The most efficient method of financing subsidiaries and associate companies in international operations through Cyprus is one of the most frequently discussed issues by clients. Especially clients from East European countries where the concept of “gift” is widely used, are confused why this is not acceptable in the case of Cyprus companies. Herebelow we outline briefly the recommended methods from the legal and tax point of view.
1. Increase of share capital of subsidiary or associate
Increase of capital of the subsidiary and allotment at par or at premium in cash or through contribution in kind is the most appropriate financing method. There are no taxation or legal issues. But in many occasions there are reasons for not issuing new capital in which case one of the following methods maybe be used.
2. Granting of loans at arm’s length conditions
Granting of loans at prevailing market conditions with the consequence though that the lender will have interest income which might be liable to taxation is another recommended method.
In the case of Cyprus company, careful tax planning must be applied in order to ensure that the tax liability will be the least possible. To do so, the interest received must constitute the major source of income for the company in which case interest is considered to be trading income, within the company’s ordinary activities and is taxed at income tax rate of 12,5% on the net profit. Furthermore, if the funds used by the Cyprus company were borrowed from another company, the tax authorities have unofficially accepted the following interest spreads for low risk financing on transactions between related parties (intra-group financing):
|LOAN AMOUNT||INTEREST MARGIN DIFFERENTIAL|
|UP TO €50 MILLIONS||0,35%|
|FROM €50 MILLIONS < UP TO €200 MILLIONS||0,25%|
|OVER €200 MILLIONS||0,125%|
But if incorrect tax planning is used and financing is not within the company’s ordinarycourse of business, then interest received is taxed at defense tax at the rate of 30% on the gross interest received; so be careful to receive correct advice.
3. Granting interest free loans
But often in international financing operations interest free loans to subsidiaries and associate companies are extensively used as a low cost funding method, which creates serious legal and tax issues summarized below:
– According to Companies Law Cap 113, an interest free loan can be granted by a Cyprus company to its subsidiary or associate company, if it is allowed by its Memorandum and there is commercial justification.
But interest free loans to unrelated third parties, without commercial justification must be avoided as most probably are not covered by the objects of the company and might find the directors in breach of their fiduciary duty towards the company.
– From the tax point of view, article 33 of the Income Tax Law, No 118 (I) 2002, applies in case of interest free loans. Under the article 33, the Commissioner of Income Tax taxes the notional interest income under Income Tax based on market rates which currently is at 9%.
4. Financial Assistance or Gift
Often neither the share capital increase nor the loan method are preferable options for the investors who prefer such financing to be non refundable and be granted by way of a gift, or as financial assistance in the equity and reserves of the subsidiary or related company. With respect to gift, according the article 25 of the Contract Law, a company can not provide gifts and such a gift most probably is void. But financial assistance in the form of an investment in the equity and reserves of the subsidiary company is permissible provided, it is allowed by its Memorandum.
Likewise from the tax point of view, a gift can not be considered as a tax allowable expense unless it is granted to approved charitable institutions in the Republic. But if the funds are granted as financial assistance then the tax treatment is expected to be as follows:
a. if there is any possibility that the Cyprus company will request repayment of the amount, then such transaction should be recorded in the books of the grantor Cyprus company as an amount receivable and the provisions of article 33 of Income Tax applies.
b. if the Cyprus company does not have right to demand repayment of the amount from the subsidiary, then such transaction should be recorded in the books of the Cyprus grantor company as investment, provided it is recorded in the books of the recipients as equity. In this case there is no tax liability.
Therefore if the financing of the subsidiary / associated company is not in the form of increased capital, then the solution is either loan at market interest rates or in case there’s no intention to claim the funds back, the appropriate method from both the legal and tax point of view is financial assistance in the form of an investment in the equity and reserves of the subsidiary. Interest free loans or gifts create serious legal and tax issues.
Edited by Phani Schiza Antoniou,