Cyprus turned the EU Parent-Subsidiary Directiveinto domestic legislation back in 2004 while preparing for EU membership. The Income Tax Law and the Special Contribution for the Defence of the Republic Law provide a liberal system of double taxation avoidance, which also applies to non-EU countries.

The EU Council of Economic and Finance Ministers (ECOFIN) announced in June of this year that it had reached political agreement for the alteration of the directive in order to prevent tax avoidance techniques. Draft legislation has not beenpublished yet,however foreign investors usingCyprus tax structures are advised to have a closer look at their current arrangements and to plan accordingly.

The directive was initially introduced to prevent double taxation of groups of companies resident in different countries by exempting dividendspaid by a subsidiary company to its parent from withholding taxes and eliminating double taxation of such income at the level of the parent company, as to promote fair competition and productivity.

However, differences between national tax systems existed by using aggressive tax-planning techniques such as hybrid loan arrangements. The resultant loss of tax revenue forced national governments to agree on a solution within EU level to close such loopholes.

The EU Council requested amendments in the directive regardingthe tax treatment of hybrid loan arrangements, requiring that if an instrument gives rise to a deductible expense in the payer’s country of residence, the receipt of the income is taxable in the recipient’s country of residence.

Further the EU Council proposed the adoption of comprehensive anti-abuse rules (GAAR), adapted to the specifics of the directive.

ECOFIN announced that these amendments will be adopted at one of the next European Council sessionsonce the text of the directive is finalised. Member states will be required to transpose these amendments to their national legislation by the end of 2015. In this manner companies will clearly be required to show their real economic substance as well as commerciality of their transactions.

The advantage of Cyprus’ tax legislation is that most Cyprus structures do not use hybrid instruments. Therefore, generally the proposed changes to the directive are not expected to have a material effecton Cyprus. It is advisable, however, for structures involving Cyprus entities that utilize such arrangements to be reviewed at an early stage so that appropriate action can be taken.

As far as the introduction of GAAR is concerned, Cyprus follows the ‘substance over form’ and ‘business purpose test’ doctrines. The Assessment and Collection of Taxes Law, which was amended to transpose the EU Mutual Assistance Directiveinto domestic legislation, already contains anti-abuse rules, under which the tax authorities may disregard false transactions, which they consider to be in place for tax purposes and assess the taxpayer on the proper object of tax. The provisions apply to both local and international transactions, for residents and non-residents.

It is vital for any international structure tofactor in the anti-avoidance rules of the other countries concerned and their tax authorities’ approach to international structures. One of the best ways of achieving this end, is by ensuring that any international structure has as much economic substance as possible.