In July 2002 the House of Representatives of Cyprus has enacted the long discussed tax reform. Taxes are reduced substantially, both for corporations and individuals. Major changes in the tax legislation are also effected.

CORPORATIONS

The status of International Business Companies “IBCs” formerly known as offshore companies gradually ceases to exist. As from 1.1.2006 there will be only one type of legal entities, with no difference between local and offshore companies. Ultimately all companies will bear corporation tax of only 10% on their net profits. No withholding tax on dividends interest or royalty in the hands of non-residents. Cyprus is becoming an even more attractive business centre, as it is widely expected that from the year 2004 Cyprus will be the European Union country with the lowest corporation tax.

The taxation of companies will now onwards be based on residency rather than source. This change creates substantial opportunities for International tax Planning

Resident companies

Participation exemption is introduced for dividends received from other companies. Companies are regarded as residents of Cyprus if they are managed and controlled from Cyprus.
Income arising or derived from sources in or outside Cyprus from the following activities is liable to tax in the hands of resident companies:

• Profits from a business activity, such as trading, manufacturing, mining, agricultural, profession or vocation.
• Interest, subject to certain conditions.
• Rents and royalties.
• Profit from sale of goodwill.

Non-resident companies

The income of non-resident companies which is carried out through a permanent establishment in Cyprus, including rents and royalties as well as profit from the sale of goodwill, is liable to tax.
Permanent establishment exists where there is:

• a fixed place of business
• a place of management
• a branch
• an office
• a factory
• a workshop etc.

The following do not constitute a permanent establishment:

• Storage facilities
• Display and delivery of goods facilities.
• Maintaining of stocks.
• Maintenance of goods for the purpose of processing by another person.
• A fixed place of business solely for the purpose of purchasing goods or for the collection of information.
• An independent agent.

Trading Losses

Losses are carried forward from year to year without any restriction.
Losses from one activity can be set-off against profits from another activity.
Group loss may be set-off against profits within the same group of resident and not resident companies

Expenses allowable

Expenses which are wholly and exclusively incurred in the production of income.
Depreciation of fixed assets employed in the business.

Expenses not allowable

Entertaining expenses in excess of 1% of gross revenues, or gross sales, or C£10.000 whichever is the lower.
Expenses relating to private saloon cars, such as fuel, maintenance costs etc.
Interest on loans for the purchase of saloon cars and any assets not used in the trade.

“Group companies” means:

Company holding not less than 75% of the voting shares of the other company
Not less than 75% of the voting shares of two companies are held by another company.

Corporation Tax Rates

The corporation tax rate is only 10% on net profits.
Ship companies may elect to pay either tax on profits at the rate of 4.25% or to pay tonnage tax.
Additional tax at 5% will be imposed on company profits in excess of C£1.000.000 for 2003 and 2004.

Withholding taxes

There is no withholding tax on payments to non-residents in respect of:

• Dividends
• Interest
• Royalties arising from the use of an asset in Cyprus are subject to a 10% withholding tax.Film rentals are subject to a 5% withholding tax.
• Income of non-resident entertainers is subject to 10% withholding tax.
• Reorganizations of businesses
• Based on the EU Directive
• No taxes on the transfer of business.
• No taxes on the transfer of assets.
• No taxes on the exchange of shares.
• Losses incurred prior to the merger may be carried forward by the new company.
• No stamp duty is payable on documents to effect the merger.

Transitional provisions concerning International Business Companies

Companies of international business activities (IBCs) may continue to bear tax at the rate of 4.25% on their net profits, for the years 2003, 2004 and 2005, provided that:

• These IBCs were granted a Central Bank permit prior to 31/12/2001.
• These IBCs were operating and did prepare and submit audited financial statements to the Tax Authorities at least for 2001.
• Otherwise, IBCs which are registered after 1.1.2002 and those Companies which fail to file audited financial statements for 2001, will be taxed at the rate of 10% on their net profits, just like local companies.

If a company elects to be taxed at 4.25%, the company, must continue to derive income only from sources outside Cyprus. In such case (i.e election) the following are liable to tax during the years 2003, 2004 and 2005.

• Gains from the sale of shares.
• Interest received.
• The company cannot claim group loss relief.
• Losses up to 2000 can be carried forward only for 5 years.
• The company will not benefit from the reorganization provisions.

The result of the above conditions is that the company will be treated as before the new law comes into effect.

INDIVIDUALS

Residents are individuals who stay in Cyprus 183 days or more in any tax year. They are taxed on the following income:

• Business profits from any activity, profession or vocation.
• Rents and royalties.
• Profit from sale of goodwill.
• Income from employment.
• Pensions.

Non-resident individuals are taxed on:

• Profits from a business activity which is carried out through a permanent establishment in Cyprus.
• Rents from immovable property situated in Cyprus.
• Profit from sale of goodwill.
• Pensions in respect of employment exercised in Cyprus subject to certain conditions.
• Emoluments from employment exercised in Cyprus.

Allowances granted to individuals

• Contributions to social insurance fund.
• Life assurance premiums.
• Contributions to approved provident funds or pension schemes.
• Contributions to medical funds.
• 20% of the emoluments, up to a maximum annual amount of C£5.000, for an individual who for the first time comes to Cyprus to be employed. This exemption is valid for 3 years and the 3-year period begins on 1 January of the year following the year of his coming to Cyprus.
• All other personal allowances such as spouse, children and old age are no longer granted.

— TAX RATE TABLE –

If employed outside Cyprus no tax.
If employed in Cyprus for 183 days or over he is taxed on all salary received.
If employed in Cyprus for less than 183 days he is taxed on the proportion of his salary.

The law comes into effect on 1 January 2003.

CONTRIBUTION TO DEFENCE FUND

The following types of income are liable to contribution:

• 10% on interest received. Interest closely connected with the ordinary course of business of a company is not subject to this provision, as such interest is regarded to be profit,
• taxable under the provisions of income tax law.
• 3% on net rents after the deduction of 25% out of gross rents.
• 15% on dividends received from abroad, subject to certain conditions.
• 15% on dividends paid. This provision does not apply to the payment of dividends to a Cyprus company as well as to non-resident shareholders.
• 15% on deemed dividend distribution of 70% of distributable profits of the company. This provision does not apply to non-resident shareholders.
• IBCs electing to be taxed at the rate of 4.25% for the years 2003, 2004 and 2005, will not be subject to the defence fund contribution.