TaxLegi 31.01.2022

Executive summary On 9 December 2021, the Cypriot House of Representatives approved the longawaited bills amending the Income Tax Law as well as the Special Contribution for the Defense of the Republic Law with respect to the definition of corporate tax residency and the imposition of withholding tax on outbound payments of dividends, interest and royalties made to companies resident or registered in jurisdictions included in the EU list of non-cooperative jurisdictions on tax matters (Annex I) (the so-called EU Blacklist, referred to as the EU List). The relevant laws implementing the new provisions were published in the Official Gazette of the Republic on 21 December 2021 and will be effective as of 31 December 2022. This Alert summarizes the new provisions. Detailed discussion Amendment to the definition of corporate tax residency Currently, the definition of corporate tax residency is solely based on the management and control criterion. As of 31 December 2022, the definition of corporate tax residency is expanded to additionally include the incorporation test. More specifically, a company which is incorporated or registered in Cyprus, and its management and control is exercised outside Cyprus, should be considered a resident of Cyprus for tax purposes unless it is a tax resident in another country. Introduction of withholding tax on outbound payments to EU listed companies Withholding tax on dividend payments Dividends paid by a Cypriot tax resident company to a company which is a resident in a jurisdiction that is included on the EU List, or to a company incorporated or registered in a jurisdiction included on the EU List and not considered to be tax resident in another jurisdiction which is not included on the EU List, will be subject to 17% withholding tax on the amount of the dividend paid. The withholding tax applies where the company receiving the dividend is included on the EU List and such company participates directly in the Cypriot company paying the dividend by more than 50% in voting rights or owns more than 50% of the share capital or is entitled to 50% or more of the profits of the Cypriot company. In addition, withholding tax shall apply in the case where two or more associated enterprises, which are included on the EU List, participate directly in the Cypriot company paying the dividend and collectively have more than 50% in voting rights or own more than 50% of the share capital or are entitled to 50% or more of the profits of the Cypriot company. No withholding tax will be imposed on dividends paid in relation to securities listed on a recognized stock exchange. Change in the deemed dividend distribution rules Under certain conditions, a nonresident person may be entitled to a refund of tax withheld under the so-called deemed dividend distribution rules. As per the amended law, any tax so withheld should not be refunded if the recipient of the dividend is a company included on the EU List. Withholding tax on interest payments Withholding tax at the rate of 30% will be imposed on interest received by or credited to a company which is resident in a jurisdiction included on the EU List, or to a company which is incorporated or registered in a jurisdiction included on the EU List and is not resident in another jurisdiction that is not included on the EU List, if the interest is derived from sources within Cyprus. However, no withholding tax shall apply on any interest payments made by an individual. Further, no withholding tax will be imposed on interest received by or credited to a non-Cypriot tax resident company which relates to securities listed on a recognized stock exchange. Withholding tax on royalty payments Royalties paid to a company which is not a tax resident of Cyprus and is a tax resident in a jurisdiction included on the EU List, or to a company which is incorporated or registered in a jurisdiction included on the EU List and is not resident in another jurisdiction that is not included on the EU List, will be subject to 10% withholding tax. However, no withholding tax shall apply on any royalty payments made by an individual.

Registration - EY - Cyprus (pleyground.eu)

Contacts:

• Philippos Raptopoulos - Head of Tax & Legal Services
• Petros Krasaris - International Tax and Transaction Services
• Petros Liassides - Direct Tax Services
• Eleni Papachristodoulou - International Tax and Transaction Services

Executive summary

Cyprus’ Double Tax Treaty network has been further expanded with a new tax treaty concluded with Jordan. The Treaty between Cyprus and Jordan was signed on 17 December 2021. Cyprus’ internal ratification process has been finalized. As such, the Treaty will enter into force upon its ratification by Jordan and once the two countries exchange ratification instruments.

In addition, protocols for amending the existing tax treaties with Switzerland and Germany are also now effective.

This Alert summarizes the key provisions of the new tax treaty and the amending protocols.

Detailed discussion

Treaty with Jordan

Withholding taxes on dividends, interest and royalties

The Treaty with Jordan (the Treaty) provides for a 5% withholding tax on dividends if the beneficial owner of such dividend is a company (other than a partnership) which holds directly at least 10% of the capital of the company paying the dividends. In all other cases, the withholding tax rate is 10% of the gross amount of the dividends paid, assuming the recipient is the beneficial owner of the dividends.

Moreover, the Treaty provides for a 5% withholding tax on the gross amount of interest paid provided that the recipient is the beneficial owner of such income. However, if the beneficial owner of the interest income is the government, political sub-division, local authority or the National Bank of the other Contracting State, such interest shall be exempt from withholding tax.

In addition, the Treaty provides for a 7% withholding tax on the gross amount of royalties or fees for technical services (as defined in the Treaty) provided that the recipient is the beneficial owner of such income.

Capital gains tax

In general, capital gains are taxable only in the Contracting State in which the alienator is resident, except for gains relating to immovable property and gains from the alienation of movable property of a permanent establishment for which the source jurisdiction maintains taxation rights. However, capital gains arising to a resident of a Contracting State from the sale of shares in real estate rich companies deriving more than 50% of their value directly from immovable property may also be taxed in the source state. This provision applies only to gains which are attributable to the immovable property. Moreover, this provision does not apply to the sale of shares listed on an approved stock exchange.

Other key treaty provisions

Contrary to the 2017 Organisation for Economic Co-operation and Development (OECD) Model Convention, the Treaty incudes an article on Independent Personal Services in a similar wording as it existed before its elimination in 2000.

The Treaty also includes an article on taxation of activities in the exclusive economic zone or on the continental shelf in connection with the exploration or exploitation of the seabed or subsoil or their natural resources which overrides any other provisions of the Treaty.

Article 29 of the Treaty includes a principal purpose test whereby a benefit under the Treaty shall not be granted in respect of an item of income or capital if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established that granting that benefit in these circumstances would be in accordance with the objective and purpose of the relevant provisions of the Treaty.

As noted, the Treaty was signed on 17 December 2021. Cyprus’ internal ratification process has been finalized. As such, the Treaty will enter into force upon its ratification by Jordan and once the two countries exchange ratification instruments. Once it enters into force, it will be effective as follows:

• With regard to taxes withheld at source, in respect of amounts paid or credited on or after the first day of January next following the date upon which the Treaty enters into force.
• With regard to other taxes, in respect of taxable years beginning on or after the first day of January next following the date upon which the Treaty enters into force.

Protocols to existing treaties

Protocol to the treaty with Germany

The protocol to the treaty with Germany, among others, introduces the minimum standards of the OECD’s Base Erosion and Profit Shifting (BEPS) actions. It is worth mentioning that the 2011 treaty with Germany was not listed as an agreement covered by the multilateral convention (MLI) upon the deposit of the instrument on 23 January 2020.

The protocol amends the preamble of the Treaty to specify that the treaty’s intention is to eliminate double taxation with respect to taxes covered by the treaty, without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance (including through treaty-shopping arrangements aimed at obtaining reliefs provided in the treaty for the indirect benefit of residents of third states).

The protocol also introduces specific wording to Article 7 of the treaty, Business Profits, with particular emphasis on elimination of double taxation resulting from adjustments on profits of a permanent establishment made by one of the Contracting States. It also introduces the possibility of the two Contracting States resolving the issue of double taxation by mutual agreement.

Moreover, the protocol revises the provisions of Article 27 of the treaty, Application of the Agreement in Special Cases, and provides that notwithstanding the other provisions of the treaty, no benefit shall be granted in respect of an item of income or capital if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established that granting the benefit in such circumstances would be in accordance with the object and purpose of the provisions of the treaty.

The Protocol between Cyprus and Germany is effective as from 1 January 2022 for both countries.

Protocol to the treaty with Switzerland

The protocol, among others, introduces the minimum standards of the OECD BEPS actions. It is worth mentioning that the 2014 treaty with Switzerland was not listed as an agreement covered by the MLI upon the deposit of the instrument on 23 January 2020.

The protocol amends the preamble of the treaty to specify that the treaty’s intention is to eliminate double taxation with respect to taxes on income and on capital, without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance (including through treaty-shopping arrangements aimed at obtaining reliefs provided in the treaty for the indirect benefit of residents of third states).

The protocol also revises the provisions of Article 7 of the treaty, Business Profits, to introduce a six-year limitation in relation to the right to make an adjustment to the profits attributable to a permanent establishment made by one of the Contracting States. However, this provision does not apply in the case of fraud, gross negligence, or willful default.

Moreover, Article 9 of the treaty, Associated Enterprises, has been amended to require the other Contracting State to make an appropriate adjustment to the adjustment made by the first Contracting State. Previously, the other Contracting State was required to make such adjustment only if it agreed that the adjustment made by the first Contracting State was justified both in principle and as regards the amount. The right to make an adjustment is subject to a six-year limitation unless there is fraud, gross negligence of willful default.

In addition, the protocol revises Article 26 of the treaty, Mutual Agreement Procedure, and provides that where a person considers the actions of one or both of the Contracting States result or will result in taxation not in accordance with the provisions of the treaty, such person may, irrespective of the remedies provided by the domestic law of those states, present his case to the competent authority of either Contracting State.

The protocol further introduces Article 28A to the treaty, Entitlement to Benefits, and provides that, notwithstanding the other provisions of the treaty, no benefit shall be granted in respect of an item of income or capital if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established that granting the benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of the treaty.

The protocol between Cyprus and Switzerland is effective as from 1 January 2022 for both countries. The amendments resulting from Articles II (Business Profits), III (Associated Enterprises) and IV (Mutual Agreement Procedure) of the protocol apply from 3 November 2021, without regard to the taxable period to which the matter relates.

Other developments

Cyprus is currently in the process of negotiating new treaties with Oman, Hong Kong, Vietnam, Sri Lanka, and Pakistan while the treaties with Poland and France are under renegotiation.

Cyprus expands treaty network as of 1 January 2022 (ey.com)

Contacts:

• Petros Krasaris
• Eleni Papachristodoulou

Contacts:

• Petros Liassides
  
• Myria Saparilla
  
• Herodotos Hadjipavlou

The Minister of Finance, exercising the powers conferred to him by the provisions of Article 4 (1) of the Single Public Default Rate Laws of 2006 and 2012, issued a decree, which was published on 31st of December 2021 in the Official Gazette of the Republic (Decision No. 5646 - K.Δ.Π. 552 / 2021), which sets the interest rate for late payments at 1.75%, similar to the year 2021. Such decree is applicable as of 1 January 2022.

Our team remains at your disposal for any information and/or clarifications required.

Registration - EY - Cyprus (pleyground.eu)

Contacts:

• Petros Liassides - Partner, Direct Tax
• Myria Saparilla - Associate Partner, Direct Tax
  
• Michalis Karatzis - Senior Manager, Direct Tax
• Panayiotis Gregoriou - Senior Manager, Direct Tax

By Pantelis Pavlou – Director and a member of the Central, Eastern and South-eastern Europe & Central Asia (CESA) IFRS team at EY¹

This is the question that the International Accounting Standards Board (IASB) asks when it publishes a Post Implementation Review (PIR) of an International Financial Reporting Standard (IFRS). The PIR is part of the IASB’s due process, where the Board gets the views of its constituents on newly implemented standards, normally after three years of their initial application, and assesses whether standard setting activities are necessary.

For IFRS 9 – Financial Instruments, the IASB decided to launch the PIR in phases. In September 2021, it published the part on the classification and measurement. In a paper titled: “Request for Information”, the standard setter introduced different topics and asked several questions to the public². Off course, views and comments can also cover topics other than the ones mentioned by the IASB.

Classification and measurement

Before discussing the points in the PIR, it is worth summarising the classification and measurement principles of IFRS 9. The standard introduced some changes in accounting for financial instruments in 2018, however key fundamentals, in the scope of this PIR, remained unchanged.

In short, financial assets are measured either at amortised cost or at fair value. This depends on two conditions: i) on the characteristics of the contractual cash flows and ii) on the business model in which the financial assets are held.

Financial assets are measured at amortised cost, if both criteria are met: (i) their contractual cash flows represent solely the payment of principal and interest (the so called SPPI) and (ii) they are held in a “hold to collect the contractual cash flows” business model.

In case that the financial assets are held in a “hold to collect or sell” business model, then they are measured using current values (i.e., fair value) with the changes in fair value being recorded in the Other Comprehensive Income.

Financial assets held in other business models, or whose contractual cash flows do not meet the SPPI criterion, are measured at fair value with the changes to their fair value reflected directly in profit or loss. One exception to this rule applies to investment in equity instruments not held for trading, for which an entity could make an irrevocable election to account for them at fair value through Other Comprehensive Income, but any gains/losses (including impairment losses) will not subsequently pass-through profit or loss, not even upon derecognition (no recycling). This option is available on an instrument-by-instrument basis.

Re financial liabilities, IFRS 9 mainly rolled over the requirements of IAS 39 with the only exception being the accounting for the fair value changes due to own credit risk. To eliminate the counterintuitive impact, IFRS 9 requires that these changes are recorded in Other Comprehensive Income rather than in profit or loss.

Topics in the PIR that require attention

Overall, constituents feel that the classification and measurement requirements of IFRS 9 work well and as intended by the Board. There are, though, some areas that have been flagged for further attention, of these I would highlight: financial assets with Environment, Social or Governance (ESG) targets, derecognition of financial assets, accounting for equity instruments, and clarification around some aspects of the business model.

The IASB is expected to issue a PIR on the subsequent measurement (including impairment) of financial instruments and one on hedge accounting later in 2022. Any themes linked to these areas are not discussed in this article.

Financial Assets with Environmental, Social and Governance targets

Due to, among others, changes in society, expectations of investors, regulatory pressure, we see that ESG targets are now more frequently attached to loans, credits, and other financing arrangements. Sometimes they are called as “ESG loans”. Simply speaking, these loans include terms that trigger a variability to the interest rates or other changes to the contractual cash flows, which cannot always be traced back to the basic lending arrangements (as required by IFRS 9 which would enable the financial asset to meet the conditions for the SPPI). Unless the variability could be directly linked to credit risk or it is not significant (de minimis), the financial assets would, most likely, fail the SPPI test and therefore they should be accounted at fair value through profit or loss. An outcome that is not attractive for the holder of the financial asset, which could result in a decrease of the market share of such loans.

Accounting considerations should not prevent genuine business and policy decisions and rationale; therefore, this issue needs to be immediately addressed. The IASB is seeking as much input on this topic as it can get, therefore, I would urge all who have interest on this topic to provide their thoughts with the Board.  EY, as other interested parties, will provide comments and insights via its comment letter on the PIR.

The European Financial Reporting Advisory Group (EFRAG) also drafted its comment letter³ aiming at consolidating some of the prominent European views. The Europe Union, being the front-runner in the Environmental policy, has an increasing interest on the discussions around this topic.

Derecognition of financial assets

Currently there is an asymmetry on the clarity around the principles for derecognition of financial assets on one hand and financial liabilities on the other hand. The latter is clearer resulting to more consistency in practice.

The principles of IFRS 9 on the derecognition of financial assets remain at a high level, allowing room for interpretation. This has led to some divergence in practice, especially among financial institutions. Each institution, developed its derecognition policy that applies to all financial assets, including instances of loan modifications. The accounting consequences of the dividing line between modification and derecognition are quite material, resulting, sometimes, to impaired comparability. The European prudential supervisors of financial institutions flagged this point in their recent reports, where they mentioned their intentions to raise it to the IASB in the context of this PIR.

It is important to note that clarity on this point would also impact the subsequent measurement, which as stated above will be dealt in a different consultation, and this is one of the reasons that some constituents, while they understand the reasons that the IASB opted for a phased approach, are calling for an additional comprehensive review of the whole standard. By this, they argue, the risk that issues remain unattended because they “fall between the cracks” decreases.

Accounting for equity instruments

This was heavily debated in 2017, when the EU endorsement of the new standard was a hot topic. IFRS 9, introduced changes, compared to its predecessor (IAS 39) with regards to accounting for investments in equity instruments. The most notably change was the fair value through other comprehensive income irrevocable option (as briefly explained above). Despite that the experience over the past few years with IFRS 9 has shown little evidence that a revision is needed, some vocal opposition exists on the fact that profit or loss will not depict the cumulative gains or losses upon derecognition (mainly concentrated in certain industries).

Another issue around this topic that has been raised by different constituents (including a question from EFRAG) is whether “investment in equity instruments” is too narrowly defined. On one hand, the term “equity instrument” is clearly defined in the literature, but on the other hand, there are some “equity like” instruments, that even though they do not meet the strict definition of equity, they respond to movements in market variables in a similar way. Some are contemplating the idea to consider extending the scope of this irrevocable election to include equity-like instruments, for example units of funds and puttable instruments that invest in equity instruments, associated derivatives, and necessary cash holdings.

Clarifications to eliminate divergence

Finally, a few clarifications in the standard would achieve more convergence in practice. While acknowledging and appreciating the fact that IFRS are principle based, several areas remain widely interpretable. For example, IFRS 9 does not have strict rules on assessing the business model of an entity. It also states that infrequent and insignificant sales from a portfolio held in a model “hold to collect”, would not raise questions on the business model. However, IFRS 9 does not define key terms like “infrequent” and “insignificant”. This has led to different application across entities. Addressing these issues, the IASB will do a great service to all involved in the financial reporting chain, including preparers, auditors, users, and supervisors.

Concluding this article, I reiterate the overall conclusion, that despite some drawbacks and areas of improvement, the classification and measurement part of IFRS 9 works as intended by the Board. Based on the overall feedback from comment letters, the Board should consider some limited scope improvements addressing the concerns on the areas mentioned above.

Accounting for financial instruments is, indeed, a complex topic. At EY, we are committed to maintaining a leading-edge understanding of the changes that may affect the business environment. Our tool, EY Atlas Client Edition⁴ is available for free to everyone and offers access to EY interpretations and thought leadership content.

Connect with the author via LI: www.linkedin.com/in/ppantelis

1. The views expressed in this article represent the personal opinions of the author and not necessarily the official position of EY
2. IFRS - Request for Information and comment letters: Post-implementation Review of IFRS 9—Classification and Measurement
3. IFRS 9 Financial Instruments - Post Implementation Review - EFRAG

The Ministry of Finance, through the Tax Department, issued Interpretive Circular no. 57 (“Circular”), on 29 November 2021, which refers to the tax treatment for companies whose financial year ends on a date other than the 31st of December.

Specifically, the Circular makes reference to the provisions of article 7 of the Income Tax Law and clarifies that in those instances where the financial year does not end on the 31st of December, the taxable profit will be allocated to the respective tax years on a monthly pro-rata basis.

For example:

• If the financial year ends on the 31st of march, then the taxable profits for the tax year 2021 will comprise of 3/12 of the taxable profits deriving from the financial year ending 31/3/2021 and 9/12 of the taxable profits deriving from the financial year ending 31/3/2022.
• If the financial year ends on the 30st of September, then the taxable profits for the tax year 2021 will comprise of the 9/12 of the taxable profits deriving from the financial year ending 30/09/21 and 3/12 of the taxable profits deriving from the financial year ending 30/9/2022.

In addition, the Circular indicates that for all cases, regardless of the financial year end of each company, the tax year is the year from 1st of January to 31st of December. Furthermore, the deadline for the payment by self-assessment of the final income tax liability is the 1st of August of the next year, and the deadlines for the payment of the provisional tax instalments are 31st of July and 31st of December of each respective year.

For the purpose of paying the final income tax liability through self-assessment or paying the provisional tax instalments, the determination of the taxable profit will be performed via the monthly pro-rata basis as explained above.

Contrary to tax circular 1989/19 which is revoked, Interpretive Circular no. 57 does not provide for any extension to the filing deadline of the annual Income Tax Return in case the financial reporting year does not coincide with the tax year.

EY Cyprus is at your disposal for any information and/or clarifications required.

Contacts:

• Petros Liassides - Partner, Direct Tax
• Myria Saparilla - Associate Partner, Direct Tax
  
• Michalis Karatzis - Senior Manager, Direct Tax

Further to our previously issued Tax Alert in relation to the new forms for SDC and GHS withheld on interest (tax form T.D. 602) and dividend payments (tax form T.D. 603), we would like to inform you that on 26 January 2022, the Tax Department announced that the submission deadline of tax forms T.D. 602 and T.D. 603 relating to the period January 2019 to December 2021 is extended from 31 January 2022 to 31 March 2022.

Contacts:

• Despo Kyrmitsi

The Ministry of Finance, through written communication with the Cypriot Institute of Certified Public Accountants (“ICPAC”), clarified the tax treatment of the subsidised interest rates for new business loans due to COVID19.

More specifically, the communication indicates that the subsidy should decrease the amount of interest expense claimed as deductible for Income Tax purposes to reflect the actual expense suffered by the taxpayer.

EY Cyprus is at your disposal for any information and/or clarifications required.

Contacts:

• M Petros Liassides - Partner, Direct Tax
• Myria Saparilla - Associate Partner, Direct Tax
  
• Michalis Karatzis - Senior Manager, Direct Tax
  
• Herodotos Hadjipavlou - Manager, Direct Tax