Executive summary

On 26 July 2021, the Economic and Financial Affairs Council (ECOFIN) approved Cyprus' National Recovery and Resilience Plan (RRP). The RRP sets out the measures that will be supported by the Recovery and Resilience Facility (RRF). The RRF is supported by the NextGenerationEU which will provide €800 billion across the European Union (EU) to help EU Member States recover from the COVID-19 pandemic.

In relation to Cyprus, the RRP includes several reforms and investments ranging from accessibility and overall resilience of the healthcare sector to furthering the green economy. The RRP also sets forth measures to improve tax collection and combat aggressive tax planning. These measures include a set of milestones for their enactment and assessment.

Specifically, the most important measures which will affect the Cyprus taxation system include:

• Introduction of withholding taxes on outbound payments of dividends, interest, and royalties
• Extension of the application of the tax scheme for investing in innovative companies
• Introduction of green taxes
• Introduction of specific measures to improve collection of taxes

This Alert summarizes the key measures.

Detailed discussion

— Component 2.1 – Climate neutrality, energy efficiency and renewable energy – Reform 1: Green Taxation

The objectives of this component are to improve the environment policy through measures relating to green taxation.

This component aims to promote a shift towards a more efficient use of environmental resources, reduce greenhouse gas emissions and to increase the penetration of renewable energy.

The proposed legislative changes will be based on the findings of an independent study and are expected to be implemented by 30 June 2026. These include:

• Carbon tax for fuels used in sectors of the economy not under the EU greenhouse gas Emissions Trading System
• Levy on water
• Charge on household/landfill waste

— Component 3.2 – Enhanced Research and Innovation - Reform 2: Incentives to encourage and attract investments and human capital in Research and Innovation

The objectives of this component are, among others, to strengthen links between research organizations and enterprises and increase intensity in research & development (R&D) activity and investments by both public and private organizations. Furthermore, it aims to enhance financial support to start-ups, scale-ups, SMEs and internationalize the local research and innovation (R&I) ecosystem.

Reform 2 of C3.2. relates to the extension of the application of the tax scheme for investing in innovative companies to legal entities (from physical persons currently) and will be implemented by 30 September 2022.

— Component 3.5 – Safeguarding fiscal and financial stability

The aim of this component, apart from safeguarding financial stability, is to ensure fiscal stability by combating tax evasion, tax avoidance and aggressive tax planning. It is also intended to provide policy makers with comprehensive data in order to design a fair tax system. The envisaged measures are expected to make revenue collection more efficient and Cyprus' tax system fairer, reducing the spill-over effects from aggressive tax planning.

— Reform 9: Improving tax collection and effectiveness of the Tax Department

The objective of this measure is to make tax collection more efficient and effective, through a higher level of digitalization and tax compliance as well as improving customer service.

The reform will consist in integrating different tax units, procedures, and processes, so as to offer single point of taxpayer service. It also will include legislative changes and implementation of a new IT system and digitalization of the Tax department.

The latter will include: (a) a single registration point for the tax base and Taxisnet (for electronic submission of Income Tax Returns by Individuals, Legal Persons and Employers); (b) an integrated tax auditing process based on risk assessment; (c) an integrated refunds audit; (d) an integrated and enhanced single point of service, including the direct payment of Value Added Tax and connecting businesses to a server held within the Tax Department, without the use of specialized mechanisms; (e) a process to issue single tax clearances; (f) possibility for immediate adjustments of the system to accommodate any changes in the legislation and/or procedures and extension of secure interfaces with other information systems; (g) data analysis capabilities; and (h) scanning and electronic storage of all taxpayer paper documents regarding real estate (immovable property) and capital gains with relevant security, integrity and confidentiality parameters.

The legislative changes should be implemented by 31 December 2025 and will include:

• Recently introduced legislation to implement the mandatory submission of tax returns by every natural person with income as defined in Article 5 of the Income Tax Law, regardless of the threshold starting from the tax year 2020 (subject to exceptions)
• Criminalizing the non-payment of income taxes

— Reform 10: Addressing aggressive tax planning

The overall objective of the measures under Reform 10 of C3.5 is to increase the effectiveness, efficiency and fairness of the tax system by combatting tax evasion and aggressive tax planning by multinational enterprises.

The first reform sub-measures, which will be enacted by 31 December 2021 and will enter into force by 31 December 2022, consist of:

• Imposing a withholding tax on outbound payments of interest, dividends and royalty payments made to jurisdictions in Annex I of the EU list of non-cooperative jurisdictions on tax matters.¹
• Introducing a corporate tax residency test which will be additional to the management and control test. The first test shall be the management and control and, in cases where a company is incorporated in Cyprus but its management and control is performed from another jurisdiction, it shall be considered as a Cyprus tax resident and shall be taxed in accordance with the relevant provision of the Income Tax Law, provided that the company is not a tax resident elsewhere (to avoid dual residency status).

The second reform sub-measure, which is expected to be enacted by 31 December 2024, consists of:

• Introducing a withholding tax on outbound payments of dividends, interest, and royalty payments to low-tax jurisdictions. In respect of interest and royalty payments, the Cypriot authorities may explore the approach of applying non-deductibility instead of a withholding tax.

The third reform sub-measure, which should be enacted by 30 June 2026, consists of:

• An independent evaluation which should be completed by 31 December 2024 where Cyprus will assess the effectiveness of the overall set of measures related to aggressive tax planning. This evaluation shall assess the Cyprus tax framework holistically including all measures adopted by then. The evaluation shall lead to policy action to be undertaken by Cyprus to address any shortcomings identified, including in the form of legislative changes, which shall enter into force by 30 June 2026.

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For additional information with respect to this Alert, please contact the following:

Ernst & Young Cyprus Limited, Nicosia

• Eleni Papachristodoulou | eleni.papachristodoulou@cy.ey.com

• Petros Krasaris | petros.p.krasaris@cy.ey.com

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ENDNOTE

1. https://www.consilium.europa.eu/en/policies/eu-list-of-non-cooperative-jurisdictions/.