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The use of foreign companies for investment fund activities is a widely spread phenomenon amongst international investors.
Under this scenario, foreign special purpose vehicles make investments in a range of assets, which may vary from securities to commodities, for the benefit of a large group of investors/shareholders, through funds contributed by the latter parties.
1. Reasons for setting up foreign investment funds
Risk diversification is one of the key motives for setting up separate foreign entities for investment fund activities.
Taxation also plays a key role in the choice of the jurisdiction for the establishment of investment funds; investors strive for the highest returns on their investments possible and for that reason taxation on the investment profits must be limited to a minimum, preferably to zero.
2. Important characteristics for a country to be regarded as tax advantageous jurisdiction for investment fund activities
A country should meet the following criteria in order to be regarded as tax efficient fund jurisdiction¨
it should have a broad tax exemption system for holding company income, especially in terms of the minimum percentage that a company is required to own in another company’s capital, in order to qualify for tax exemption for benefits from such company.
Investments funds will often own small percentages in the capital of the companies in which they invest. Therefore, the minimum capital participation threshold for tax exemption for the benefits from these investments should not be too high, at the risk of taxation payable over such benefits.
The broad exemption should either (and ideally) be based upon the country’s general tax system, or the country should provide for a special (zero) tax regime for investment fund activities.
it should have a large double tax treaty network, in many cases providing for reduction of (and preferably exemption from) withholding tax over dividend (and interest) payments made to companies established in such countries by subsidiaries of such companies and protection from taxation over gains upon the sale of shares in foreign companies by investee countries. Although it must be stressed that this is not an element as important as for ‘regular’ holding companies dealt with in section 1 (i.e. companies that are often are used for majority- or 100% participations).
Many countries levy withholding taxes. These taxes are usually levied over payments of dividends, interest and/or royalties made by residents of those countries. The rates of these taxes vary, but in some countries they may rise to 30%. The availability of double tax treaties, which may provide for reduction of such withholding taxes in case of payments to companies in countries that have tax treaties with the countries of residence of the paying parties, is an essential element in international tax planning. So is the capability to choose the right jurisdiction for each individual investment.
ideally, the country of establishment of the holding company would not have withholding taxation over dividend payments (or it should be relatively easy to circumvent such taxation)
It is safe to say that, within the EU, based upon its general tax system Cyprus is the most attractive jurisdiction for investment fund activities. It combines a general income tax exemption for profits from the sale of securities with a very broad tax exemption system for dividends, which does not include a minimum capital participation requirement. Cyprus does not levy withholding tax over outbound dividends.
ideally, the country of establishment of the holding company would not levy tax over gains upon the sale of shares in local companies by non-resident shareholders either.
The country should, apart from regular corporate income tax, not levy ‘hidden taxes’, such as annual wealth tax, over an investment fund’s wealth.
3. Issues to consider
Companies opting for special tax exemption regimes for investment fund activities in countries with high general income tax rates, whose general participation exemption regimes are too burdensome to provide for tax exemption for such activities (especially due to high minimum capital participation requirements in the companies in which investments take place, for tax exemption for benefits from such companies), are often not eligible for the benefits of tax treaties concluded by these countries. It may e.g. be the case that, since these companies are not formally subject to general income tax in these countries, they will not be considered as residents of these states for treaty purposes or it may be that, since they are treated as transparent entities in their states of residence, they are not regarded as ‘beneficial owners’ of their income for treaty purposes etc.
Typical offshore jurisdictions, offering general income tax exemption for offshore companies established in these countries, usually do not have any tax treaties available at all and this may make the use of companies in those countries for investment fund activities less advantageous than it seems at first glance.
If Cypriot companies are used for investment fund activities, the profits from such companies will usually already be exempt from taxation based upon Cyprus’ general tax system. This system provides for a general income tax exemption for any profits from the sale of any securities and a tax exemption system for dividends without minimum capital participation requirement in the companies in which the Cypriot companies invest. This means that there is no requirement or necessity to opt for a special regime in Cyprus for such companies, in order to achieve the desired result of full tax exemption for the companies’ profits.
Based thereupon, such companies should unconditionally be eligible for the benefits of Cyprus’ network of double tax treaties with almost fifty countries.
This obviously gives Cyprus a competitive advantage for investment fund activities, also because investment funds established in Cyprus are not liable to hidden taxes such as annual wealth tax or similar forms of taxation.
Last but not least, Cyprus does not levy any withholding tax over outbound dividends.
In addition, the massive (ab)use of toxic investment products and the related global financial meltdown, started in 2008, has caused the world’s biggest economic powers to combat the use of investment funds in lightly regulated offshore jurisdictions such as Cayman Islands, BVI etc. causing a shift of these activities to onshore jurisdictions within the EU. It is obvious that Cyprus, being an EU-Member, is an excellent alternative for offshore countries when it comes to setting up investment funds.
Another benefit of the use of Cypriot companies for investment fund activities is the so-called ‘European passport’ facility, allowing funds registered in one EU-Member State to offer their services throughout the EU. From that point of view, the choice for EU-based entities such as Cyprus is advisable as well.
4. What we can do for you
Consulco has been involved in the set up of a substantial number of investment funds in Cyprus. We have the required expertise to adequately service clients who want to structure investment fund activities, or other kind of financial services, through Cyprus. Our expertise covers the regulatory area, the area of taxation and the area of administration (bookkeeping and audit).