Tax residency, and more specifically what defines management and control, has undoubtedly become one of the most burning issues in global corporate structuring.
It is now common practice among tax and legal practitioners to discuss at length about how one defines the “tax residency” of a legal entity. In this fast changing world of transparency and exchange of information, we are often asked by colleagues, and more importantly clients, to opine on this issue. There are many obstacles that professionals in the industry have to deal with including the fact that “tax residency” is more often than not, rarely codified into legislation and when it is, it is often opaque and varies greatly from one jurisdiction to the other.
The UK, for example, includes a detailed test on individuals’ tax residency but a very broad management and control reference for legal entities. Other jurisdictions like the US, define all US incorporated entities as US tax residents, completely ignoring the management and control. And some, like India, have a mixed definition of country of incorporations and management and control test. None however clearly define what is meant with Management and Control.
Case in point: Cyprus tax residency
Cyprus Income tax law, 118(I)/2002 as amended, is not exempt from this bewildering maze. For instance, it does not define tax residency of legal entities although, interesting enough, reference is made to “management and control” of such legal entities. If one digs deeper into the Tax Department’s publications there’s a brief definition of “management and control” under “Common questions and answers”:
“Cyprus tax residents are considered persons who reside in Cyprus for one or more periods that together exceed a total of 183 days; and those legal entities that have their management and control in Cyprus”.
Cyprus tax residency certificate
On 30 October 2015, the Cyprus Tax Department issued a circular 2015/19, clarifying that a tax residence certificate request should be accompanied by a questionnaire including several matters which the Department will consider before issuing a Cyprus tax residency confirmation.
If we look at the questions more closely we are in a better position to understand the concerns of the tax authorities in Cyprus as well as perhaps a more detailed definition of tax residency for legal entities:
- Is the Company registered in Cyprus?
- Does the company have another tax residency?
- Do most Board of Directors meetings take place in Cyprus?
- Does the Board of Directors exercise control and resolve all major management and commercial decisions needed for the operations of the company and all its general policies?
- Are the minutes of the Board of Directors meetings prepared and kept in Cyprus?
- Do most of the members of the Board of Directors reside in Cyprus and are Cyprus tax residents?
- Do the Members (Shareholders) meetings take place in Cyprus?
- Has the company ever issued a general Power of Attorney? (if so, this must be made available to the authorities)
- Is the company Seal and all accounting books kept in Cyprus?
- Do local representatives submit the annual returns of the company?
- Are corporate agreements relating to the operations or fixed assets of the company executed or signed in Cyprus?
- Have all tax returns been submitted to date?
- Have all self-assessment returns been submitted?
All the above questions (the “Residency Questions”) require a reply on the form which is then executed and signed by one of the directors of the company.
As one may conclude from the Residency Questions, tax residency is not a matter of one or two facts or common practices but of a combination of many. Therefore, a complete assessment of the “management and control” and “place of exercise” can be made once all the answers to Residency Questions have been diligently analysed.
To complicate matters, and notwithstanding the Residency Questions, there are even more considerations to take into account:
- Does the company maintain bank accounts in Cyprus and/or abroad?
- Who manages those bank accounts and from where?
- Does the company maintain an office in Cyprus?
- Does the company maintain staff in Cyprus?
- Does the company maintain any permanent establishments abroad?
Will the Cyprus tax authorities reject a request for a tax residency certificate should one or two of the responses to the Residency Questions be in the negative? This might actually depend which of those questions one is referring to. For instance, is a company managed and controlled in Cyprus if the Board of Directors are all foreign nationals and residents elsewhere; and most of the Board of Directors meetings take place abroad? Obviously not.
In a nutshell, one can deduce that a company is considered to be a tax resident in the Republic of Cyprus if almost all of the questions above are answered positively and that those that are not will not imply that any management decisions are taken abroad.
Finally it is important to note that there is a very common misconception: that the Cyprus authorities would be challenging the tax residency of a legal entity claiming Cyprus residency. The fact of the matter is, in almost every single case of tax residence dispute, it’s actually the foreign authority (mostly the place of residence of the shareholder/s) which would instigate the challenge. Cyprus tax authorities would merely have to justify their decision and support their view why a company is considered Cyprus tax resident. Their decision will be based obviously on the answers to the Residency Questions that they were provided with.
Non-Cypriot companies managed and controlled in Cyprus
Similarly to the above, companies or other forms of legal entities registered outside of Cyprus but which are managed and controlled in Cyprus i.e. abide by most of the above considerations, shall be considered to be tax residents in Cyprus and be liable for taxes in the Republic.
Therefore foreign companies/entities from tax neutral jurisdictions (such as BVI, Cayman Islands, etc.) which are (or could be considered) managed and/or controlled in Cyprus are at higher risk of losing such “tax neutrality” particularly from the UBO’s country of residence perspective.
The UBO countries could decide that these “tax neutral” companies are usually not setup for commercial reasons or have no substance in the country of incorporation. This, coupled with the fact that a lot of these companies have Cypriot tax resident directors could ultimately make these “tax neutral” companies either be considered as tax residents in Cyprus or worse in the UBO’s country of residence therefore forfeiting any benefits of those tax neutral jurisdictions.
Permanent Establishment (PE)
Perhaps a clearer definition we often find codified in tax legislation around the globe is that of a Permanent Establishment or PE as defined in the OECD model convention for Double tax treaties:
“Permanent establishment means a fixed place of business through which the business of an enterprise is wholly or partly carried on.”
The definition goes on to describe several examples of what this may be.
Although helpful it nonetheless requires one major clarification: tax residency and permanent establishment are two different considerations, with differing tests and consequences.
The major impact of a company having a PE abroad are the tax liabilities that may arise from profit attributable to that other country. Where a Double Tax treaty (DTT) exists between the two countries (company tax residency and PE tax residence countries), matters become simplified in the sense that the profits of that Company shall be taxed as per the apportionment of profits between the two divisions. In the more unfortunate scenario where a company has established (knowingly or not) a PE in a country with which no DTT exists, the profits attributable to the PE may be taxable twice. Careful tax planning is therefore needed before setting up operations internationally.
PE considerations are also vital when considering tax residency when a company is seen to have established a PE in another country which leads to tax residency discussions. The difference is that, if a PE is proven to exercise the management and control for the whole legal entity, the tax residency of that company may be considered to be the place of the PE. The result will be for that country claiming tax on all of the profits of that company instead of the apportioned profits of the PE.
The author of the article is Constantinos Economides.
1. The Organisation for Economic Co-operation and Development (OECD)