Introduction
Taxes covered
Residence
Permanent establishment
Income from immovable property
Business profits
Profits from shipping and aviation
Dividends
Interest
Capital gains
Offshore activities
Elimination of double taxation
Mutual agreement procedure
Exchange of information
Assistance in collection of taxes
Entitlement to benefits
Entry into force and termination
Protocol on collective investment vehicles
The double tax agreement between Cyprus and Luxembourg was recently published by the Luxembourg authorities (for further details please see "New double tax agreement between Cyprus and Luxembourg"). The agreement – which is the first between the two countries – will enter into force once it has been ratified by both countries. It closely follows the latest Organisation for Economic Cooperation and Development (OECD) Model Tax Convention for the Avoidance of Double Taxation on Income and on Capital. In line with the OECD Multilateral Convention to Implement Tax Treaty-Related Measures to Prevent Base Erosion and Profit Shifting, it also includes:
- a preamble clarifying that it is not designed to create opportunities for double non-taxation or reduced taxation through evasion or avoidance; and
- a principal purpose test-based general anti-avoidance rule.
A protocol to the agreement also deals with collective investment vehicles. The key features of the agreement and the protocol are summarised below.
The taxes covered by the agreement in Luxembourg are:
- income tax on individuals;
- corporation tax;
- capital gains tax; and
- communal trade tax.
The taxes covered by the agreement in Cyprus are:
- income tax;
- corporate income tax;
- capital gains tax; and
- Special Contribution for the Defence of the Republic (commonly referred to as SDC tax).
The agreement will also apply to any identical or substantially similar taxes that are imposed in future in addition to, or in place of, the existing taxes.
The tie-break provisions for determining the residence of 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 are decisive, residence is settled by mutual agreement between the two countries' tax authorities.
For legal persons, residence is the place of effective management.
Article 5 of the double tax agreement, which defines a permanent establishment, is identical to the corresponding article of the OECD model convention.
Income from immovable property
The article on income from immovable property reproduces the corresponding article of the OECD model convention. It provides that income from immovable property may be taxed in the contracting state where the property is situated.
The profits of an enterprise are taxable only in the contracting state in which it is resident, unless it carries out business in the other contracting state through a permanent establishment there, in which case the profit attributable to the permanent establishment may be taxed in the contracting state in which it is located.
Profits are to be calculated on an arm's-length basis, as if the permanent establishment was a distinct and separate enterprise, after the deduction of expenses which are incurred for the purposes of the permanent establishment, including executive and general administrative expenses. If profits of a permanent establishment have customarily been determined by an apportionment of the total profits of the enterprise to its various parts, the same method may continue to be used provided that the result is in line with the abovementioned principles.
Profits from shipping and aviation
Profits from the operation of ships (whether in international traffic or inland waterways) and aircraft in international traffic are taxable only in the contracting state in which the enterprise is resident. Residence is determined by the place of effective management. If a shipping enterprise's place of effective management is aboard a ship, it is deemed to be in the contracting state in which the home harbour of the ship is located or, if no such home harbour exists, in the ship operator's contracting state of residence.
Dividends paid by a company resident in one contracting state to a resident of the other are subject to zero tax in the contracting state from which they originate, provided that the dividend's beneficial owner is a company (but not a partnership) resident in the second contracting state which directly holds at least 10% of the capital of the company paying the dividends. Otherwise, tax payable in the first contracting state is limited to 5% of the gross dividends. In any event, Cyprus imposes no withholding tax on dividends paid to shareholders overseas.
Interest paid by a company resident in one contracting state to a resident of the other is taxable only in the contracting state in which the recipient is resident. Royalties are taxable only in the contracting state in which the beneficial owner is resident. These exemptions do not apply if the interest or royalties derive from a permanent establishment through which the beneficial owner of the income (who is also a resident in one of the contracting states) carries out business in the contracting state from which the income is paid. The amount of interest and royalties that qualify for exemption is limited to what would be payable on an arm's-length basis.
As Cyprus and Luxembourg are EU member states, EU legislation, including the EU Interest and Royalties Directive (2003/49/EC), the EU Parent-Subsidiary Directive (90/435/EC) and the EU Anti-Tax Avoidance Directive (2016/1164/EC), will also apply.
Gains derived by a resident of one contracting state from the alienation of immovable property (or of moveable property associated with a permanent establishment) situated in the other may be taxed in the contracting state in which the property is situated. Gains from the disposal of shares in a company which derive more than half of their value directly from immovable property situated in the other contracting state may be taxed in the state in which the property is situated. Gains derived from the alienation of all other property (including ships or aircraft and ancillary equipment) are taxable only in the contracting state in which the alienator is resident.
The double tax 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.
A resident of one contracting state carrying out offshore exploration or exploitation activities in the territory (including in territorial sea or the exclusive economic zone) of the other is deemed to be carrying out business through a permanent establishment there if the activities are carried out for 30 days or more in 12 months. The article dealing with offshore activities also includes rules for determining when the 30-day threshold is exceeded in respect of offshore activities undertaken by associated enterprises.
Profits from maritime or air transport, towing, mooring, refuelling and similar activities in connection with offshore exploration and the exploitation of resources are taxable only by the country in which the enterprise concerned is a resident.
The general provisions regarding income from employment are modified to the effect that remuneration derived by a resident of one contracting state employed in offshore activities in the other may be taxed in the second state. However, if the employer is not a resident of the second state and the employment amounts to less than 30 days in any 12-month period starting or ending in the fiscal year concerned, the remuneration is taxable only by the country of the employee's residence. Salaries, wages and similar remuneration derived from employment aboard ships or aircraft engaged in offshore supply and similar activities are taxable in the contracting state in which the enterprise carrying out the activities is resident.
Gains derived by a resident of a contracting state from the alienation of assets (either tangible or intangible) that derive the majority of their value from exploration or exploitation rights in the second contracting state or its exclusive economic zone may be taxed in the second state.
Elimination of double taxation
For most categories of income, elimination of double taxation in Luxembourg is achieved by the exemption method. Luxembourg will exempt any income which may be taxed in Cyprus from Luxembourg tax, but may apply the same rates of tax as if the income or capital had not been exempted in order to calculate the tax liability on the balance of the taxpayer's income. No exemption is available in respect of income which is exempt from tax in Cyprus. For dividends and earnings of sportspeople or entertainers, the credit method is used. The credit is limited to the part of the tax which is attributable to any income derived from Cyprus.
In Cyprus, the elimination of double taxation is achieved by the credit method, with credit being limited to the part of the tax attributable to the income concerned.
The article dealing with the mutual agreement procedure reproduces the corresponding article of the OECD model convention verbatim, apart from omitting any provision for arbitration.
The exchange of information article reproduces Article 26 of the OECD model convention verbatim.
Assistance in collection of taxes
Since Cyprus and Luxembourg are subject to EU Directive 2011/16/EU on administrative cooperation in the field of taxation there is no article dealing with this issue.
In line with EU Commission Recommendation 2016/136 on the implementation of measures against tax treaty abuse, the agreement includes a principal purpose test-based general anti-avoidance rule in line with the OECD Multilateral Convention to Implement Tax Treaty-Related Measures to Prevent Base Erosion and Profit Shifting. It provides that benefits under the agreement should be withheld if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit.
Entry into force and termination
The agreement will enter into force when the two governments inform one another that the requisite constitutional procedures have taken place. Its provisions will have effect in both contracting states from the beginning of the following year. It will then remain in force until terminated. Either country may terminate the agreement by giving written notice of termination through diplomatic channels of at least six months no earlier than five years after the agreement enters into force. The agreement will cease to have effect from the beginning of the following calendar year.
Protocol on collective investment vehicles
The protocol to the agreement deals specifically with collective investment vehicles. It provides that a collective investment vehicle is a resident of a contracting state if it is liable to tax there by reason of its domicile, residence, place of management or any other similar criterion. A collective investment vehicle is also considered liable to tax if it is subject to the tax laws of the contracting state concerned, but is exempt from tax only if it meets all of the exemption requirements specified in its domestic tax laws. A collective investment vehicle is deemed to be the beneficial owner of any income it receives.
For further information on this topic please contact Philippos Aristotelous at Elias Neocleous & Co LLC by telephone (+357 25 110 110) or email ([email protected]). The Elias Neocleous & Co LLC website can be accessed at www.neo.law.