TaxLegi 29.2.2024

The European Union Emission Trading System (EU ETS) was established in 2005 as a cornerstone of the EU's policy to combat climate change and constitutes a central tool for the reduction of greenhouse gas emissions. Essentially, the ETS was a 'cap and trade' system, where a limit or cap is set on the total amount of certain greenhouse gases that can be emitted by sectors covered by the system, however, with recent developments many sectors will no longer have a cap on emissions making them liable for all their emissions.

In the challenging context of the Maritime arena, the EU ETS incorporates GHG emissions from passenger and cargo vessels over 5,000 Gross Tonnage (GT) from 2024 expanding the scope to also include offshore ships over 5,000 GT from 2027. The initiative follows the European Union’s commitment to achieving a 55% reduction in GHG emissions by 2030 as part of the fit for 55 initiative. Key to incorporating these new regulations effectively in Cyprus has been the work of the Department of Environment, which is coordinating the national implementation, using local legislation to embed the requirements for maritime sector compliance. 

However, a number of complexities arise in its implementation, such as determining the scope for the maritime sector which can be a challenging task. Defining which vessels and voyages fall under the scheme poses several questions. For example, a significant portion of global shipping operates under non-EU flags - how should one approach ships that sail under non-EU flags but operate in EU waters and vice versa? Naturally, the EU has addressed this issue by requiring any vessels falling within the scope and transiting through EU waters to account for their GHG emissions and apply the ETS for Maritime. However, vessels transitioning from international ports to EU ports are granted a 50% discount on their emissions. Does this provision imply that a vessel can reduce its emissions by 50% simply by sailing out of European waters, or will the vessels need to provide evidence of economic activity outside the EU? Moreover, could this allowance potentially open floodgates for malicious compliance?

Further complexities lie in the Monitoring, Reporting, and Verification (MRV) of emissions from ships. The MRV is inherently a challenging task due its mobile nature, especially when compared with static power plants or factories. Intensifying the issue, Statista estimates that there are around 58,000 merchant ships trading internationally[1], presenting significant logistic burdens for reporting frameworks.

Additionally, technological limits also compound difficulties. Unlike other sectors, maritime transport has fewer options for large-scale, cost-effective alternative propulsion technologies for greener transportation. For example, unlike vehicles, it is unlikely for vessels to be able to run on electricity or other renewable sources of energy as current technology cannot support the long distances travelled by vessels. Therefore, although the shipping industry has seen strong developments in greener ways of transportation at the moment they cannot run on net-zero carbon emissions, hence, costs from the ETS will exist.

Moreover, including shipping within the EU Emission Trading Scheme (ETS) could create potential competitive disadvantages. The cost of inclusion into the ETS could significantly increase for maritime companies, potentially leading to those costs being passed onto consumers. It’s clear that the primary competitive disadvantage will be for Europeans who would have to shoulder these additional costs. In addition to absorbing the extra costs, many vessels may need to evaluate their willingness to travel to EU destinations considering the additional administrative procedures and associated expenditures. This additional financial burden could likely result in a phenomenon known as "carbon leakage". This is a situation where businesses and operations are transferred to regions with less stringent carbon emission regulations in an attempt to minimise costs. This shift could also lead to a decreased supply of vessels within the EU, causing additional inflated prices.

Finally, subjecting the maritime sector to the EU ETS potentially unveils legal complexities since shipping is a global industry and any regional regulation could cause discordance with international maritime law and pose disagreements with non-EU countries, especially given that most agreements within the maritime industry are made outside the EU. This issue becomes even more pronounced for vessels owned by one party and operated by another. The EU ETS for Maritime, by default, mandates the vessel owner to record and account for their emissions allowances. However, when the owner is not the operator, this likely wouldn't be the case, necessitating further Mandate Agreements to be signed between the owners and operators.

In conclusion, the implementation of the EU ETS in the maritime industry indeed presents a host of complexities. However, it can't be refuted that it serves as a potent tool to drive emissions reductions towards a greener economy. Only through careful planning and execution, can we hope to mitigate the threat of climate change, securing a sustainable future for generations to come.

 

[1] Global merchant fleet - number of ships by type | Statista

 

By:

Anthony Charalambous, Assistant, Indirect Tax | EY Cyprus

• The Cyprus Tax Department has increased the thresholds applicable to taxpayers' transfer pricing documentation obligations.
• The higher thresholds are effective for tax year 2022.

Executive summary
On 1 February 2024, the Tax Department issued revised thresholds relating to taxpayers’ obligation to prepare a Cyprus Local File for transactions falling within the ambit of Section 33 of the Income Tax Law (ITL) (i.e., intercompany transactions). The revised thresholds are applicable for the tax year 2022.

Detailed discussion

In accordance with the provisions of the ITL, the Cyprus Local File obligation arises for connected persons that are tax residents in Cyprus, or permanent establishments in Cyprus of non-tax-resident persons (Liable Taxpayers) if their transactions with connected persons either exceed (or should have exceeded based on the arm’s-length principle) €750k in aggregate per category of transaction per tax year.

As a result of the discussions that took place with interested parties, including the Ministry of Finance, it was agreed to increase the above-mentioned thresholds as follows:

• From €750k to €5m for connected transactions falling under the category “Financing".
• From €750k to €1m for all other categories of connected transactions (i.e., “Goods,” “Services,” “Royalties and Other Intangibles” and “Other”).

The increase of the threshold is effective for the tax year 2022 and the relevant amendment of the ITL is expected to be completed at a later date.

It should be noted that the provisions of Circular 6/2023 regarding the application of simplification measures for taxpayers that are exempt from the requirement to prepare Cyprus Local File continue to apply. (For background, see EY Global Tax Alert, Cyprus tax authorities issue transfer pricing simplification measures, dated 12 July 2023.)

 

For additional information, please contact:

Charalambos Palaontas

Partner | Transfer Pricing Services

Phone: +357 25 209 709 Charalambos.Palaontas@cy.ey.com

As per our previous publications and alerts, we had the opportunity to communicate a significant development - the introduction of BEPS 2.0 Pillar Two or Global Minimum Tax. The European Union unanimously adopted a directive in December 2022 (the ''Minimum Tax Directive'').

Currently, the tax community is focusing on Pillar Two and it is on top of the agenda and minds of tax directors, advisors and tax authorities as they discuss and elaborate on the technicalities.

Even though Cyprus has not yet transposed the rules into the domestic legislation, it is expected to enact the new legislation in the next couple of weeks with a retroactive effect as of 31 December 2023.

The elements of Pillar Two rules
The Minimum Tax Directive provides a common framework for Member States to implement the Global Anti-Base Erosion (GloBE) Model Rules into their national laws, as agreed by the OECD/G20 as part of BEPS 2.0 project ''Addressing the Tax Challenges of the Digitalisation of the Economy''.

In principle, the Pillar Two rules provide a coordinated system of interlocking rules which are designed to ensure that large multinational and domestic groups pay at least 15% effective minimum tax in every jurisdiction in which they operate.

Such interlocking rules include:

1. the Income Inclusion Rule (IIR),
2. a Qualified Domestic Minimum top up tax (QDMTT) as well as
3. the Undertaxed Profits Rule (UTPR)

Since December 2022, the OECD/G20 Inclusive Framework (IF) on BEPS has released a series of documents in the form of administrative guidance that focus on clarifying the Pillar Two rules. What is relevant to note is that in November 2023, the EU Council issued a statement effectively adopting the administrative guidance issued by the Inclusive Framework in December 2022, February 2023, and July 2023, including the Safe Harbours, confirming that such guidance is compatible with the Minimum Tax Directive. The Council also reiterated the need for Member States to remain consistent with the afore-mentioned guidance when transposing the Minimum Tax Directive.

Challenges faced by MNE groups and large-scale domestic groups
Quoting from the preamble of the Directive, ''For an efficient application of the system, it is crucial that procedures are coordinated at a group level. It will be necessary to operate a system ensuring the unobstructed flow of information within the MNE group and towards tax administrations where constituent entities are located.''

The effectiveness and fairness of the global minimum tax reform heavily relies on its worldwide implementation and the compliance of multinationals with their relevant obligations. However, outside of the EU, Pillar Two is not mandatory but rather takes the form of an optional common approach. It is interesting to note that besides the adoption of Pillar Two in the EU, there is little to no activity in Africa and Americas. For example, the US is yet to introduce Pillar Two. In addition, in Asia-Pacific, there is a first implementation wave of jurisdictions adopting Pillar Two rules but with different policy decisions (e.g., some countries, such as Japan, are only adopting IIR). Moreover, there are certain countries that decided to postpone the implementation to 2025. Finally, Switzerland has decided to adopt only QDMTT for the time being. Inevitably, the inconsistent adoption of the rules increases complexity and makes tax compliance harder.

Apart from the tax challenges faced by multinational enterprises (MNEs) and large-scale domestic groups in light of the staggered implementation and the need to monitor the Pillar Two developments in relevant jurisdictions (as mentioned in the previous paragraph), in-scope groups are also required to deal with the administrative aspects associated with the application of the rules and their design.

Pillar Two involves a sequence of reporting procedures such as:

• Multi-year forecasting to support financial planning and analysis (FP&A) and budgeting (i.e., forecasted cash tax and effective tax rate (ETR) impacts of the new minimum taxes)
• Estimated annual ETR
• Minimum tax estimated payments to the various jurisdictions
• Year-end tax provisions
• Country-by-country reporting
• Minimum tax information reporting and tax compliance filings

Technology is a key enabler for Pillar Two readiness
Technology is a key enabler that can empower MNEs and large-scale domestic groups to address the data challenges posed by BEPS 2.0 Pillar Two.

No doubt that in-scope groups are required to navigate through the complexities of Pillar Two heavy compliance and reporting demands. Impacted multinationals are making a coordinated enterprise-wide effort to holistically address the Pillar Two compliance requirements by increasing the capacity of their tax function and by redesigning their IT systems in such a way that enables them to respond to the data challenges posed by Pillar Two through automated processes.

The new approach of data gathering and processing is a matter of business strategy concerning C-suite leadership as the digitization and automation play crucial role as compliance with Pillar Two through manual massive-in-size data gathering, consolidation and reconciliation would be extremely complex and could include data gaps which could give rise to penalties and tax leakages.

Even though structured data can be extracted from established accounting or enterprise resource planning systems, such information is sourced from different datasets such as business unit forecasts, legal entity forecasts, and actual full-year financial results. Challenges arise in evaluating the availability, quality, completeness and accuracy of such data and in organizing such in a headquarters-driven project through solutions which consolidate the data into an overall system that is appropriately designed to respond to the rules of Pillar Two. The solutions should enable the users in interpreting the information and exposures, take informed decisions in tackling those and ultimately enable the tax provisioning and administration.

In-scope groups are recognizing the need to evaluate the data analytic requirements of Pillar Two and consider leveraging their existing systems or design new data collection and processing systems which can respond adequately to the new reality. The deployment and testing of solutions and their implementation can either be undertaken in-house or be outsourced to service providers, so that the solution can effectively and efficiently extract data and align such with the relevant computations and develop relevant analytics.
What’s more to data processing and tax provisions is that a crucial opportunity is presented to MNEs and large-scale domestic groups to showcase the value of data collected to influence strategic decisions and shape their corporate strategy using, for example, valued data for other strategic decisions related to environmental, social and governance or sustainability reporting (ESG).

EY Globe Engine (Saas)

EY has a long and strong experience with software as a service (‘SaaS’) solutions for our clients. Examples of such solutions include:

• FIRST, our AEOI (Automatic Exchange of Information) reporting solution
• MDR (Mandatory Disclosure Rules) Web
• GVRT (Global VAT Reporting Tool)

EY, having performed several Pillar Two impact assessments assisting our clients with understanding the impact of Pillar Two as well as their readiness to comply with the new regime, has further developed the EY GloBE Engine for Pillar Two compliance. The EY GloBE Engine is web-based solution that enables companies to perform the calculations necessary (including transitional safe harbor analysis), to support provisions in their accounts and generate their GloBE information returns.

The GloBE solution is scalable and customisable to be adapted to our clients’ operating model needs. The output of our solution can be fed into existing processes and software solutions while Application Programming Interface (API) capabilities can be offered as a customisation item. The GloBE Engine solution provides comprehensive support from data collection, reporting and tax filing, to tax provisions and compliance support.

 

By:

Eleni Papachristodoulou

Director, International Tax and Transaction Services

Eleni.Papachristodoulou@cy.ey.com

 

Elena Christodoulou

Assistant Manager, International Tax and Transaction Services

Elena.Christodoulou1@cy.ey.com