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Tax residency and substance of Cyprus companies
The Organization for Economic Co-operation and Development (OECD), the European Union and other countries on an individual basis, have embarked on a process of introducing stricter rules regarding the taxation of income earned by their residents in foreign jurisdictions.
This activity, which is referred to as Base erosion and profit shifting (BEPS) endorsed by the G20 refers to tax avoidance strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations. Over 100 countries and jurisdictions are collaborating to implement the BEPS measures. In July 2013, the OECD launched an Action Plan on BEPS, identifying 15 specific actions to address this issue in a comprehensive and coordinated way, following the core principles of coherence, substance, and transparency. Countries and jurisdictions have been invited to express their interest to join this framework as Associates, to participate on equal footing and to commit to implement the comprehensive BEPS Package. Timelines for implementation may differ to reflect the level of development of participating countries.
Article 246.2 of The Federal Law of the Russian Federation on controlled foreign companies refers specifically to foreign organizations that may be recognized as Russian tax residents.
Organizations, which meet at least one of the following conditions, can be considered to have their effective management and control in the Russian Federation:
- The majority of director Board Meetings are held in the Russian Federation, or
- The executive body of the organization regularly performs its activity from within the Russian Federation, or
- The principal (managing) officers predominantly perform their managing activity from within the Russian Federation.
Reference is made to the necessity for substance, specifically, (clause 4).
“A foreign organization shall be viewed as an organization whose effective management is performed outside the Russian Federation, in particular, where its commercial activity is performed using its own qualified staff and assets in the State (territory) of its permanent location with which the Russian Federation has an international agreement on tax matters.”
In a situation where the case under review involves an agreement for the avoidance of double taxation the concerns remain substantially the same.
Therefore, when a Company claims to have its tax residence is Cyprus it should be able to demonstrate/prove that the management and control and the substance of the company is indeed located in Cyprus. Failing this, the foreign tax authority may treat/deem the company as a tax resident of the country, where the shareholder/beneficial owner is tax resident, thus taxing the income accordingly.
The higher the activity in terms of volume and value of transactions, the higher the substance and management and control is required.