Mary Trimithiotou
On July 3 2020, the Law implementing the provisions of the EU Anti-Tax Avoidance Directive 2016/1164 (ATAD I) with respect to exit taxation rules and the provisions of the amending Directive 2017/952 (ATAD II) relating to the hybrid mismatch rules was published in the Official Gazette of the Republic of Cyprus (Law). The Law came into force with its publication and applies retrospectively as of January 1 2020 with the exception of reverse hybrids which will be effective as of January 1 2022.
A. Exit Taxation Rules
A Cypriot tax resident company or a non-Cypriot tax resident company which has a permanent establishment (PE) in Cyprus shall be subject to tax at an amount equal to the market value of the transferred assets, less their value for tax purposes, in any of the following cases:
1. The Cyprus tax resident company transfers asset(s) from its head office in Cyprus to its PE in another country in so far as Cyprus no longer has the right to tax the transferred assets due to the transfer.
2. A PE in Cyprus of a non-Cypriot tax resident company transfers asset(s) from its PE to its head office or another PE in another country in so far as Cyprus no longer has the right to tax the transferred asset(s) due to the transfer.
3. The Cyprus tax resident company transfers its tax residence from Cyprus to another country, except for those assets which remain effectively connected with a PE in Cyprus.
4. A PE in Cyprus of a non-Cypriot tax resident company transfers the business carried on by its PE from Cyprus to another country in so far as Cyprus no longer has the right to tax the transferred assets due to the transfer.
Where a company tax resident in a Member State transfers into Cyprus its assets, tax residence or the business carried on through a foreign PE, the starting value of the transferred assets for tax purposes must be equal to the value as determined by the Member State at the point of exit, unless this does not reflect the market value of the transferred assets, being the amount for which an asset can be exchanged, or mutual obligations can be settled between unrelated parties.
The exit taxation rules 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 prudential capital requirements or for the purposes of liquidity management.
Payment Deferral of the Exit Tax
In accordance with ATAD I, a taxpayer has the right to defer the payment of an exit tax by paying it in installments over five years, provided certain conditions are met. In such cases, interest may be charged in accordance with the legislation of the Member State of the taxpayer or of the PE, as the case might be. If there is a demonstrable and actual risk of non-recovery, taxpayers may also be required to provide a guarantee as a condition for deferring the payment.
B. Hybrid Mismatch Rules General principles
Hybrid mismatches result from the discrepancies in the tax treatment of a payment or an entity in two or more jurisdictions. The rules covered by the ADAT may arise in cases such as the following:
1. Between associated enterprises; (associate enterprise means an entity in which the taxpayer holds or an individual that directly or indirectly 50% or greater voting, capital or profit interest)
2. Between a taxpayer and an associated enterprise;
3. Between a head office and its PE’(s); or
4. Under a structured arrangement, that is, an arrangement involving a hybrid mismatch where the mismatch outcome is priced into the terms of the arrangement, or an arrangement that has been designed to produce a hybrid mismatch outcome, unless the taxpayer or an associated enterprise could not reasonably have been expected to be aware of the hybrid mismatch and did not share in the value of the tax benefit resulting from the hybrid mismatch.
In case of a hybrid mismatched identified, deductions provided arising from hybrid mismatch shall be denied. If Cyprus is the recipient of a payment shall tax the payment accordingly and thus neutralizing the hybridity.
For a hybrid arrangement to be caught by the rules, a mismatch outcome needs to result, namely, in:
A. A Deduction Without Inclusion (DWI): If the Cyprus resident party is the payer, the deduction of a payment or a deemed payment between a head office and a PE or between two or more PEs of the same entity will be denied, and if the Cyprus-resident party is the recipient and a deduction is given to the overseas payer, the recipient will be taxed unless an exception applies; or
B. A Double Deduction (DD): Double deduction due to hybridity is neutralized by Cyprus denying the deduction of any payment, expense, or loss in Cyprus in the event Cyprus is the investor jurisdiction. If Cyprus is not the investor jurisdiction but rather is the payer, then the deduction is allowed but only in the case where the investor jurisdiction denied the deduction.
Scope
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 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 whereas it is considered as equity in the payee jurisdiction).
2. Hybrid entity mismatches: 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.
3. 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 got the ownership of the payments on the underlying asset. Such hybrid transfers are typically designed in financial centers and derive from complex structures.
4. Hybrid PE mismatches: Situations where the business activities in a jurisdiction are treated as being carried on through a PE by one jurisdiction while those activities are not treated as being carried on through a PE in the other jurisdiction.
5. Imported mismatches: Situations where the effect of a hybrid mismatch between parties in third countries is shifted into the jurisdiction of a Member State through the use of a non-hybrid instrument thereby undermining 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.
6. Tax residency mismatches: Situations where a taxpayer is a resident for tax purposes in two or more jurisdictions. Specifically, in the event where such deduction is allowed from the taxable base of the taxpayer in Cyprus and is also allowed as deduction in other jurisdictions, Cyprus will deny the deduction to the extent that the other jurisdictions allow the duplicate deduction to be set off against income that is not dual inclusion income.
Exceptions
A grandfathering provision up to December 31 2022 is available regarding hybrid mismatches deriving from a payment of interest under a financial instrument to an associated enterprise where the following applies cumulatively:
1. The financial instrument has the characteristics of conversion, rescue by own means or impairment; and
2. The financial instrument has been issued with the sole aim of meeting loss-absorbing capacity requirements applicable to the banking sector and the financial instrument is recognized as such in the loss-absorbing capacity requirements of the Cyprus resident company.
In implementing the ATAD provisions, Cyprus has opted to adopt the available exemptions where Cyprus is the recipient jurisdiction and the deduction is not denied by the payer jurisdiction. In this regard, Cyprus will not include in the tax computation of the recipient taxpayer the income deriving from the following payments:
1. A payment to a hybrid entity when the mismatch outcome is the result of differences in the allocation of payments made to the hybrid entity;
2. A payment to an entity with one or more PE when the mismatch outcome is the result of differences in the allocation of payments;
3. A payment to a disregarded PE; 4. 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 is disregarded under the laws of the payee jurisdiction.
C. Reverse Hybrid Rules: applicable as from 2022
The Law includes provisions with respect to reverse hybrid entities. This is an entity that is incorporated or established in Cyprus that is treated as transparent for Cypriot tax purposes and one or more non-resident associated enterprises holding in aggregate a direct or indirect interest of at least 50% of the voting rights, capital ownership or rights to profit in such entity is/are located in a jurisdiction(s) that regards the entity as a person subject to tax in Cyprus. In such case, the hybrid entity is treated as a company resident for tax purposes of Cyprus and its income is subject to (Corporate) Income tax and Special Contribution to the Defense Fund in Cyprus to the extent that such income is not subject to tax in Cyprus or elsewhere.
This provision will not apply, however, to collective investment vehicles provided they meet certain conditions (i.e., widely held, holds a diversified portfolio of securities and is subject to investor-protection regulation).
* This publication has been prepared as a general guide and for information purposes only. It does not purport to be comprehensive or to render legal advice.
