Even though ‘substance’ is a widely known tax concept which is a key consideration in international structures and tax planning, it does not have a specific meaning. Substance is usually considered together with the tax residency. The typical definition of an entity having economic Substance is that a transaction or entity located in low tax jurisdiction (like Cyprus) must have an economic purpose and relevant infrastructure besides being created ‘artificially’ and only for the purpose of reducing tax liability.
Since the Organisation for Economic Co-operation and Development (OECD) presented its action plan on base erosion and profit shifting (BEPS), the importance of substance has significantly increased. The ultimate goal of the BEPS initiative is to prevent the granting of double tax treaty benefits where international corporate structures are set up for the sole purpose of accessing those benefits.
If a structure is found to lack substance, an organisation could face a considerably higher effective tax burden as well as investigation by the tax authorities.
Reasons for establishing substance in Cyprus
Cyprus’ strategic location, EU membership, developed legal system, competitive corporate tax rate of 12.5%, personal tax incentives, well-educated local workforce and business-friendly environment make Cyprus an ideal country for this purpose.
Under the Cyprus tax legislation a company is a tax resident in Cyprus if it is managed and controlled from Cyprus.
In addition, taking the above and other measures in Cyprus can mitigate other tax risks such as potential challenges on beneficial ownership and transfer pricing, as well as controlled foreign company (“CFC”) rules.
Cyprus substance rules
Although economic substance is not defined, the key steps a company in Cyprus may take to establish or enhance its substance status in its jurisdiction of establishment are the following:
- the company is incorporated in Cyprus
- it should be considered whether the company is tax residence only in Cyprus
- the majority of the board directors are residents in Cyprus
- the majority of the board of directors meetings take place in Cyprus
- the board of directors exercise control and make key management and commercial decisions necessary for the company’s operations and general policies
- the board of directors’ meetings are prepared and kept in Cyprus
- the corporate seal and all statutory books and records are maintained in Cyprus
- the corporate filing and reporting functions performed by representatives are located in Cyprus
- agreements relating to the company’s business or assets are executed and/or signed in Cyprus
- the meetings of the shareholders of the company take place in Cyprus
- Moreover it should be considered whether : a)The company issued power of attorney, b)the due tax returns were filed, c) the self-assessments for the tax years that are due have been paid
However, these Cyprus substance requirements may not be decisive.
The global trend as regards commercial companies, involving the establishment of a fully operational commercial set-up with offices, staff and qualified managers doing real work clearly seems to be gaining ground in Cyprus too.