5 Tax Planning Considerations 5.1 However, there are various tax considerations to be addressed in the light of the tax status of the CIT, and the benefits obtained under tax treaties, to the extent that the CIT can be an alternative option, or act in collaboration with the CRC, replacing or even competing with the CRC itself. Indeed, in which cases can the CIT act as an alternative to the CRC? Expanding this further, there is one main question: can the CIT be an alternative to the CRC for treaty shopping in respect of zero or reduced withholding taxes? Can the CIT be an alternative to the CRC for receiving income from the assets of a foreign permanent establishment? Can the CIT be an alternative option to the CRC in the case of dividend income? Can the CIT be an alternative option to the CRC in respect of interest payments or royalties? Each circumstance raised by each question will be examined consecutively.
5 Tax Planning Considerations
However, there are various tax considerations to be addressed in the light of the tax status of the CIT, and the benefits obtained under tax treaties, to the extent that the CIT can be an alternative option, or act in collaboration with the CRC, replacing or even competing with the CRC itself. Indeed, in which cases can the CIT act as an alternative to the CRC? Expanding this further, there is one main question: can the CIT be an alternative to the CRC for treaty shopping in respect of zero or reduced withholding taxes? Can the CIT be an alternative to the CRC for receiving income from the assets of a foreign permanent establishment? Can the CIT be an alternative option to the CRC in the case of dividend income? Can the CIT be an alternative option to the CRC in respect of interest payments or royalties? Each circumstance raised by each question will be examined consecutively.
5.2 CIT : Alternative Option
The interposition of a CIT with a CTC can be used in treaty shopping to the same extent as the CRC, as a conduit vehicle for enabling the investor to access a reduced withholding tax or nil withholding tax, especially for Eastern European investments.
For example, visualise the situation where a foreign company pays royalties to another foreign company where no tax treaty is involved. The withholding tax may well be high. If on the other hand the foreign country paying the dividends has concluded a tax treaty with Cyprus, pursuant to which the royalties are exempted from tax, then the interposition of a CIT will enable the royalties to be received free of withholding tax, assuming, of course, that there is no application of any anti-avoidance provisions in respect of beneficial ownership or Limitation on Benefits articles or any such applicability. Further, the distribution of royalties by the trust to the foreign recipient will be made with no withholding tax in Cyprus, so long as the intellectual property rights are granted for use outside Cyprus.
In respect of income from the assets of a foreign permanent establishment, the CIT can replace the CRC. Suppose the CRC has established a permanent establishment abroad, but the profits from such establishment are taxable at 10% on the worldwide income of the company because the requirements for the exception do not apply: the permanent establishment – directly or indirectly – engages in more than 50% in activities producing investment income, and the foreign tax burden is substantially lower than that in Cyprus.
Can the CIT be a substitute for the CRC when considering dividend income? In the case where the CRC has investments in foreign countries but its shareholding in each case is less than 1%, the foreign dividend income is taxable at 15% on the overall (including Special Defence Contribution), because the international participation exemption does not apply.
However, if the CIT owns the investment, the dividend income is not subject to any tax. Even though, in principle, the CIT could have been subject to the Special Defence Contribution because the international participation exemption does not apply, in practice the income tax authorities do not impose any Special Defence Contribution on the CIT so long as the beneficiaries are non-Cypriot residents because they consider the trust a see-through vehicle.
Active interest received by a CRC suffers income tax at 10% but not any Special Defence Contribution. However, in the case of a CIT, there is no income tax in respect of interest income. Consider now the scenario where the interest is passive, which will be subject to 10% income tax on 50% of the interest received, and 10% Special Defence Contribution on the whole amount of the interest, resulting in 15% tax overall. If the interest income is received by the international trust, then there will be no Special Defence Contribution and no income tax.
If we now consider that – instead of interest income, the CRC received royalty income, the profits of such income will be subject to 10% income tax in Cyprus. However, if the recipient is a CIT then no tax will be payable in Cyprus.
5.3 CIT : In Collaboration with CRC
In what circumstances may the CRC and CIT act in collaboration? In the most common structure, the CIT owns a CRC: the CIT has – as its principal function – the holding of shares in the operating CRC, and the CRC is the one which is responsible for making the investments, and which owns liquid funds and real estate.
This type of structure is highly recommended for a variety of reasons. The accounts of the CTC are not complicated, because the trustee of the trust has only one acquisition, being the shares of the CRC. The CRC, which is responsible for the investments, enjoys the benefits of the tax legislation: distribution of dividends, interest and royalties by the CRC to the trust are not taxable and will be made with 0% withholding tax.
Furthermore, the CRC can enjoy the benefit of the tax treaties or EU Directives as applicable, and obtain nil or reduced withholding taxes on incoming interest and dividends. This structure is commonly used for extracting royalties from affiliated licensing companies, where the royalty is free of withholding tax because of the EU Interest and Royalties Directive, provided, of course, that the Directive is applicable. However, it can also be used for extracting royalties from non-affiliated EU licensing companies, or from non-EU licensing companies, at a nil or reduced withholding tax pursuant to the Cyprus tax treaties. In any event, in such a case, the Cyprus company will receive the royalties from either an EU-affiliated licensee, or a non-EU licensee, and will retain a licence fee, for example – let us say – 5%, on which it has to pay 10% corporate income tax. The remaining 95% will be paid to the CIT where there will be no additional taxation. In general, any source tax withheld on the royalties received by the Cyprus company can be deducted from corporate income tax payable in Cyprus.
5.4 Tax Deferment
Is tax deferment possible with the use of the CIT? A discretionary CIT can indeed be used in tax deferment. Dependant on the tax regime applicable to each beneficiary, trust income may be subject to taxation only on the distribution of the income by the trustees. The income can be accumulated for the entire perpetuity period pursuant to s.6 of the International Trusts Law, permitting the extension of time and re-investment of the profits. In any event, the distribution of profits to foreign beneficiaries will be made with no tax, and the distribution will be made free of withholding tax. Alternatively, in tax deferment cases, the CIT can be used in collaboration with the CRC, so that the income of the CRC is retained by the company pending distribution to the CIT.