New Cyprus-Luxembourg double tax agreement enters into force
The double tax agreement between Cyprus and Luxembourg was signed on 8 May 2017 and entered into force on 21 May 2018 following the completion of both countries’ domestic ratification procedures. The agreement will apply to income arising from 1 January 2019 with regard to taxes deducted at source and for tax years beginning on or after that date for other taxes.
The agreement is the first between the two countries. It closely follows the latest version of the Organisation for Economic Cooperation and Development (OECD) Model Tax Convention for the Avoidance of Double Taxation on Income and Capital and is in line with the OECD Multilateral Convention to Implement Tax Treaty-Related Measures to Prevent Base Erosion and Profit Shifting (BEPS). The agreement includes, among other things:
- a preamble which makes clear 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.
Income from immovable property
Income from immovable property may be taxed in the contracting state where the property is situated.
Dividends paid by a company resident in one country to a resident of the other are subject to zero tax in the country from which they originate as long as the dividend’s beneficial owner is a company (but not a partnership) resident in the second country which directly holds at least 10% of the capital of the company paying the dividends. If these conditions are not satisfied, any withholding tax in the first country is limited to 5% of the gross dividends. These provisions affect only dividends paid by Luxembourg investee companies to investors in Cyprus, since Cyprus does not impose withholding tax on dividends paid to shareholders resident overseas.
Interest and royalties
Interest paid by a company which is a resident of one country to a resident of the other is taxable only in the country in which the recipient is resident. Royalties are taxable only in the country 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 of one of the two countries) carries out business in the country from which the income is paid. There are also provisions in the articles dealing with interest and royalties that limit the amounts qualifying for exemption to what would be payable on an arm’s-length basis.
As both countries are EU members, EU legislation – including the EU Interest and Royalties Directive (2003/49/EC), the EU Parent Subsidiary Directive (2011/96/EU) and the EU Anti-tax Avoidance Directive (2016/1164/EC) – will also apply.
Gains derived by a resident of one country from the alienation of immovable property (or of moveable property associated with a permanent establishment) situated in the other may be taxed in the country 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 country 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 country in which the alienator is resident.
Like many of Cyprus’s recent double tax agreements, the agreement with Luxembourg 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 in which they could 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 country that carries out offshore exploration or exploitation activities in the territory (including the territorial sea or exclusive economic zone) of the other is deemed to be carrying out business through a permanent establishment there if the activities last 30 days or more in any 12 months. The article dealing with offshore activities also includes rules for determining when the 30-day threshold has been exceeded in respect of activities undertaken by associated enterprises.
Gains derived by a resident of one signatory country from the alienation of assets (either tangible or intangible) that derive the majority of their value from exploration or exploitation rights in the second country or its exclusive economic zone may be taxed in the second country.
Elimination of double taxation
For most categories of income, the 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 tax rates 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 the 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 the credit being limited to the part of the tax attributable to the income concerned.
Entitlement to benefits
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 based on the OECD Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS. 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 entered into force on 21 May 2018, when both countries completed their ratification procedures, and its provisions will apply in both countries from the beginning of 2019.
The agreement will remain in force until it is terminated. Either country may terminate the agreement by giving at least six months’ written notice through diplomatic channels no earlier than five years after the agreement entered into force. Its provisions will cease to have effect from the beginning of the following calendar year.
Protocol on collective investment vehicles
A 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 pay tax there by reason of its:
- place of management; or
- any other similar criterion.
A collective investment vehicle is also considered liable to pay tax if it is subject to the tax laws of the contracting state concerned but is exempt from tax only if it meets all exemption requirements specified in its domestic tax laws. A collective investment vehicle is deemed to be the beneficial owner of any income that it receives.