Date: 14th November 2024

In today's world where companies operate across borders, the concept of economic substance has become an important factor for businesses who need to establish a
genuine presence in a chosen jurisdiction. If you are considering to use Cyprus as your their tax base, then understanding and implementing economic substance is critical to ensure your company is considered a tax resident in Cyprus. This guide explains what is economic substance in Cyprus, its importance, key requirements, and potential consequences of non-compliance. 

WHAT IS ECONOMIC SUBSTANCE ?

Economic substance refers to the requirement that a company must have a tangible, genuine business presence and that it must conduct meaningful economic activities within the jurisdiction where it claims to be tax resident.

Modern international tax law, largely reinforced by the Organisation for Economic Co-operation and Development's (OECD) Base Erosion and Profit Shifting (BEPS) initiative, means companies have to demonstrate real operational infrastructure, decision-making processes, and legitimate business functions in the chosen jurisdiction. The principle of the regulations is to ensure that companies tax outcomes align with their economic activities, preventing the artificial shifting of profits to low-tax jurisdictions without a corresponding real presence.

WHY CYPRUS ECONOMIC SUBSTANCE IS AN ATTRACTIVE OPTION?

In an era of increased tax transparency and increased compliance regulations, establishing economic substance in Cyprus is attractive for several reasons:

1. To benefit from Cyprus's attractive tax regime, including its competitive 12.5% corporate tax rate, extensive network of double tax treaties, and various exemptions, a company must prove its tax residency in Cyprus. 

2. Mitigating Controlled Foreign Company (CFC) Regulations: Many countries have Controlled Foreign Company (CFC) regulations to prevent residents from deferring or avoiding tax on profits earned by foreign subsidiaries. Your Cyprus company has to prove economic substance, in order for home country authorities to accept Cypriot tax residency and treat its profits accordingly.

3. International Standards: Adhering to economic substance requirements ensures your company complies with EU Anti-Tax Avoidance Directives (ATAD) and OECD guidelines, safeguarding against reputational damage, penalties, and international scrutiny.

4. Banking Services: Banks in Cyprus and overseas are demand proof of economic substance before opening or maintaining corporate bank accounts.

5. Credibility and Reputation: By demonstrating economic substance in EU jurisdiction, a company can build trust with business partners, investors, and regulatory bodies, enhancing your company's overall credibility and long-term viability.
 

HOW TO ESTABLISH CYPRUS ECONOMIC SUBSTANCE?

Establishing and maintaining economic substance is a continuous process that involves several factors depending on a company's activities and structure. In most cases, the following factors are required: 

1. Physical Presence and Office Space: Rental contract for a dedicated, functional office space in Cyprus, with furniture, telephone line, internet facilities, mailing services, etc. Note that residential premises are generally not considered sufficient. 

2. Management and Control: A  majority of the directors should be Cyprus tax residents and  possess the necessary qualifications and experience to make independent, strategic decisions for the company.

3. Board Meetings: Regular board of directors' meetings should be held in Cyprus, where key strategic and operational decisions are made and recorded in signed minutes and resolutions.
 

4. Record Keeping: Important corporate documents, such as minutes, resolutions, agreements, and financial statements must be maintained and accessible at the company's registered office in Cyprus.

5. Local Personnel: There should be at least one staff employed who is registered with the Cyprus social insurance system (can be part-time), who performs local tasks. 

6. Local Expertise: Company should engage local professionals such as lawyers, accountants, and auditors to provide essential and regulatory services to the company.

7. Local Bank Account: Company should open and maintain a corporate bank account with a local bank in Cyprus, with local signatories to prove that transactions and operations are in Cyprus.

8. Operational Activities: The core income-generating activities of the company must be are actually performed in Cyprus.

9. Dedicated Communication: The company must maintain local contact details, including a Cypriot telephone number, email domain, and preferably a website registered at its Cyprus address.

HOW WE CAN HELP?
Our team of experts understand the intricacies of economic substance requirements and can  provide comprehensive support, from structuring your company to ensure substance, to setting up your local physical office, hiring your local staff and assisting you with ongoing compliance. Our experienced associates will help you navigate the local regulations, to ensure your Cyprus company is fully compliant with international tax standards. Partner with us to build a strong, compliant, and tax-efficient foundation for your business in Cyprus.

Disclaimer: This guide is for informational purposes and does not constitute legal advice and is valid at the time of publication. Always consult professional advisors before taking any decisions concerning your financial and residential status.