The new Cyprus-United Kingdom double tax agreement
November 2018 | SPECIAL REPORT: CORPORATE TAX
Financier Worldwide Magazine
November 2018 Issue
On 22 March 2018, Cyprus and the UK signed a new double taxation agreement. Once it has been ratified by both parties, it will replace the current agreement, which dates back to 1974. Most of the main provisions of the new agreement are substantially the same as those of the existing agreement, but the new agreement, which is based on the 2014 OECD Model Convention, introduces modern-day standards on exchange of tax information and base erosion and profit shifting. The key features are summarised below.
Article 1 – persons covered
Article 1 includes a new paragraph dealing with fiscally transparent entities. It provides that income or gains – derived by or through an entity or arrangement that is treated as wholly or partly fiscally transparent under the tax law of either country – is to be treated as income or gains of a resident of a country on the same terms as other residents of the country concerned.
Article 3 – definitions
The definitions of Cyprus and the UK have been expanded to include their offshore waters, in line with current practice, and the wording has been aligned with the OECD Model Convention.
Article 4 – residence
The ‘tie-break’ provisions for determining residence for individuals who are resident in both countries are the same as in the OECD Model Convention, namely permanent home and centre of vital interests, country of habitual residence and nationality, in descending order. If none of these criteria is decisive, residence is to be settled by mutual agreement between the two countries’ tax authorities.
For legal persons resident in both countries, the competent authorities of the two countries will determine residence by mutual agreement, having regard to the entity’s place of effective management, the place where it is incorporated or otherwise constituted and any other relevant factors. If the authorities cannot agree, the entity will not be considered a resident of either for the purposes of claiming any benefits provided by the agreement, except those provided by articles 22 (elimination of double taxation), 24 (non-discrimination) and 25 (mutual agreement procedure). A protocol to the agreement sets out the detailed factors to be considered when determining the residence of legal persons.
Article 10 – dividends
The article dealing with dividends has been considerably shortened and simplified, and aligned with the OECD Model Convention. If the beneficial owner of dividends paid by a company resident in one country is a resident of the other country the dividends are exempt from any withholding tax, unless the dividends are paid out of income (including gains) derived directly or indirectly from immovable property by an investment vehicle which distributes most of this income annually and whose income from such immovable property is exempted from tax, in which case withholding tax is limited to 15 percent of the gross dividends.
However, if the beneficial owner of the dividends is a pension scheme established in the other country, no withholding tax is payable. These provisions are relevant only to dividends paid from the UK, since Cyprus does not impose withholding taxes on dividends. This exemption does not apply if the dividends derive from a permanent establishment in the country from which the dividends are paid, through which the beneficial owner of the income (who is also a resident in one of the contracting states) carries on business.
Article 11 – interest
The wording of the article on interest has been aligned with the OECD Model Convention, but its effects are unchanged. Interest arising in one contracting state and paid to a resident of the other who is its beneficial owner is exempt from withholding tax. This exemption is limited to interest calculated on an arm’s length basis. It does not apply if the interest derives from a permanent establishment in the country from which the interest is paid, through which the beneficial owner of the interest (who is also a resident in one of the contracting states) carries on business.
Article 12 – royalties
The article has been considerably shortened and simplified, and aligned with the OECD Model Convention. The withholding tax of up to 5 percent on cinema films and video media for television provided for in the 1974 agreement has been removed.
Under the new agreement, if the beneficial owner of royalties paid by a resident of one country is a resident of the other country the royalties are exempt from withholding tax. This exemption is limited to royalties calculated on an arm’s length basis. It does not apply if the royalties derive from a permanent establishment in the country from which the interest is paid, through which the beneficial owner of the interest (who is also a resident in one of the contracting states) carries on business.
Article 13 – capital gains
The 1974 agreement does not include any provisions regarding taxation of capital gains. Under the new agreement, gains derived by a resident of one country from the alienation of immovable property (or of moveable property associated with a permanent establishment) situated in the other, or from the alienation of unlisted shares deriving more than 50 percent of their value directly or indirectly from immovable property situated in the other country, may be taxed in the country in which the property is situated. Gains derived from the alienation of all other property (including ships or aircraft operated in international traffic) are taxable only in the country of which the alienator is a resident.
Article 17 – pensions
Article 17 replicates the basic principle from the OECD Model Convention that in general pensions are taxable only by the country in which the recipient is resident. This is no different from the current provision. In addition, the article introduces new provisions regarding tax-deductibility of pension contributions. Contributions made by or on behalf of an individual who is employed or self-employed in one country (host state) to a pension scheme that is recognised for tax purposes in the other country (home state) are treated as if they were made to a recognised pension scheme in the host state, both for the purposes of determining the individual’s tax liability in the host state and determining the taxable profits of the employer, if any, in the host state.
There is also a substantive change to the provisions for taxation of pensions paid in respect of government service, for example pensions paid to retired civil servants or military personnel. Under the 1974 agreement, all pensions, including those payable in respect of government service, are taxed only in the country in which the recipient is resident. Under the new agreement, pensions payable in respect of national or local government service will be taxed only in the country from which they are paid, unless the recipient is both a national and a resident of the other country, in which case the pension is taxable only in the country in which the recipient is resident. This aligns the tax treatment of pensions with the UK’s other double taxation agreements.
Article 20 – offshore activities
The new agreement includes comprehensive provisions regulating the taxation of offshore hydrocarbon exploration and exploitation activities, intended to ensure that each state’s taxation rights in respect of offshore activities are preserved in circumstances where they might otherwise be limited by other provisions of the agreement, such as those dealing with permanent establishment and business profits. Special rules are required because of the short duration of some of these activities.
Article 22 – elimination of double taxation
In the UK, Cyprus tax payable on profits, income or chargeable gains from sources within Cyprus will be credited against any UK tax computed by reference to the same amounts. Profits of permanent establishments in Cyprus of UK-resident companies and dividends paid by Cyprus-resident companies to UK-resident companies are exempt from UK tax, subject to satisfying the conditions for exemption under UK law. In the case of non-exempt dividends paid to a UK-resident company which controls 10 percent or more of the voting power of the company paying the dividend, relief for Cyprus tax will be given under the credit method, taking account of the Cyprus tax payable by the company on the profits out of which the dividend is paid. In Cyprus credit will be given for UK tax payable, up to the amount of the Cyprus tax on the income concerned.
Article 23 – entitlement to benefits
Article 23 is a principal purpose test anti-abuse rule identical to the one set out in paragraphs one and four of article 7 of the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting.
Article 29 – entry into force
The new agreement will enter into force once both countries have completed their respective domestic ratification procedures. It will take effect in Cyprus from the beginning of the following calendar year. In the UK, it will take effect from the same date in respect of taxes withheld at source. In respect of corporation tax, it will take effect from 1 April following its entry into force, and in respect of income tax and capital gains tax, it will take effect from 6 April following its entry into force.
The current agreement between Cyprus and the UK is one of Cyprus’s oldest agreements still in force. Although the changes the new agreement makes will have little direct effect on the tax liability of most taxpayers, their significance should not be underestimated. The modernisation of the provisions, the emphasis on beneficial ownership and arm’s length pricing, and the introduction of up-to-date information exchange and anti-abuse provisions align the agreement with present-day best practice, ensuring that it provides clarity and certainty.
Constantinos Christofi is a tax consultant and financial controller at Elias Neocleous & Co LLC. He can be contacted on +357 2511 0144 or by email: firstname.lastname@example.org.
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