After ten years of negotiations, Luxembourg and Cyprus signed their first double-tax treaty on 8 May. It is waiting to be ratified by both contracting states. Should they do so before the end of the year, it will take full effect on 1 January. Here, partner Emily Yiolitis and associate Marisa Efstathiou of the international law firm of Harneys burrow into the details.
Like most double tax treaties, the treaty complies with the Organisation for Economic Co-operation and Development Model Tax Convention for the Avoidance of Double Taxation, with two slight adjustments. These adjustments include:
- a preamble, which says that the treaty is not designed to create opportunities for non-double-taxation, or any form of reduced taxation through evasion, or even avoidance; and
- a 'principal purpose test'-based anti-avoidance rule, designed to preclude 'treaty abuse' whereby one of the contracting states might acquire benefits unjustifiably.
The treaty contains no clause that calls for mutual assistance in the collection of taxes, since both contracting states are members of the EU, thus being subject to EU Directive 2011/16/EU that deals with administrative co-operation. In addition, the exchange of information between the two parties complies with article 26 of the OECD Model Convention verbatim.
What taxes are covered?
The specific taxes that the treaty covers are as follows.
- Luxembourg: income tax; corporation tax; capital gains tax; communal trade tax.
- Cyprus: income tax; corporation income tax; capital gains tax; and the "special contribution for the defence of the republic tax" (the SCD tax.)
Article 5 of the treaty defines the phrase 'permanent establishment' and 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 states that income from immovable property may be taxed in the contracting state where the property is situated.
Provisions for determining the residence of people who reside in both countries are the same as in the OECD Model Convention. These include 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.
The profits of an enterprise are taxable only in the contracting state in which it is resident unless it carries on 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.
The withholding tax rates on dividends have been reduced to 0% in the case when there is at least 10% participation by a tax-resident company.
However, this increases to 5% of the gross amount in all other cases. In terms of interest payments, there are no withholding tax rates, much like royalty payments, where it is also 0% as long as the recipient of the royalties is, in fact, the beneficial owner of the income.
The elimination of double taxation
With regards to elimination of double taxation, the exemption method is to be used in Luxembourg, whereas (as with most double-tax treaties) in Cyprus, it must be done through the credit method, with credit being limited to the part of the tax a priori to the income concerned. Additional comprehensive clauses have also been added, which regulate the taxation in the field of offshore activities, including exploitation and exploration activities. These additional provisions have been adopted to guarantee each contracting state's rights under these circumstances.
The treaty states that:
- any gains derived by a resident of one of the contracting states, from the alienation of immovable property (or movable, if associated with a permanent establishment) which is situated in the other contracting state may be liable to tax in the country in which the property itself is situated;
- any gains derived from the disposal of shares in a business organisation, which acquire more than 50% of their value from immovable property situated in the other contracting state, may be taxed in the contracting state in which the property is situated; and
- any gains derived from the alienation of any other form of property are liable to tax only in the contracting state of which the alienator is a resident.
The treaty intends to preserve each state's rights to levy taxes in respect of offshore activities, stopping some of its other provisions from otherwise limiting those rights.
A person who carries out offshore exploration or exploitation activities in one contracting state to the territory (including the territorial sea or exclusive economic zone) of the other for an aggregate of 30 days or more in any 12 months is deemed to be carrying on business through a permanent establishment there.
The treaty 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 off shore exploration and exploitation of resources are taxable only by the country of which the enterprise concerned is a resident.
With regards to employment income, the provisions 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 residence of the employee. 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 on the activities is resident.
Exchange of information
With regards to exchange of information, the treaty reproduces Article 26 of the OECD Model Convention verbatim.
Abuse of any exchange of information in Cyprus is safeguarded by the provisions of the Assessment and Collection of Taxes Law. Requests for exchange of information are solely dealt with by the International Tax Relations Unit (ITRU) of the Tax Department. Exchange of information may take place only through the ITRU: direct informal exchange of information between tax officers bypassing the competent authority is prohibited. The authorities that ask for the information must already have a strong case even before they make their request. Accordingly, it will not be possible to follow up a suspicion without first gathering significant evidence. Moreover, the written consent of the Attorney General is required before any information is released to an overseas tax authority.
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.
The enhancement of trade
The treaty bodes well for both parties, and upon ratification, it shall enhance trade and encourage economic growth of both contracting states. The Treaty will increase Cyprus' popularity as a preferred destination for any form of foreign direct investment coming from Luxembourg and other European nations, investments which are part of a larger collective investment vehicle put in place, which is strictly regulated, and is compliant with the protocol of the OECD Model Convention
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.