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  • Tax Newsletter - September 2020 - EU Anti-Tax Avoidance Directive (ATAD I And ATAD II)

Tax Newsletter - September 2020 - EU Anti-Tax Avoidance Directive (ATAD I And ATAD II)

16 September 2020

On 19th of June 2020, the Cyprus House of Representatives voted into Law the provisions of the EU Anti-Tax Avoidance Directive (ATAD EU 2016/1164) in respect to exit taxation and hybrid mismatches rules.

Exit Taxation - Applied retrospectively as of 1st January 2020

A transfer of an asset by a Cyprus company or a Cyprus permanent establishment of a non Cyprus company shall be treated for tax purposes as a disposal and taxed accordingly assuming a disposal value equal to the current market value of the transferred asset. The following transfers are subject to exit tax:

1. Transfer of assets from its Cyprus head office to a permanent establishment (PE) in another Member State or in a third country in so far Cyprus no longer has the right to tax the transferred assets due to the transfer;

2. Transfers assets from a Cyprus PE to a foreign PE or to its head office abroad in so far as Cyprus no longer has the right to tax the transferred assets due to the transfer;

3. A Cyprus tax resident company transfers its tax residence outside Cyprus, except for any assets which remain connected with a PE that remains in Cyprus;

4. A Cyprus PE transfers its business to another country where Cyprus no longer has the right to tax the transferred assets due to the transfer.

The exit taxation provisions are not applicable in the case of assets which are expected to return in Cyprus within a period of 12 months provided these assets relate to the financing of securities, assets provided as collateral or when the transfer of assets is made to meet capital requirements or for the purposes of liquidity management.

A taxpayer has the right to defer the payment of an exit tax by paying it in instalments over five years (subject to certain conditions).

Hybrid Mismatches - Applied retrospectively as of 1st January 2020

Hybrid mismatch arrangements are those arrangements which create differences between the tax treatment of an item in two countries. These rules are typically limited to mismatches being created as a result of hybridity and therefore should not impact the allocation of taxing rights under double tax treaties.

Hybrid mismatches are triggered when they arise between associated enterprises, between a taxpayer and associated enterprise, between a Head Office and its foreign PE, between two or more PEs of the same company or under a structured arrangement involving a hybrid mismatch, where the mismatch is priced into the terms of the arrangement or an arrangement that has been designed to produce a hybrid mismatch.

The hybrid rules address the following consequences of hybrid mismatches:

  • Double Deduction (DD):

DD is defined as the hybrid mismatch which leads to a deduction of the same payment, expenses or losses in one jurisdiction and in another jurisdiction in which the payment has its source, the expenses are incurred, or the losses are suffered.

To the extent that a hybrid mismatch results in a double deduction, the deduction shall be given only in the Member State where such payment has its source.

  • Deduction Without Inclusion (DWI):

DWI is defined as the hybrid mismatch which leads to the deduction of a payment between the head office and the PE or between two or more PEs in any country in which that payment is made without a corresponding inclusion for tax purposes of that payment or deemed payment in the payee jurisdiction.

To the extent that a hybrid mismatch results in a deduction without inclusion, Cyprus shall deny the deduction of such payment and where a resident of Cyprus is the recipient of the payment Cyprus will tax the payment.

Under the Law, the hybrid mismatch rules apply to both Cypriot tax resident companies and foreign companies with a PE in Cyprus and covers the following hybrid mismatch arrangements:

  1. Hybrid Financial Instrument Mismatches

Situations where the qualification (categorisation) of a financial instrument or the payment made under it differs between two jurisdictions (e.g. the instrument is considered as debt in the payer jurisdiction and as equity in the payee jurisdiction)

  1. Hybrid Entity Mismatch

Situations where an entity is qualified as opaque under the laws of one jurisdiction (i.e., a taxable entity under the laws of that jurisdiction) and qualified as transparent by another jurisdiction (i.e., the partners of the entity are taxable on their share of profit under the laws of that other jurisdiction).

  1. Hybrid Transfers

A hybrid transfer is an arrangement to transfer a financial instrument where the laws of two jurisdictions differ on whether the transferor or the transferee has the ownership of the payments on the underlying asset.

  1. Hybrid Permanent Establishment Mismatch

Situations where the business activities in a jurisdiction are treated as being carried on through a PE in that jurisdiction while those activities are not treated as being carried on through that PE in the other jurisdiction.

  1. Imported Mismatches

Situations where the effect of a hybrid mismatch between parties in third countries is shifted into the jurisdiction of a Member State via the use of a non-hybrid instrument which results in undermining of the effectiveness of the rules that neutralize hybrid mismatches. This includes a deductible payment in a Member State under a non-hybrid instrument that is used to fund expenditure involving a hybrid mismatch.

  1. Dual Tax Residency Mismatches

Situations where a taxpayer is resident for tax purposes in two jurisdictions resulting in the double deduction of expenses that are treated as tax deductible by both jurisdictions.

  1. Reverse Hybrid Rules - Applicable as from 2022

A reverse hybrid entity is an entity incorporated or established in Cyprus that is treated as transparent for Cypriot tax purposes (e.g., partnership) of the foreign owners holding in aggregate a direct or indirect interest of at least 50% of the voting rights, capital ownership or rights to profit thereof is/are located in a jurisdiction/jurisdictions that regards the Cyprus entity as a person subject to tax in Cyprus (ie a non- transparent entity).

In such case, the hybrid entity is treated as a company resident for tax purposes in Cyprus and its income is subject to Corporate Tax (CT) and Special Contribution of Defence (SDC) in Cyprus to the extent that such income is not subject to tax in Cyprus or elsewhere.

Exceptions

It is understood that the provisions with regard to hybrid mismatches shall not apply to inconsistencies in the treatment of hybrid instruments arising up to 31 December 2022 resulting from interest payments on the basis of a financial instrument to a related undertaking, where certain conditions are met.

In addition, where Cyprus is the payee jurisdiction and the deduction is not denied by the payer jurisdiction, Cyprus has opted for the possibility not to include the income in the taxable income of the Cyprus tax resident payee in relation to:

  • when the mismatch outcome is the result of differences in the allocation of payments made to the Cyprus entity or PE.

 

  • Where the Cyprus PE is disregarded by the country of the payer.

 

  • A deemed payment between the head office and PE or between two or more PEs when the mismatch outcome is the result of the fact that the payment to the Cyprus PE is disregarded under the laws of Cyprus.