In adapting to the shifts in global standards for company establishment and taxation policies, companies face greater regulations on the demonstration of economic substance in the EU. In other words, an EU-registered company must prove that its management, business activities, and executive functions are real and in the jurisdiction of registration and tax residency.
With increased international standards to what is considered economic substance for EU companies, Cyprus is a key location to establish tax residency and substance. Benefits of Cyprus company formation include a strategic location, stable legal system, EU membership status, competitively low corporate tax rate at 12.5%, as well as several other tax incentives for individuals and businesses alike. The growing industries of Cyprus alongside an educated, professional pool of talent in the workforce make the jurisdiction a friendly locale for businesses and its employees.
The Aspen Trust Group reviews the role of economic substance for EU companies, significant economic substance legislation to know about, and the top ways your company can be sure to pass economic substance tests in Cyprus.
How Economic Substance for EU Companies is Determined
The driving force behind the establishment of economic substance for EU companies began in December 2017 with the introduction of the Code of Conduct Group by the Council of the EU. Through this group, investigations are carried out on the tax policies of EU member states as well as third countries. As a result, an EU blacklist of 13 international financial centres (IFCs) was published that presented concerning components of economic substance requirements.
In June 2018, a scoping paper issued by the EU laid out the economic substance requirements that IFCs were required to implement by 2019 regarding the real economic activities of legal entities.
Other international organizations have also taken measures to create better substance requirements in conjunction with the European Union. Mandates have also come from the OECD such as the Base Erosion and Profit Shifting (BEPS) regulation. The EU’s policy framework as well as the principles of the OECD are the new guiding policies for all financial centres worldwide, as demonstrated in the OECD’s Forum on Harmful Tax Practices.
Economic substance in the EU is established through two tests – The Directed and Managed Test and The Core Income Generating Activities Test. These two tests check that business management is done within the jurisdiction of tax residency, including decision-making events and the inclusion of the minutes of meetings, and that income derived from the relevant business activities meet certain thresholds within the jurisdiction of tax residency as well.
An additional test, The Adequate Test, serves to remind companies that a physical presence and a reasonable number of in-jurisdiction employees to perform business operations are required to establish a true business presence in Cyprus.
The Role of Headquartering for Legal Entities
Headquartering in the tax residency of Cyprus is the foundation for meeting economic substance EU criteria. Having a physical presence, with local or tax resident employees, and participating within the local business community are the key takeaways in the path towards passing the substance tests. In this article, we will cover more areas of business operations that stem from the headquarters of a business that are fundamental to establishing true economic substance and enjoying the benefits of Cyprus’s favorable tax regime.
Creating Economic Substance
There are seven areas of business activities that can affect the economic substance in EU company assessment. Focusing on and improving upon these vital operations can ensure that your company never has to worry about substance and related tax penalties.
Office Real Estate
One of the most important aspects of economic substance by EU standards is creating a formal office or headquarter in Cyprus. A P.O. Box puts the company at risk by skirting around an actual presence in the country. Purchasing and utilizing office real estate in the tax jurisdiction is an essential base step towards demonstrating real economic activity that occurs in Cyprus.
Once a real location is established, internal operations must be conducted to pass an economic substance test. Hiring locals or relocating foreign nationals who are part of the management team allows for transparency and proof of in-country activities, especially if these individuals qualify to be tax residents of Cyprus.
Decision-Making in Headquarters
Another important focus for companies should be the location of the decision-making process. Even if shareholders or management often go overseas, the company should take initiative to encourage decisions to be made in person in Cyprus. This ensures that the company’s tax residency is never in question.
Company formation in Cyprus requires certain thresholds for employee registration depending on the structure. It is important to not only meet these requirements but also to hire enough employees to complete normal business operations.
Outsourcing, which we will also discuss, can be a useful tool in the business process, but it should not be relied upon for all business functions when measures must be taken to establish the economic substance in the EU.
There are no regulations that prohibit outsourcing, however, companies should be aware of the impact that reliance on too much outsourcing can have on the overall substance of the company.
Crucial management functions should remain within the company and clear, regular communication should be established between the company and outsourcing partners throughout the entire length of the process to ensure that substance remains mostly in Cyprus.
Retain Documents In-House
All legal documents and company-related paperwork should remain in the Cyprus office or be accessible in the office at any time if they are uploaded to cloud data systems. Accounting and reporting documents should be included and management must approve each of these to assert that vital business operations and core income-generating activities are indeed occurring within the jurisdiction.
Finally, Cyprus companies should focus on improving participation within the local ecosystem of businesses. Establishing a local domain, company and employee profiles, and local contact information are significant components of establishing a business presence in Cyprus. Moreover, participation and networking within the local business community offer many rewards beyond just meeting economic substance EU requirements, such as beneficial partnerships and stronger, healthier business practices.
Pass the Economic Substance Test with The Aspen Trust Group
Cyprus presents international companies with one of the most advantageous tax and business environments anywhere in the world, but to qualify for these benefits companies need to establish and maintain economic substance by EU standards.
Further, businesses can utilize the aspects of economic substance requirements for tax purposes but also to gain more credibility and worthwhile business partnerships at large. The global community is increasingly turning its attention towards eliminating offshore structures and other legal entities that do not contribute positive and relevant activities to their tax jurisdictions.
The Aspen Trust Group has a team of international professionals ready to assist your business with Cyprus company formation, employee relocation, and other risk assessment services to ensure that your company avoids EU blacklisting under recent economic substance legislation. Let us help you meet economic substance EU requirements for rewarding business practices in Cyprus’s ideal tax jurisdiction.