The Cypriot government has announced that it will defer the implementation of the above Directive until 1 January 2025. However, they have not, to date obtained a derogation to this effect (unlike in the case of the requirement to store customs data electronically1).

The rest of the EU, and no doubt many other countries which are applying tests similar to this, will be applying the substance requirement from 1 January 2024.

What does this mean? An Example

A group of EU and non-EU investors, decided a few years ago to develop an apartment block in Slovenia2 and to make it simple, they need a holding company and as Cyprus is ahead of the EU on notional interest deduction (NID)3 such that none of them need worry about treaty relief claims for interest or dividends.

Slovenia is a beautiful country but its finances, like most small countries, are not great. The development project is debt funded from Cyprus. Interest has accrued but not paid and now that some apartments are being sold there is cash which can be used to pay interest. As a 100% subsidiary, the Interest and Royalties Directive4 should permit interest to be paid gross to Cyprus.

Clearly the Slovenian company has no desire nor incentive to withhold tax from its parent company (save as a protection, just in case). But the Slovenian tax authority might question whether there is any substance in Cyprus in accordance with ATAD3.

The process is that the Slovenian tax authority must ask the Cypriot tax authority whether the Cypriot company in this case has substance. What is Revenue Cyprus going to say? Ask me next year? We are not complying in this year? The dog ate my homework?

In my view, the Slovenian Tax authority would, should, and could direct the Slovenian company to withhold tax at 15%. Even if that is eventually recovered, who wants to make interest free loans to the Slovenian government?

And what if one of the investors was based in Germany (BDR)? Could the German Bundesfinanzamt claim to be able to tax the interest and ignore Cyprus altogether? Given that the German corporate tax rate is 25% and the Slovenian tax withheld is 15%, then there would be a clear incentive for Germany to do this as an alternative to receiving dividend income from the Cypriot company.

The message

John Donne said ‘no man is an island’. Whilst Cyprus is actually an island, in tax terms it is not. It is part of the EU and accordingly in the sphere of taxation, its ability to act unilaterally, as if it were an island for tax purposes instead of a state in a wider Union, is limited.

And of course who pays? The taxpayer. Whatever the Government of Cyprus says, it would be imprudent to rely on the Government’s position. Make sure you have substance in Cyprus now.


1. COMMISSION IMPLEMENTING DECISION (EU) 2023/237 of 1 February 2023 granting a derogation requested by certain Member States to use means other than electronic data- processing techniques for the exchange and storage of information related to the customs declaration for goods brought into the customs territory of the Union laid down in Articles 158, 162, 163, 166, 167, 170 to 174, 201, 240, 250, 254 and 256 of Regulation (EU) No 952/2013 of the European Parliament and of the Council laying down the Union Customs Code (notified under document C(2023) 667).

2. It could be any EU member state.

3. The EU equivalent is DEBRA (Debt-equity Bias Reduction Allowance).

4. 2003/49/EC.

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