On January 1, 2012 the tax treaty between Cyprus and the UAE is set to come into effect. Adriaan Struijk, Chairman of the Freemont Group, looks at how this partnership can offer a more secure solution for outward investment into the EU or Russia.
In February 2010, a tax treaty was signed between Cyprus and the UAE. The treaty largely follows the Organisation for Economic Co-operation and Development model (OECD) convention for tax treaties. A treaty applies only between residents of countries, and its aim is to avoid double taxation and make international tax planning more predictable. The UAE treaties often have a somewhat different definition of who is a resident, compared to the OECD model convention or the local definition. This is mostly the case because countries that conclude treaties with the UAE are not eager to give away too many taxing rights, since income in the UAE itself is not taxed. Some treaties therefore restrict benefits only to nationals of the UAE or government entities and determining which individual or company is resident in which country is important in order to establish who can benefit from the treaty.
In the treaty between Cyprus and the UAE, an individual is considered resident of the UAE if he is resident there under UAE law. In Cyprus, an individual is considered resident if he is liable to tax there by reason of his residence. The Cyprus criterion follows the OECD model, but the UAE criterion does not. This is favourable because it means that under this treaty an expatriate in the UAE with a residence visa can be considered a resident for the purposes of the treaty; the same point is often unclear in the UAE treaties since, if the liability for tax requirement is included, the question arises whether one can be liable for tax in the UAE since there is no tax. If, on the basis of these criteria, an individual is considered resident in both states, then the treaty determines that the person shall be considered resident in the country where he has a permanent home available to him.
The residency tests for companies for the purposes of this treaty are as follows: the UAE considers a company resident if it is formed under the laws of the UAE; this will therefore include international companies operating out of Ras Al Khaimah. Cyprus considers a company resident if the place of effective management is in Cyprus.
If the result is that the company is considered a resident of both countries, then the place of effective management will be decisive. If, therefore, UAE tax residence of the company is important, and there could be issues as to whether effective management of the company is exercised in Cyprus or not, it is better to use a UAE incorporated company than one incorporated in the British Virgin Islands for example, because only the first one has treaty protection. This could be an issue when, for instance, a company owned by a resident of Cyprus owns real estate in the UAE. Under Cypriot law, if the effective management of the company is considered to be in Cyprus then the income from the real estate would be subject to 10% corporation tax in Cyprus; however if a UAE company is used to hold the real estate then it is not only the domestic law of Cyprus that applies but the residency of the company will have to be determined by looking at the treaty. Hence it will be more difficult to argue that the company is resident in Cyprus and applying the 10% tax.
In the absence of a treaty Cyprus levies a 10% tax, called a 'special contribution of defence', on royalties paid to non-residents if these are earned on intellectual property-rights used in Cyprus. For instance a franchise fee paid by a McDonalds restaurant in Cyprus would attract a 10% special contribution of defence when paid to an offshore company in the British Virgin Islands, but if it is paid to a UAE company that is resident in the UAE it will not be taxed. The new treaty prevents Cyprus from levying this tax if paid to a resident of the UAE. Cyprus does not have any withholding taxes on interest and dividend payments to non-resident individuals or companies. When these payments are made to persons who are residents of Cyprus, the special contribution of defence is levied at 15% and 17% respectively.
But what happens when the payments are made to an offshore company, which in turn owned by a resident of Cyprus? Currently, the practice is to not levy the taxes in these cases either, but as a matter of law it is unclear which leaves scope to start imposing tax at some point in the future. This is not an entirely unrealistic perspective considering the budgetary problems that Cyprus faces. How this uncertainly could be relevant to tax planning for a resident of Cyprus is perhaps best illustrated as follows: Cypriot company owners could have his company employ himself, keep his salary low, and pay out the remainder in dividends, on which he pays 17% tax. Instead, he could hold the shares by an offshore company rather than himself and pay zero per cent on the dividends paid to the offshore company. Currently this works, but there is the uncertainly whether this will remain acceptable in the future.
Luckily there is now an easy solution to prevent this uncertainty and that is to hold the shares by a RAK FTZ international company instead of by a company formed in an offshore jurisdiction without a treaty (or with a less favourable treaty). As is the case for royalties, the treaty stipulates that Cyprus is not allowed to levy taxes on dividends and interest paid to a company that is under the terms of the treaty considered a resident of the UAE. Normally, a provision is included in tax treaties stipulating that the recipient company also has to be the 'beneficial owner' of the dividends (or interest/royalties), but there are situations in which the company itself is not considered the beneficial owner. This would be the case, for instance, when the company has no discretion to use the funds be has to pay them onwards.
But this critical term – beneficial ownership – is a moving target; some countries have very wide interpretations of beneficial ownership. With the Cyprus-UAE treaty there is no beneficial ownership requirement included with regard to dividends, interest, and royalties. So, if the treaty is applicable then it is simply sufficient to ensure the company is tax resident in the UAE. This can be easily realised by using a RAK FTZ international company with locally resident directors. Obviously this gives much more certainty to international tax planning structures than planning in the absence of a treaty, or planning with a treaty that does include the beneficial ownership requirement.
Cyprus has the lowest corporate tax rate, rate of VAT, and social security taxes in the EU, and is a major gateway for investment into the EU, Russia and other former USSR countries. This is because Cyprus doesn't tax incoming dividends from subsidiaries in these countries and has zero withholding taxes on dividends, interest and royalties going out. Being part of the EU it benefits from the parent subsidiary directive, which prevents the remitting country from levying a withholding tax on dividends, and the interest and royalty directive, which prevents the remitting country from levying withholding taxes on interest and royalties, provided certain conditions are met.
Another advantage is that Cyprus doesn't have specific transfer pricing rules, apart from a general rule that transactions between related companies should be concluded at 'arms length prices'. This makes it possible to use a Cypriot company as an invoicing vehicle by obtaining an EU VAT number to invoice customers in the EU if an EU originated invoice is preferred. The profit margin left in Cyprus can be purposely kept low, and will only be taxed at 10%. Cyprus is also a very attractive location for setting up EU compliant mutual funds, private equity funds, and securities brokerage firms. This is because the profits realised by these firms are largely exempt in Cyprus. Doing business is easy because the business language is English and the laws are largely based on English law.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.