Cyprus holding companies are widely used in the context of international business structuring to optimise the channelling of inbound and outbound investments with countries that have signed a double tax treaty with Cyprus.

The Tax Department recently issued a circular on the value added tax (VAT) treatment of holding companies, which aims to provide clarity regarding the circumstances in which Cyprus holding companies can be deemed to be earning income that may constitute taxable income.

Determining taxable activity

The general position and practice regarding the VAT treatment of dividends remains unchanged. The mere acquisition and holding of shares by a Cyprus company in other entities does not constitute taxable business activity in the sense of the exploitation of assets to generate income.

The justification for this approach is that dividends derived from such share holdings are deemed to arise solely through the ownership of shares, rather than from a form of business activity undertaken with the aim of generating income. Consequently, an entity which merely holds shares or a similar form of participatory interest in another entity is not deemed to be conducting a taxable activity. However, if the holding company goes beyond the mere exercise of its rights as a shareholder and becomes actively involved in the management of its subsidiaries, either directly or indirectly, this may constitute a taxable activity.

The test for determining whether such an involvement in management exists is an objective one. There are no European Court of Justice decisions that set out concrete rules or precedents on this matter. Each case must be considered individually on its particular facts and circumstances.

The circular points out that the term ‘management’ may encompass a wide range of activities, ranging from organisation and administration to strategic decision making. These actions may be undertaken by:

  • the legal entity holding the shares (directly); or
  • a person employed by or associated with the legal entity (indirectly).

Any assessment should be based on substance rather than form. For example, do the directors of the subsidiaries have and exercise autonomous powers to manage their business or do they merely rubber stamp decisions made at the holding company level? These issues must be decided based on concrete evidence, such as the extent of overlapping or common directorships and records of board meetings.

A holding company which holds a controlling interest in a subsidiary clearly has the power to influence the subsidiary’s decision-making process. If the facts show that it exercises this power, any dividends received may be deemed to constitute a consideration for management services provided and thus income from a business activity.

An additional relevant factor is whether, as a matter of fact, the holding company has the necessary human and other resources to offer such services.

The circular recognises that, in some cases, a holding company cannot exercise its power to influence its subsidiary, but instead may be a passive investor with the exclusive objective of receiving dividends without being involved in management.

There is established case law to the effect that the involvement of a company in the management of an investee company is an economic activity under Article 3 of the VAT Law and Article 9(1) of the EU VAT Directive (2006/112/EC) and is therefore subject to VAT under Article 5 of the VAT Law and Article 2 of the directive.

A holding company, like other businesses, must register for VAT if:

  • its taxable supplies exceed the registration threshold; or
  • it receives services from overseas suppliers which must be accounted for under the reverse charge mechanism.

Otherwise, a holding company may register voluntarily. The amount of VAT that a holding company can recover on its inputs will be based on an apportionment between its taxable and non-taxable activities.