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Questions over the viability of existing structures often arise when the true ‘beneficial ownership' of a dividend, interest or royalty payment is being considered by a tax authority, mostly in accordance with a specific double taxation convention's anti-treaty-shopping provisions.
What constitutes beneficial ownership has long been discussed and is now included in the updated OECD Model Convention and commentaries, which identifies the beneficial ownership as a recipient's ‘right to enjoy' income without any legal obligation to apply the received monies in a particular way, e.g. to pay it on to an offshore company.
With greater international adherence to such provisions, Cyprus has been proactive and innovative with the introduction of a Notional Interest Deduction (NID), which enhances the benefits of Cyprus' network of double tax treaties.
Introduced in 2015, the NID regime allows for a reduction in the overall effective tax rate in Cyprus, where new equity, within certain parameters, has been introduced into a Cyprus company from a related (offshore) entity for use in a finance or licensing arrangement. In effect, the new law allows Cyprus companies an interest deduction on new equity, and removes distortions between equity and debt finances. NID granted on new equity cannot exceed 80% of taxable profit calculated before allowance for the NID.
Unlike a traditional back-to-back arrangement, the ‘beneficial ownership' of a royalty or interest payment can remain in Cyprus when utilising the NID regime, as seen in the illustration below, whilst allowing for benefits under the provisions of a particular DTC to be maintained, such as the reduction or elimination of withholding tax at source.
It is important to remember that local substance is essential for any such Cyprus structure to achieve its intended objective, with management and control being the applicable concept for tax residence in Cyprus, usually achieved by appointing Cyprus-resident directors, bank signatories and key-decision-makers.
Attention should also be paid to measures currently being introduced as a result of the OECD's Base Erosion and Profit Shifting (BEPS) Action Plan, which will undoubtedly have a future impact on any corporate structuring arrangements.
For instance, when considering cross-border finance arrangements, BEPS Action 4 calls for the adoption of a domestic fixed ratio rule, which is applied to tax adjusted earnings, thus limiting deductions.
Whilst any changes in the UK are unlikely to take effect before mid-2017, France and Germany have already adopted certain measures to accommodate BEPS Action 4. The EU is even considering a draft Anti-Tax Avoidance Directive, which has proposed what borrowing costs would be deductible.
Accordingly, it may be worthwhile considering the setup of any finance arrangement immediately, as the OECD has suggested the grandfathering of existing debt to soften the impact of any new measures, with existing schemes being allowed to continue within certain time-frames and anti-avoidance criteria.
Finally, it is worth acknowledging the continued presence of IBC companies registered in the BVI or other jurisdictions like the Seychelles, even in the most sophisticated structures, such as that explained above.
Indeed, with new laws in the BVI and Seychelles guaranteeing a high-level of confidentiality, whilst adhering to international expectations in corporate governance and compliance, the SE jurisdictions are destined to remain an important component in many corporate structures for some time to come.