business to stand up to examination or cross-examination if it be suggested that the true management and control of the company is exercised elsewhere.

Every practitioner in the tax field – and perhaps especially in the international tax field – is familiar with a plan, which was sound in theory but did not work in practice. A reason for such failure can often be found in a lack of attention to practical details of this kind. Such lack of attention can sometimes be simply a matter of oversight, but very often it results from a misplaced wish to make economies. For example, the minutes of the meetings of the directors are of crucial importance. They must be sufficiently detailed to demonstrate the all-important “management and control” but they should not contain any information of a sensitive or damaging nature. The drafting of these minutes is not a job, which can be left to an inexperienced junior. Or again, it very often happens that there is a particular individual that is the true brains behind the enterprises but does not live in Cyprus. It may not be possible for the directors to have meaningful meetings without him. He has therefore got to travel to Cyprus for the purpose, and for him to save his time – and his air fare – by not making the journey, may prove to be a false economy.

We do not intend to be discouraging; quite the contrary. The problems alluded to here are essentially problems of awareness: it is important that the individual ultimately responsible for the success of the transaction – be the chairman of the holding company or the individual entrepreneur or whosoever – understands why the transaction takes the form which it does.

More analysis on the 3 important criteria

1. Directorship
The majority of Directors must be Cypriot residents. Therefore for example, 2 Cypriot Directors should be appointed and 1 non resident Director in a company with 3 directors in total.

2. Board Meetings & Board decisions.
A resident company must be able to provide evidence that its day - to - day management as well as important decision making process lies in Cyprus. Therefore, regular Board meetings must take place in Cyprus, or the majority of board meetings to take place in Cyprus. In this respect the company must be in a position to provide legal evidence that these facts do exist. In most of the cases under common law this is proven by the minutes book and the text contained in the board minutes.

Therefore the board minutes must be kept in such detail and in such a way so that it proves useful and valuable in the common law courts in case needed.

Examples of items/matters that is advisable to be referenced in the board minutes are the following, (the list is not exhaustive):

1. Important strategic alliances formed with other companies, as well as changes in corporate strategy.
2. Substantial contracts of representation, contracts of purchases of hardware, software or other fixed assets and tools. Such commitments should be passed through Board Minutes approval, and substantiated properly in the minutes books.
3. Co-operation agreements with associates as well as recruiting decisions and subsequent personnel hiring. Reference to the terms of payment, and or subsequent bonuses commissions etc., should also be made.
4. Substantial sales or service contracts should be approved by the board. That way, the board may grand its authorization to a specific person in in the country of operations to sign such substantial contracts on behalf of the company, thereby avoiding frequent and unnecessary use of the general Power of Attorney (if any is present).
5. Important investment decisions, participations in other companies or establishment of subsidiaries in Cyprus or abroad.
6. Frequent review analysis and approval of monthly, quarterly or bi-annual (the most) Internal Financial Statements of the companies and its subsidiaries.
7. Declaration of annual bonuses to management as well as declarations of dividends.
8. Any decisions to issue a Power of attorney should also be approved by a board decision.

It is interesting to note here that not all decisions need to be necessarily taken after the prior approval of the Board, unless the nature of these decisions is such, that a prior written Board approval is required (together usually with an extract of the minutes) by a third party, either state or private third party. This is usually again the case of important acts of capital or other commitments of the company. An example is the sale or purchase of real estate.

So, for example, if it is (and it indeed seems to be) difficult and/or impractical for the directors to visit Cyprus on a regular basis (monthly for example), management decisions that do not require prior board approval can very well be drafted and approved backdated at a later stage, or even subsequently approved by post dated board meetings. (i.e. ratified).

3. Operational Infrastructure

(a) Premises
A company should be able to illustrate that the Cyprus office is a real operational base. In this respect, utilizing the offices of accountants and lawyers in the island as the companies premises it should rather be avoided. Rather, it should have a distinct identity through separately owned office premises on the island. That way a Cyprus registered company will be able to demonstrate in a safer way that its residency is indeed on the island.

On the other hand however, by relocating the office of a Cyprus company from that of its lawyers or accountants, will force the company to incur additional costs associated with the premises.

An efficient way of demonstrating the existence of real operational base of the company and thus satisfy the relevant criteria is to utilize the specially constructed office premises some companies are developing on the island. They are efficient because they are very small (i.e. in term of square meters) individual offices and they are wisely located, although distinct, above or under accounting and/or legal firms offices on the island.

Thanks to their size (between 20–25m² up to 35–40m²) their cost is quite inexpensive. The monthly rental depends mainly on whether office facilities will be provided (i.e. PCs, telephone system, internet etc.) in which case they range from €18 to €25 per square metre. Alternatively, a naked office will cost from €14 - €20 per square metre and the tenant will buy its own office equipment.

In fact such an office space is strategically located in the same building exactly one floor below our office. This is very convenient especially in the case we will provide the nominee directors ourselves.

(b) Employees
The existence of employees in the company’s payroll combined with registration of these employees with the District office of the Ministry of Labour and Social Welfare Labour of Cyprus is by itself a strong evidence (combined with other factors) that the company’s residence is in Cyprus. (alone however, it doesn’t mean much).

Director’s compensation

There are two cases involved here. Residents of the Republic of Cyprus and Non-residents. The decisive criterion is simple. Residency in Cyprus of over 183 days in a 12-month period of a director will automatically lead to tax residency as long as we are referring to a physical person. When non-residents are appointed as directors of the company, their emoluments are not taxable in the Republic of Cyprus. Such a director may be taxable in the country of his residence however.

We advice you to hire full-time (real) staff in Cyprus. This employee(s) will also be appointed as directors of the company and satisfy one of the three key elements of residency as we have seen earlier.

In case however one does not intend to hire fulltime staff in reality, to this respect we recommend that the various professional fees you will be charged for our services be shown as director’s compensations / salaries. The company will be registered in the Ministry of Labour (Director of Social Insurance department) as an employer and will be permitted to employ people in Cyprus. On the salaries of these individuals the company must pay the various payroll contributions of 10% (total) on the employee’s salaries. Along with an 8% deduction that the company will deduct from the “employees” salaries the total must be remitted to the Director of Social Insurance Fund monthly. An amount of annual paid vacation leave of 20 working days (or a relevant percentage if not full-time) must also be provided to this “employee” in accordance with the law.

The above action is strongly recommended because it represents the most powerful legal weapon the company will have in the event or necessity of having to demonstrate its Cyprus tax residency, and the procedure as such does not bring to the company any substantial additional costs.

Aspects concerning general accounting practice in Cyprus

1. General aspects

Accounting and legal aspects in general terms follow the English system in every material respect thanks to the mark the British left on the island after 100 years of ruling. Cyprus has adopted and uses International Accounting Standards for reporting by Cyprus registered companies for more than 25 years now. The Cyprus Inland Revenue bases its taxation rates on the accounting profits of a company (with very few exceptions and deviations). These accounting profits are computed by the company and presented in the Financial Statements of the company subsequently audited by auditors certified and licensed by the Republic of Cyprus to perform such auditing activities. Once these Financial Statements have been audited, an Annual General Meeting (AGM) of the company’s shareholders must take place. During the AGM the auditors report is read and the Financial Statements are approved.

The auditors must then submit these Financial Statements (FS) along with all other tax related analyses, forms and computations, to the Inland Revenue Authorities.

The usual practice is that the FS will be examined by a Tax assessor and some questions, queries, clarifications or additional documentation will be raised and/or asked for. A meeting with the auditor in the Inland Revenue office is also a common practice where more questions are asked and/or more information is provided. In case no agreement is reached on hot or disputed items or areas, the assessor has the discretionary power to decide the issues according to his or her judgment and issue his or her assessment.

In this case, the taxpayer (company) has the right to object the assessment and seek re-examination of the subject. In case no agreement is reached again, the taxpayer has the right of appeal, first to the Tax Tribunal and then to the Supreme Court (both of them are customary actions and quite often lead to favourite judgment).

2. Revenue Recognition

The income of the company should be substantiated by adequate audit evidence in a way that satisfies the company’s auditors. In addition to the auditors however we should always keep in mind that the Inland Revenue may also ask for additional disclosure or evidence.

Generally speaking a sales contract or a (signed by customer) invoice with proper description suffices. In cases where invoices represent repetitive services, or services stipulated by a contract, they do not necessarily require a signature. Positive alternative evidence may also be the fact that inwards transfers of funds originate from the bank account of the customer. If this also is not the usual case, a separate agreement should be presented with the arrangement behind the deal having some other legal entity paying for the services rendered to the customer. As an alternative to the presentation of such agreement may also be adequate correspondence between the three parties, which explains the reasoning behind this fact.

Unusually large revenue streams should always have an independently drawn piece of evidence however, or a signature on a contract or invoice. Unusually large could be defined as single transactions with amounts outside the normal volume (or average volume) of the company’s normal course of business.

Language is usually not a problem as long as there is a valid business reason behind not using English. If you do business in Russia for example it is by definition necessary to have all documentation in the Russian language, which is your case of course. The only issue with language is a cost issue in case it is required by the auditors or tax authorities to translate into English (or Greek) some parts of this documentation.

3. Profit margins

Every industry has its general rule of thump when referring to the gross margins of the specific industry business. Such gross margins are generally known statistics and usually available to both the government and the private sector. In this respect both the Inland Revenue and large audit firms do maintain their own statistics and calculate industry averages. We do make use of such statistics during the “analytical review” of our audit work.

We do need to point out however, that this type of evidence is only of a corroborative nature, i.e. it doesn’t represent primary evidence.

It wouldn’t generally be a major trouble because some (or even more than some) of the companie’s projects show low profitability, as long as the overall profitability of the company is substantial.

Moreover, the first year of operations/profitability is very critical in this respect. The first year indices, accounting ratios and specifically gross profit margin will form the base on which subsequent years’ examinations and comparisons will be made. In these subsequent years (2nd, 3rd etc…) the Inland Revenue will question substantial fluctuations in the profit margins, especially decreases of course, irrespective of the volume of turnover. Profit margins like some other accounting ratios are valid no matter if the turnover increases or decreases substantially.

4. VAT Implications

The VAT Law does not include any special provisions for IBCs. The Law applies to them as it applies to other businesses. IBCs which make supplies only outside the Republic they have a right to register (just to claim refunds of any input tax on the purchase of goods and services in Cyprus or on imported goods if they have a business establishment in the Republic (fully fledged office) or have their management and control in the Republic, and the supplies made outside the Republic, would have been taxable if made in the Republic.

However, if IBCs make taxable supplies in Cyprus they are liable for registration, subject to the threshold registration limit. If they make exempt supplies only, they have neither an obligation nor a right of registration.

IBCs belonging in the Republic, that they do not have an obligation or right of registration, but they receive services from outside the Republic falling within the Third Scheme, they have to apply the provisions of reverse charge, subject to the provisions of prescribed registration limits.

The registration threshold is C£9.000 per year.

5. Cost recognition

There are two general rules for cost deductibility and everything else is based on these.

First of all, costs must have been incurred solely for the production of income. A considerable number of rulings exist, of cases taken to the Supreme Court which give some guidance on what is regarded as “incurred solely for the production of income”.

Two examples of expenses which are not incurred solely for the production of income are expenses relating to issue or increase of share capital of the company, and the payment of fines. These two are just two general examples.

The second general rule is the existence of original invoices or receipts or contracts issued on the name of the company itself.

In addition to the above, there are also hundreds of pages of legislation in the Tax Code which provide exclusions and/or limitations on the deductibility of expenses.

One of them follows under 6 below.

6. Hospitality or Entertainment expenses

These expenses are limited by law to 1% of turnover up to C£10,000

Trust and Confidentiality in this business

Confidentiality and trust represents the element with utmost importance of the implementation of above residency schemes. The general broader aspects of this business naturally begin with the confidentiality principle. It is an internet element of the whole system of nominee shareholding and directorship which begins with the regulatory environment (Central Bank of Cyprus) and ends with the Cypriot professional firm servicing the clients.

One should be able to understand the mechanism behind the nominee directors.

It is true that these directors have real power in their hands, and naturally there are some mechanisms that are aiming to reduce their powers in the good sense. Here we enlist some of there confidentiality and trust enhancing elements present:

1. Resignation letters:
We issue undated resignation letters of our directors so that you can change them instantly. However this necessitates prompt and advance annual payment of our fees.

2. Instrument of Trust (shareholders)
We issue this document signed by our nominee companies.

3. Reputation
Our business is based on the vital aspects of confidentiality and trust. We, as a firm, do not exist without this element inherent in our operations. With a history of 25 uninterrupted years in the professional services arena in Cyprus and other countries, you should be assured that the trust and confidentiality entrusted in our hands is warranted.

4. Employee’s confidentiality agreement
All of our employees sign (upon arrival in our firm) proper confidentiality agreements regarding the treatment of client confidential information as well as the general conduct with client affairs.

5. Professional Indemnity Insurance
Our firm carries proper professional indemnity insurance.

6. The Cyprus Association of Certified Public Accountants
The American Institute of Certified Public Accountants
Through our partners/shareholders professional licenses, we are members of both of the above organizations. Any misconduct by our firm partners or employees can be immediately reported to these associations with the risk to have our professional license revoked at any time. Having in mind that our entire operations are based on these licenses and without them we do not exist as a firm, you can realize the importance of this safeguarding element.

7. BKR International
Our firm is a member of BKR International since 1991. This membership by definition carries with itself a high level of quality and trust. It is a membership granted only after a thorough review of the entire activities of a firm as well as general reputation.

Moreover, our Managing Director Mr Christodoulos Damianou is currently the Chairman of BKR International in Europe, Middle East and Africa and a member of the Worldwide Board. Being in the position to be elected to represent the interests and reputation of a prominent international organization of accounting firms worldwide, essentially proves by itself the respectability, trust and professionalism of our firm.

8. References
References can be obtained from our Chamber of Commerce, Commercial banks in Cyprus, etc.

Sources used in this commentary:

In writing this commentary we have borrowed text and interpretations of treaty text from international tax text books especially from the book “Cyprus double tax and other treaties” of the late Mr Demetriades, a prominent and very much respected Cypriot lawyer.

Disclaimer:
This commentary is issued for general information only. It can neither be used, copied or circulated or used by any third party related or not, without our prior written approval, nor can it be used to base important decisions without our prior consultation.