Recently, the Cyprus Central Bank issued guidance to banks & credit institutions, advising them of the new mandatory refusal to take on new clients or to continue servicing existing accounts with so-called shell or letter-box companies.

This has exemplified the requirement for businesses to have real substance in order to operate and benefit from tax residence in Cyprus. These guidelines are due to be incorporated into the Central Bank’s AML Directive shortly, so what does this mean for Cyprus based businesses? Firstly, its necessary to describe what the Central Banks classifies as a Shell company.

SHELL, SUBSIDIARY & LETTER-BOX COMPANIES

A shell company is defined using the following characteristics:

• It has no physical presence in its country of domicile, apart from a mailing address.
• It is not publicly traded.
• has no established economic activity, little to no independent economic value and no documentary evidence to suggest otherwise.
• It has no tax residence or has tax residency in a jurisdiction recognised as a tax haven.
• It is registered in a jurisdiction in which companies are not required to file audited financial statements.

The key elements of substance are management adequacy and capital, the key steps to establishing physical presence in Cyprus:

1. Recruit a management team to be located in Cyprus. Ideally individuals possessing the knowledge and skills needed to control and oversee the main operations of the company and can make important business decisions in Cyprus.
2. Recruit a team of employees, a receptionist, HR Officers, IT support staff: the presence of any lower level staff members shows decisive obligation.
3. Consider actively taking part in the local business community by joining the Cyprus Chamber of Commerce or the Cyprus International Businesses Association.
4. Trading companies incorporated in jurisdictions recognised as tax havens must become tax resident in an appropriate jurisdiction in order to continue to use banks in Cyprus.
5. Sufficiency of capital means ensuring your business has enough funds to assume its liabilities and operation risks for the current financial year. Therefore, this proves that the company is not a mere proxy, and the profits or losses from the operations evidently belong to it alone.

LIMITATIONS TO PHYSICAL PRESENCE

The guidelines stipulate that trading companies with no effective place of business or management, and therefore no substance, will not be permitted to maintain bank accounts in Cyprus. Additionally, representation by means of nominee services provided by corporate service providers or lawyers does not count as being physical presence.

As long as the company’s Beneficial Ownership information is revealed, and they demonstrate that they are engaged in legitimate business, these limitations do not apply to the following vehicles:

• Holding companies owning investments in shares.
• Holding companies owning intangible or other assets.
• Real estate or property.
• Companies undertaking group financing activities.
• Companies acting as a treasurer.
• Companies established to facilitate currency trades or corporate mergers.

SIZE OF CAPITAL REQUIRED

The optimum degree of presence required for a Cyprus company will be determined by the company’s individual requirements. For example, if a holding company only has one investment and the only decision is to declare a dividend once a year, or if a financing company only has one loan, the physical presence required is much less than for a larger business.

Banks & lenders in Cyprus may choose to take on a shell-company client, however a high risk-based approach will need to be followed in their dealings & servicing. Going forward, Cyprus Banks will be required to carry out a review of their customers to identify such companies, and must have informed the Central Bank (the deadline of which was August 1st) whether they have passed and whether they intend to continue their business relationship with the relevant entities.

A company lacking sufficient management and capital may be entirely disregarded by foreign tax authorities, effectivley rendering any taxes payable by the Cyprus may also be payable to the Beneficial Owners country of residence. The availability of a notional interest deduction in Cyprus incentivises companies to increase their capital and substance, and to benefit from reduced tax rate on new equity.

We have local taxation specialists on hand to assist with any restructuring or incorporations in Cyprus, contact us for more information.