Cyprus targets tax avoiding letter-box companies

Cyprus Central Bank wants to prevent firms from using EU single market freedom-of-establishment rules to set up letter-box companies for tax benefits in the country.

The regulator underlined the need for businesses to have real substance in order to operate and benefit from tax residence in Cyprus.

The warning states that so-called ‘shell’ or ‘letter-box’ companies – that lack of proper substance – may not only be denied benefits under double tax agreements or EU directives, but may also mean that the company is unable to operate a bank account in Cyprus.

On 14 June 2018 the Central Bank of Cyprus issued a circular to credit institutions that it regulates, advising them against opening new bank accounts or continuing existing accounts with companies that are regarded as ‘letter-box’ companies.

A letterbox company seeks to minimize tax liability by establishing domicile with a mailing address in a country that is more tax-friendly, while conducting business elsewhere.

These guidelines are due to be incorporated into the Central Bank’s Anti-money Laundering Directive in the near future.

The guidelines stipulate that trading companies with no effective place of business and management, and hence no substance, will not be permitted to maintain bank accounts in Cyprus. Further, trading companies incorporated in jurisdictions recognised as tax havens must become tax resident in an appropriate tax jurisdiction in order to continue banking in Cyprus.

These restrictions do not apply to holding companies which own investments in shares, intangible or other assets, including real estate or ships, companies undertaking group financing activities or acting as group treasurer or companies established to facilitate currency trades, asset transfers or corporate mergers, provided that their beneficial ownership is identifiable and they demonstrate that they are engaged in legitimate business.

A company lacking sufficient management and capital may be entirely disregarded by foreign tax authorities, running the risk that – in addition to any taxes payable by the company in Cyprus – its income is imputed to the beneficial owners in their own country and taxed there.

“With increased transparency and automatic exchange of information, Cyprus companies which do not have real substance run tax risks, including the risk of having their Cyprus tax residency status questioned, losing the benefits of Cyprus tax residence and becoming liable to tax elsewhere,” said Michalis Loizou, a Tax Consultant at Cyprus-based Elias Neocleous & Co, in an opinion piece published by International Law Office.

New European laws make it possible for EU member nations to reject a company transfer if it determines an “artificial arrangement” will be set up in the destination country.

The move away from unconditional EU single market freedom-of-establishment rules has caught the attention of the largest EU business lobby group, BusinessEurope, which represents more than 10,000 companies in the bloc. It warned against a proposal that restricts the movement of companies.

Article written by Pedro Goncalves – International Investment