Cyprus, a thriving European nation strategically located at the crossroads of three continents, has established itself as a popular destination for international business activities. However, in recent times, Cyprus has witnessed increased scrutiny from international organizations regarding real and economic substance. This article aims to shed light on the significance of substance in Cyprus and its implications for businesses.
Understanding real substance
Real substance refers to the presence of actual economic activities conducted by a company beyond mere legal and administrative formalities. It involves the physical presence of employees, tangible assets, decision-making processes, and the provision of core functions and services within a jurisdiction. Real substance ensures that companies’ activities genuinely contribute to the local economy and are not artificially structured to exploit tax benefits.
The importance of real substance in Cyprus
Compliance with international standards: Cyprus, as an active member of the European Union (EU) and the Organisation for Economic Co-operation and Development (OECD), is committed to upholding international standards on tax transparency and fair taxation. Demonstrating real substance is crucial to align with the requirements set by these organizations and avoid potential reputational risks.
Substance over form: In recent years, there has been a global shift towards substance over form, emphasizing that the economic reality of a transaction or business structure should prevail over its legal form. This shift aims to combat aggressive tax planning and profit shifting, ensuring fair tax contributions and preventing the misuse of tax advantages.
Attracting foreign investment: By strengthening real substance requirements, Cyprus aims to attract high-quality foreign investment and discourage purely tax-driven structures. Investors seeking long-term stability and sustainable growth are more likely to choose jurisdictions that demonstrate genuine economic substance, which benefits both Cyprus and the investors themselves.
Economic substance framework in Cyprus
Economic substance is the set of requirements which a Cyprus company should meet in order to perceive it is actually existing in that jurisdiction.
The requirements for economic substance are the following:
- The company director should be local;
- The company should have employees, whose qualifications should be in line with the activities of the company and who should be local;
- The company has local expenses;
- The company has an office sufficient to carry out profit-generating activities;
- The company carries out activities generating profit in the jurisdiction.
The key elements of economic substance are:
- The actual implementation of profit-generating activities;
- Place of effective management;
- Current local expenses;
- Office rental.
To comply with requirements companies should pass the test for the organization of economic substance. In passing this test, it is necessary to ask yourself the following questions:
- Are you planning to identify the company as a tax resident in this jurisdiction?
- If yes, has the jurisdiction adopted economic substance legislation?
- If yes, are the company’s activities (key activities aimed at generation of profit) associated with the relevant activities specified in the legislation?
- If yes, which substance level is required for these activities?
- If yes, are you planning to carry out actual management and control in this jurisdiction?
- If yes, are other elements of substance, the set of which depends on the relevant activities, complied with?
- Employees;
- Address;
- Expenses;
- Other.
If any requirement mentioned above is not and cannot be complied with, you need to think about changes in the structure of the company, its management, and functionality, or about the need to take more radical measures, for example, change of tax residence.
In the end real and economic substance are vital aspects that Cyprus is actively addressing to maintain its position as an attractive destination for international businesses and investors. By embracing international standards and implementing substance requirements, Cyprus reinforces its commitment to fair taxation, transparency, and sustainable economic growth.
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