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Cyprus commercial companies and the need for ‘substance’



There are many benefits for foreign investors using Cyprus to carry out commercial activities. A fully operational basis provides a more rational and beneficial solution than the traditional agency structure.

In the past, the use of Cyprus in commercial operations was mainly through agency structures, whereby the Cypriot company would basically subcontract its operations to another entity which, depending on the set-up was either the ‘main’ company of the group (the one actually carrying out the activities) or an entity based in an offshore jurisdiction.

However, thanks to a Corporation Tax rate of 10% and various other advantages that Cyprus has to offer, companies now have a first-class opportunity to work on a fully operational (or substantive) basis, thus avoiding any disputes as to the role of the company within a structure. Considering the ever-heavier fiscal requirements, including Controlled Foreign Companies (CFC) regulations worldwide, the fully operational basis is regarded as a more rational and beneficial solution than the agency structure.

In addition to the Corporation Tax rate, which is the lowest in the European Union and is a flat rate irrespective of type and level of income (this is not usually the case in other traditional financial centres), Cyprus offers the following main advantages to offer commercial companies:

  • its membership of the European Union which, in combination with its strategic geographical position, makes Cyprus a gateway to the booming manufacturing countries such as China and India via which they may enter the EU and vice versa for European and other countries to expand their operations to the Far East;
  • the absence of any Withholding Tax for payments of dividends to non-Cyprus residents, irrespective of the country in which the shareholder is based and irrespective of the legal form of that shareholder;
  • the island’s excellent telecommunications and other infrastructure which, together with the business-friendly time zone, eliminate the barrier of distance in carrying out commercial activities from Cyprus;
  • the country’s well-educated, skilled and multilingual workforce, which means that there is an abundance of talent available to service the needs of such structures;
  • the extensive network of double tax treaties that Cyprus has signed with countries from every part of the world with beneficial provisions relating not only to corporate but also to personal taxation;
  • the high quality of professional advisers which can provide a sound background of support services, such as banking, audit, and legal.

Thanks to these and many other advantages, operating through Cyprus and using appropriate tax planning/structuring to mitigate Cyprus tax (sometimes to effective levels well below 10%) is a far better strategy nowadays than trading through an offshore company registered in a tax haven.

Depending on its activities, a commercial company also needs to register for VAT. The VAT Authorities require supporting documentation indicating the trading nature of the company’s activities before proceeding with registration. Indeed, VAT may be another significant reason for including Cyprus in international business structures since it applies the lowest permissible standard VAT rate in the EU (15%).

Cyprus companies can be used for the invoicing/re-invoicing of goods and services (and for the receipt of trading commissions) from any country to any destination and for transit trade activities in combination with the operation of bonded warehouses, bonded factories and free trade zones.

Furthermore, Cyprus companies may provide services such as marketing, accounting, executive staff, consultancy, market research, commission agency services, intermediation, client introduction and many more. They may employ expatriate staff (relocated from the main company) who benefit from double tax treaty provisions by paying tax and social insurance at low rates in Cyprus and thus avoiding possibly far higher tax rates in their home country.

‘Substance’

Commercial companies present a peculiarity in terms of the quantity and extent of the resources required for carrying out their operations. This peculiarity is known as ‘substance’ and usually means that a company has:

  • its own employee/s (i.e. the company is registered with the Department of Social Insurance as an employer)
  • its own office space
  • a telephone and fax line
  • an e-mail address
  • a website

It should be stressed that whatever the qualifications of the employee/s, real work which adds value to the company must be performed from Cyprus. This also has the advantage of reducing some of the costs incurred elsewhere in the group since some of the work will be done in Cyprus.

A trading company which implements all or some of the above will not only enhance its ‘substance’ but will also strengthen its Cyprus tax residency claim beyond any doubt.

The establishment and maintenance of a substance structure will undoubtedly increase the overall cost of a Cyprus company but the resulting benefits far outstrip this extra burden. Furthermore, there are various ways in which the cost of the ‘substance’ factors outlined above can be kept at a minimum, including use of part-time employees, business centre facilities, etc.

Efforts currently being undertaken by all European and other countries against ‘virtual’ set-ups will make life for such arrangements (also known as ‘empty box’, ‘letterbox’, ‘registered office’, etc.) increasingly difficult.

In its ruling on the well-known Cadbury case (Cadbury Schweppes Plc and Cadbury Schweppes Overseas Ltd v Commissioners of Inland Revenue), the European Court of Justice decided that the application of UK’s Controlled Foreign Companies (CFC) legislation, which required the inclusion of profits of Irish subsidiaries of Cadbury Schweppes Plc to its taxable base in the UK, constituted a restriction on the freedom of establishment. The cornerstone of the decision was the fact that added-value work was being carried out by the company’s Irish subsidiaries. The Court further ruled that such a restriction is justified only in relation to ‘wholly artificial arrangements which do not reflect economic reality’. In defining such ‘artificial arrangements’, the Court pointed to a ‘letterbox’ or ‘front’ company as an example, and indicated that objective evidence about premises, staff and equipment should be requested in order for an arrangement to be justified as real or non-artificial.

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.


Fiducenter is an independent provider of corporate and domiciliation services, with Luxembourg origins and more than 30 years of existence. It has offices in Luxembourg (head office), Cyprus and a recently opened office in Singapore. Fiducenter offers corporate and fiduciary services, as well as tax, legal and financial advice and planning, asset management, accounting, tax and VAT registration and administration, business centre services and other.

For more information visit www.fiducenter.com.cy, or e-mail fiducenter@fiducenter.com.cy


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