Confirmation of the reality of the business
The concept of the reality of the business or the dominance of the content over the form in the tax evasion is an emerging and important subject area in the global economy. Lack of economic content (that is, the absence of the real management and commercial activity) is a wake-up call signaling the tax evasion in many jurisdictions.
The stance of many foreign tax authorities and public opinion on the tax evasion has become tougher over the past few years. There is an increased risk that the tax optimization schemes that fail due to artificiality, poor implementation and/or lack of the commercial activity will be perceived as the tax abuse or worse, as the tax evasion.
Recent developments, both from the point of view of the domestic law and from the point of view of the EU and the international community, have attached great importance to the content, indicating that international cooperation is the only way to solve the problem of the tax evasion without affecting the structures of the real commercial value, whose activities make economic sense.
Under the OECD Model Convention, a company can qualify for the contractual benefits if the following conditions are met (usually found in the tax agreements):
1. The company is the tax resident of the state in which it is registered;
2. The company is the “beneficial owner” of the distribution of income (i.e. dividends, interest, royalties).
For example, consider the case of an international group of companies that includes a subsidiary under the national laws of Cyprus (or other commonly used jurisdictions for holding the investments, like Luxemburg, Malta, the Netherlands, etc.).
If this entity is effectively managed form abroad (for example, by the parent company of the group) or by a foreign beneficial owner, the tax residency in the country of incorporation of the company claiming the benefits under the treaty (i.e. Cyprus) may be at risk.
In such a case the tax authorities in the countries of origin or the country of residence of the shareholders may take the position that Cypriot company is not a resident of Cyprus due to the fact that it is effectively managed and controlled from another jurisdiction.
"Good governance" is directly related to the primacy of the content over the form. If the company in the above example does not have the Directors who actually make decisions (that is, decide what to do with the income received by the subsidiary), it may face serious objections from the tax authorities of a foreign state regarding the reality of its activities, the result of which may be a loss of the tax residency in the country of its location (for example, Cyprus) and the loss of the right to use the provisions of the agreements on the avoidance of double taxation.
Things get even more complicated when you apply the beneficial ownership test, which is provided in almost all the tax agreements. This test helps to determine whether a legal entity, even if it is a tax resident of another country, party to the agreement, receives income for itself and not for someone else (i.e. whether this company is a real operating company or is acting as an intermediary company/distilling company). The host organization must not, directly or indirectly (for example, through the provisions contained in the agreements between the shareholders/partners), have an obligation to pay the dividends, capital gains, interest or royalties that it receives to a party outside its country of residence.
In 2012 the G20 governments decided to take action to attack and defeat the aggressive tax planning. An OECD report dated February 12, 2013 addressed the issues of the base erosion and profit shift (BEPS) as recent international tax planning and the use of the offshore tax evasion tools have become a major threat to the economy as a whole. The main reason for implementing BEPS action plan is to counter this trend, especially double non-tax structures, and to resolve the situations where the profits are perceived to be geographically separate from the operations.
Also in 2012 the European Commission launched a similar initiative, adopting the Action Plan to Fight Against Tax Fraud and Tax Evasion, including a proposal to address any deficiencies in the EU Parent and Subsidiary Directive that were used by some companies to avoid taxation. Accordingly, in November 2013 the European Commission adopted a proposal to amend the Directive, introducing a single rule for the prevention of the tax evasion, which denies the benefits of the Directive for the artificial tax structures.
In terms of Cyprus tax law, a company is a tax resident in Cyprus if its “management and control” is exercised in the Republic of Cyprus. While no other substantive requirements are formally imposed, recent international litigation and the global trend of the tax jurisdictions demonstrate the need to ensure that there is no discrepancy between the form and the content of the agreements, as well as the importance of managing and controlling the company operations where they claim to be. Cyprus also follows the doctrines of “the content over the form” and “verification of the business purpose”, which allow Cyprus tax authorities to re-qualify artificial or bogus transactions or structures. Assessment and Collection of Taxes Law includes a general rule for the prevention of the tax evasion, whereby the tax commissioner can disregard the structure/transaction (on the basis that it is a fake or fictitious transaction) and evaluate the person concerned from the point of view of the proper object of taxation. These provisions apply to both local and international transactions, residents and non-residents.
When analyzing the content requirements, the starting point and the most important issue to consider is the management structure of the company, which is usually reflected in the composition of the board of Directors. The appointment of the Directors requires careful planning to ensure that the above risks are addressed. The physical presence of the Directors of the company claiming to be a Cyprus tax resident company and the evidence that major decisions have been made in Cyprus will serve as a safeguard against future problems.
When determining whether a company is effectively managed and controlled in a specific country, a foreign tax administration or court (depending, of course, on the specific case and the nature of the business of the company in question) will generally take into account the following factors:
- Do the Directors of a Cypriot company have the appropriate knowledge and the necessary academic qualifications to act in their capacity as the Directors and make the necessary decisions?
- Do the Directors actually make such decisions or are they simply acting on behalf of or on the instructions from a third party?
Achieving the content over the form consistency in Cyprus: Amazon Corporate & Immigration Services approach
In light of the above, it is not surprising that the number of tax investigations initiated by the foreign tax authorities has increased significantly recently. Through the Cyprus Tax Department the foreign tax authorities are now asking Cypriot service providers the following specific questions in relation to foreign residents with the interests in a Cyprus company (“CypCo”):
- Are the Directors appointed in a Cypriot company also the employees of your office?
- If you answered yes to the first question, please indicate how many other leadership positions the same people hold.
- Please provide a copy of the service agreement between CypCo and the fiduciary agent (in many cases such agreements indicate the provision of the management services and, more importantly, the fact that the appointed Directors will only act on the instructions of the client).
As a result of these local and international developments, we urge all the clients to consider transforming their Cypriot companies with a concept of the content over the form.
The reality in Cyprus is that sometimes the service providers related to the establishment and operation of the companies in Cyprus do not take the changed requirements for the content of the company and the reality of its activities seriously. The few providers that claim or advertise these services are not actually offering the solutions that add value to their customers' businesses, but rather overpriced services that in no way mitigate the tax risks that the customers face. The result of such actions is not only the loss of the tax advantages, but also the loss of the business reputation of the companies and their owners.
Amazon Corporate&Immigration Services has significant experience in providing customized solutions for international clients setting up Cypriot businesses. We consider it our duty to inform all the clients of the importance of the economic content and all the risks associated with the establishing a legal structure designed to achieve the specific tax-related objectives.
Services provided by Corporate&Immigration Services
The list of our services related to ensuring that the client companies comply with the requirements for the management, control and economic content of the business include:
- Consulting on the compliance with the requirements for the maintenance of a Cyprus tax resident company.
- Management services.
- Office rent.
- Services for the employees.
- Business insurance.
- Insuring the availability of a telephone line and facsimile.
- Creation of a corporate website
- Placement of the shares of a Cypriot company on an alternative market.
- Creation of an independent IT environment.
With this in mind, Amazon Corporate & Immigration Services has developed a marketing proposal that simply outlines the many opportunities for creating “economic content” in Cyprus, which is the starting point for the many options open to the clients wishing to establish and maintain a strong presence in Cyprus.
It is clear that in the current environment, when the tax policy around the world is becoming more aggressive, it is prudent to defend against the problems by creating a structure only for obtaining the contractual benefits. One way to do this is to ensure that any holding or financial structure has as much economic substance as possible, for example, by providing the holding company with additional functions such as regional administrative and marketing headquarters.
In recent years a number of companies have not only strengthened their claims for Cyprus tax residency, but also gained operational and economic benefits by locating regional administrative offices and headquarters in Cyprus, taking advantage of Cyprus strategic position, EU membership, low costs and high quality of life. Amazon Corporate & Immigration Services is well placed to advise international groups on this matter and we are pleased to invite you to undertake an assessment of the existing structure of your Cyprus company without any additional commitment on your part.