The Cyprus holding companies are widely used in the context of international business structuring for the optimization of the channels of incoming and outgoing investment in/from the countries that have signed an agreement with Cyprus on avoidance of double taxation. Recently, the Tax Department has published a guide to VAT accounting for holding companies, which is designed to provide clarity with respect to the circumstances under which the Cyprus holding companies can receive taxable income.

Definition of taxable activities

The common position and practice regarding the regime for levying VAT on dividends remain unchanged. The simple acquisition and ownership of shares in other companies by a Cypriot company does not constitute a taxable business activity in the sense of exploiting assets for income generation. The reason for this approach is that the dividends received from such ownership of shares are considered to arise solely at the expense of ownership of shares, rather than from the form of business activity carried out for the purpose of income generation. Consequently, an enterprise that simply owns shares or a similar form of a stake in another organization is not considered to be taxable. However, if a holding company goes beyond the simple exercise of its rights as a shareholder and takes an active part in the management of its subsidiaries, directly or indirectly, this may constitute a taxable activity.

The test for determining whether such participation in management exists is objective. There are no decisions in the European Court that set out specific rules or precedents on this issue. Each case must be considered individually on specific facts and circumstances. The instruction states that the term “management” can cover a wide range of activities, from organization and administration to the adoption of strategic decisions. These actions can be taken directly, that is, by a legal entity owning shares or indirectly - by a person hired or connected with a legal entity that owns the shares.

Any evaluation should be based on the essence, not on the form. For example, do the directors of affiliated companies exercise autonomous powers to manage their business, or do they simply mechanically approve decisions made at the level of the holding company? These issues should be resolved on the basis of specific facts, such as the degree of duplication or general powers of the director and decisions of the board of directors.

A holding company that has a controlling interest in a subsidiary company clearly has the right to influence the decision-making process in the subsidiary. If the facts show that the holding company exercises this right, any dividends received can be considered a reward for the provided management services and, therefore, income from business activities.
An additional important factor is that the holding company has the necessary human and other resources to provide such services. The instruction states that in some cases the holding company can not use its authority to influence its subsidiary, therefore it is a passive investor with the sole purpose of obtaining dividends without participation in management.

The current jurisprudence is that the company’s participation in the management of the invested company is recognized as economic activity in accordance with Article 3 of the VAT Law and Article 9 (1) of the EU VAT Directive (2006/112 / EU) and therefore it is subject to VAT in accordance with Article 5 of Cyprus Law and Article 2 of the EU Directive.
A holding company, like other companies, must be registered by a VAT payer if its taxable supplies exceed the registration threshold or it receives services from foreign suppliers that must be taken into account within the framework of the reverse charge mechanism.

Otherwise, the holding company can be registered voluntarily. The amount of input VAT that the holding company can reimburse will be based on the distribution between its taxable and non-taxable activities.

In a press release of January 29, 2018, the Council of Europe announced the second set of additional directives on the negotiations detailing the position of the EU-27 (27 EU Members without the UK) regarding the transition period with respect to Brexit. These directives give the Commission the authority to initiate discussions with the UK on the terms of Brexit and establish a transition period, no longer than until December 31, 2020.
During the transition period in the UK, full and constant application of the EU legislation is provided. However, the state will no longer participate in the EU administration and the decision-making process.
On January 30, 2018, the EU Commission published a document warning the companies of the key challenges in the customs and VAT that they will have to be overcome when the United Kingdom is not a Member of the EU. If no other transition period is agreed between the EU and the UK, the European Customs and VAT regulations in the UK will no longer apply from March 30, 2019, as the UK officially announced its intention to leave the EU on March 29, 2017. This document provides a brief overview of the customs and VAT implications that will arise from the actual date the UK left the EU. From the date of delivery to and from the UK, it will be qualified as imports and exports, rather than intra-Community sales (including the filing of customs declarations, the application of customs duties, etc.).
The document also emphasizes that a number of licenses (for example, customs licenses, the status of the Authorized subject of economic activity) issued by the UK government will no longer operate in the EU and the imports to the UK will no longer be able to use the preferential tariff agreements concluded by the EU with third countries.
A number of other issues, such as the impossibility of the UK to use the European MOSS system and VAT refund procedure after the end of EU membership, are also briefly considered. Moreover, the British companies will be treated as non-EU companies, so they may need to appoint a fiscal representative in a number of Member States for their local registration as VAT payers.
On November 7, 2017, the UK government also published a draft law on taxation (cross-border trade), which is part of the basic legislation establishing the British legislative framework in the field of customs and VAT. At this stage, there are no detailed provisions on many issues. The bill has passed the second reading in the Parliament on January 9, 2018. At present, there is no declared position regarding the transition period, but it is expected in the upcoming government statements.
According to the information document to the British bill, it is designed in such a way to be flexible enough for a range of possible outcomes of the negotiations, including a transition agreement and a scenario where the agreement has not been reached.
In any event, there is uncertainty in the final form that Brexit will acquire and its timing. In this regard, it is recommended for the British companies, as well as European companies with British ties and interests to prepare for the worst possible option, the so-called “complex Brexit scenario”. Along with other issues for the settlement, the implications for VAT and customs clearance will be central to the preparation of Brexit.

The companies which have customers in the European countries have to determine the state in which their income is subject to VAT and related consequences with respect to the indirect tax.

The supply of “services” is defined as something that is not a “commodity”. Each supply of services should be analyzed in the light of the rules of the place of delivery in order to ensure the right accounting of VAT by the right person in the proper jurisdiction. It is especially important on making global sales that may lead to VAT obligations, and the rules of the place of delivery are the starting point for this.

As in the case of goods, there are different rules for determining the place of delivery (as well as, accordingly, the place of their taxation) for the services provided to the business (B2B) and services to the end user (B2C).

As a general rule, the provision of B2B services is taxed at the location of the client. In this case, the customer must provide the VAT number to the service provider, otherwise such a transaction is considered as B2C. If the client is a resident of a third country (not EU Member State) and does not have a European VAT number, he must provide documents confirming the conduct of his economic and business activities for his consideration as a business client.

The provision of B2C services (for end users), as in the case of the supply of goods, is subject to VAT at the place of registration of the supplier.

The mechanism for the tax collection in the case when the country of the supplier does not coincide with the country where the service is provided is similar to that mechanism that is used for the delivery of goods: when the B2B service is provided, the supplier issues a VAT invoice at a rate of 0%, and the customer reports on VAT by means of the reverse charge mechanism. When the B2C service is delivered, the supplier issues a VAT invoice at the rate of his country.

It is important to explain what the reverse charge mechanism is. This mechanism was created to simplify VAT reporting in 1993, when the European VAT was reformed to launch a single market. Its essence is that the responsibility for VAT accounting is shifted from the seller to the buyer. The recipient of the goods/services is obliged to declare both his purchase (input VAT), as well as the supplier’s sales (output VAT). That is, he displays in his declaration the amount of VAT (at the rate of his country) to pay and the same amount of VAT to deduct. Thus, two postings cancel each other in terms of cash flow. However, from the point of view of regulatory authorities, this is the way to report for this transaction. This information is also displayed in reports on the supply of goods or services for cross-border supplies (EU Sales List).

The mechanism for accounting and payment of VAT for various transactions is shown in the following table below:


Инфографика

Exceptions are electronic, telecommunication, TV and radio broadcasting services B2C, when the obligation on VAT in the customer’s country lies with the supplier. In this case, he can use Mini One Stop Shop (MOSS). We will discuss this topic in details in one of our following blogs.

In order to ensure VAT revenues in the country of actual consumption of the service, special tax rules were introduced at the place of effective use and consumption of the service:

  • B2C services provided by the intermediary are taxed at the place where the main transaction is taxed in which the intermediary participates. For example, a private owner of a villa in Spain wants to move furniture to his house in Germany, for this purpose he asks the intermediary to find a company that will carry out the transportation. Regardless of where the intermediary is registered, a Spanish tax will be levied for the commission, since the place of departure is the place of taxation within the European transportation of goods.
  • B2B and B2C services related to real estate are taxed at the location of this property.
  • Passenger transportation services (both B2B and B2C) are subject to VAT in proportion to the distance along the route in the territory of each country. For example, the price of a ticket for a bus trip from Poland to France via Germany will include VAT in Poland, Germany and France, which is proportional to the distance traveled in each of these countries. If the route passes through Switzerland, VAT will not be charged for the distance traveled in this country, since Switzerland is not a member of the EU.
  • Intra-European transport of goods B2C (goods departing from one Member State and arriving in another) are taxed at the place of departure.
  • Subsidiary to cargo services B2C services, such as loading and unloading services, are taxed in the Member State where these services are physically performed.
  • Services B2B and B2C for short-term lease of vehicles (up to 30 days, in case of vessels - up to 90 days) are taxed at the place where the vehicle is actually transferred to the client’s disposal.
  • Long-term rental services for vehicles B2C will be taxed at the place where a private customer is registered, he has a permanent address or usually resides, except for the cases when the service provider for renting a pleasure craft is registered in the same Member State in which he transfers the vessel to the customer.
  • Services for holding cultural, artistic, sports, scientific, educational, entertainment and similar events, both B2B and B2C, are taxed at the place where these events take place.
  • Restaurant and catering services of B2B and B2C are subject to VAT at the place where the services are physically performed. When these services are delivered in passenger transport operating within the EU, the tax is paid at the place of departure.
  • Electronic services B2C provided by suppliers from third countries to the customers in the EU should be taxed at the location or residence of the customer. For example, if an individual living in Hungary uses an American online library, the Hungarian VAT must be paid for the amount of the service of the American company.
  • Telecommunication, TV and radio broadcasting services B2C will be taxed at the place where the customer is registered, he has a permanent address or usually resides. If these services are provided by the suppliers from third countries to private customers in the EU, they are taxed at the place where the private customer uses this service. For example, a German private customer with a Swiss telephone service provider using his mobile phone in Germany will pay German VAT. When using his mobile phone during his holidays in Cyprus, Cypriot VAT will will be charged for his calls from Greece.

Each EU Member State is responsible for implementing a rule for the effective use and consumption of the service. In this regard, Member States have the right to decide on a change in the location of the provision of services (both within and outside their territory) for vehicle rental services or certain B2C services for the customers outside the EU if the place of service provision in accordance with the rules of the place of effective use and consumption differs from the place of service in accordance with the general rule. Such an opportunity is provided to EU Member States to prevent double taxation, tax evasion or distortion of competition.

As you can see, it is necessary to understand the nature of this service and the status of the client for the correct definition of the rule for the taxation of the service. But it is often not enough, as pan-European rules are just the tip of the iceberg. Since the VAT rules of each individual European country can differ significantly, in order to plan adequately the activities of a specific company with specific counterparties, it is necessary to study the practice of law enforcement in the relevant jurisdictions.

On July 27, the list of organizational and legal forms of foreign counterparties on the countries / territories was officially published (and therefore entered into force), operations with which can be recognized as controlled for the purpose of control of transfer pricing (TP). This list was approved by the Resolution of the Cabinet of Ministers of Ukraine No. 480 of July 4 of this year (hereinafter - the List) for the implementation of the provisions of the Tax Code of Ukraine on TP, namely the clause "d" 39.2.1.1 art.39, and it is another criterion for the recognition of the operation as controlled one. If we look more widely, this can be seen as the next step of our government within the framework of global campaign on de-offshoring, namely to fulfill the commitments to implement the BEPS plan (its minimum standard), which Ukraine assumed with the acquisition of an official BEPS membership from 1 January, 2017.

The list includes more than 90 organizational and legal forms from 26 countries and territories. The absolute majority of organizational and legal forms on the list are partnerships (about 80% of total amount). There were also some forms of investment funds and companies, limited liability companies, associations, international companies, etc. It is noteworthy that the List includes the forms of the companies not only of those jurisdictions that are traditionally used in tax planning schemes (for example, the British LLP or the UAE free zone company), but also organizational and legal forms in the jurisdictions with traditional tax load (Germany, France, Poland) and even exotic for our perception types of the companies of Asian countries (Korea, Japan, Israel).

The Government used the data of the OECD report on taxation of partnerships, as well as the information bases of the International Bureau of Fiscal Documents, to compile the List. The main criterion was the payment of profit tax.

That is, from now on, the fiscal authorities believe that if a non-resident is established in one of the organizational and legal forms of one of the states specified in the List, he does not pay the tax on the profit of the enterprise, including the income outside the state of registration, and / or he is not a tax resident of the country of registration. Accordingly, all the transactions of the Ukrainian taxpayers with such counterparties, with the volume of more than 10 million UAH for the reporting period will be recognized as controlled, and therefore the TP rules will be applied to them.

The only way to avoid control is to prove the opposite, that is, the payment of tax by a non-resident in the country of registration in the reporting year. Then business transactions with this non-resident in this reporting period will be recognized as uncontrolled, if, of course, there is compliance with other criteria defined by law. This possibility is provided for by the part 2 par. 39.2.1.1 art.39 of the Tax Code.

The bad news is that neither the procedure for confirming the tax payment nor the list of documents by which such payment can be confirmed has been established. And this means that, in practice, a taxpayer may face difficulties in proving the fact of paying a tax in the country of registration to the Ukrainian fiscal authorities.

The matter of the possibility of applying the provisions of agreements on avoidance of double taxation to the payments of such non-residents is not less important. Most likely, it will become difficult to use in practice the advantages of the international agreements in the tax sphere for non-residents, whose organizational and legal form is included in the List.

Another important issue - which reporting period will the transactions with counterparties be started to monitor, which organizational and legal form is included in the List? We assume that the disputes will inevitably arise on this issue, since the Tax Code contains two conflicting norms. Thus, the second part of par. 39.2.1.2 Article 39 establishes the moment when this criterion of the controllability of business transactions comes into force - on 1 of January of the reporting year, following the calendar year in which the countries were included in the List. This means that the deals made since 2018 will fall under the control of the TP.

At the same time, cl.41 Subsection 10 of the Transitional Provisions of the TCU states that economic transactions with non-residents, which organizational and legal form is included in the List, are recognized as being controlled from the date of introduction of the List. And this means that this norm makes report for the operations committed this year already.

We still incline to the first option, because the second one contradicts at once two basic principles of the Ukrainian tax legislation, established in art. 4 of the TCU: presumption of legitimacy of the decision of the taxpayer in the event of legal conflict and stability - a ban on the introduction of any elements of the taxes and fees in less than 6 months before the start of the new budget period.

Summarizing, we want to note that Ukraine is moving towards a worldwide policy to fight with tax evasion and approving the concept of paying taxes at the place of business and earning income. It is also obvious that in the future such a struggle will only intensify. The approval of the List has become, even though expected, but still a challenge for the businesses using the tax optimization schemes with the help of the foreign partners and counterparties. We see this as another signal to the need of revision of such structures.