A controlled foreign company is a company which is registered and conducts business in a different country or jurisdiction than that of the controlling owner. Tax authorities around the world generally have in place rules to prevent the use of such structures as a tax avoidance strategy, whereby profits are diverted from a higher to a lower tax jurisdiction, often with the use of an offshore tax haven.
Legislation preventing the use of such overseas tax havens as a means of reduce corporate and income tax has been in place in many countries for a number of years, including the US, the UK and most other European countries. Basically these rules operate on the same principle – if profits are diverted to a CFC, then profits are apportioned and charged as if they were earned in the country in which the owner is tax resident, and charged at the appropriate tax rates.
There are a number of tests used to determine if a non-resident company is controlled by a person or persons from a different tax jurisdiction. These again differ from country to country, but, in the UK, for example, control is determined by reference to:
- Legal control;
- Economic control;
- A joint venture test; and
- Accounting standards.
CFC rules apply not only to large corporations but also to medium and small companies as well, all of whom may find themselves under scrutiny by local and foreign tax authorities.
Cyprus does not have any CFC rules at present, but that does not mean the impact of such legislation can be ignored if a Cypriot company is part of a wider international group. Of course, Cyprus is not a tax haven but, with its low corporate tax rate, there may need to be prove that any operation established in the country has “substance”, and has not merely been created as a tax avoidance mechanism.
in essence, if a foreign structure appears to lack substance, tax authorities may challenge its validity, and seek to tax profits in higher tax rate jurisdictions. Substance is not precisely defined in any Double Tax Treaty or other legislation, and can be open to differing interpretations. Nevertheless, substance is something that needs to be defined by reference to practice and concrete examples.
Typically, the definition of economic substance is if a transaction or entity based in a low tax jurisdiction has an economic purpose, and there is an infrastructure to support it, such infrastructure being real and not an artifice created for the purpose of reducing tax. This can be achieved by various means.
For example, ensuring that all entities, including holding companies, have a real physical presence in Cyprus, with a local office and staff employed, administering the day-to-day management of the company. This means employing local staff, for example, and paying social security and payroll tax, as applicable.
Such demonstrations of economic substance may include the following:
- The company with its own office (rented or owned) and physical address in Cyprus;
- There are qualified directors and managers who are located in Cyprus and other relevant Cypriot employees;
- The company maintains local bank accounts with local authorised signatories;
- The accounting records are maintained in Cyprus with the accounts’ work performed by local accountants;
- Regular Board meetings are held in the country and minuted;
- There is a website, email address and telephone number.
Whilst Cyprus may have no CFC rules itself at present, this does not mean the issue can be ignored. Local CFC rules imposed by another country may require a Cypriot company to demonstrate for foreign tax purposes that it has real economic substance. In such cases, the obligation may be on the Cypriot company to demonstrate that it is performing genuine business in Cyprus.
This can raise genuine concerns about the increased cost of establishing and maintaining a Cypriot company because of the need to maintain a physical office etc. This does not necessarily need to be the case. AJD Consultants, for example, can provide a registered office address, resident director and company secretary. and offer other advice to ensure that the test of economic substance can be passed. In addition, we can provide advice as to means of structuring the company so that tax can legitimately be minimised.
Please contact us directly if you required further information as to how we can help you comply with CFC rules.