Features of dividend payments to a non-resident registered under the laws of the Republic of Cyprus

Author: Olena Andriyko, lawyer at F&P

The Republic of Cyprus has long remained one of the most popular jurisdictions for foreign investment due to its favorable tax regime and advantageous provisions in bilateral double taxation avoidance agreements.

In this article, we will examine the key aspects of dividend payments to non-residents from the Republic of Cyprus and the possibilities of applying a reduced withholding tax rate on repatriated income.

What does the legislation say?

The Tax Code of Ukraine defines that income sourced in Ukraine includes any income received on the territory of Ukraine by residents or non-residents. This can include income from activities, interest, dividends, royalties, and other investment income paid by Ukrainian residents or representatives of foreign companies.

Dividends are considered both classical payments to founders from profits and any payments by legal entities to their participants in connection with the distribution of net profit.

When Ukrainian companies or branches of foreign companies pay income to non-residents, they must withhold tax at a rate of 15%. This tax is paid at the time of income payment, unless otherwise stipulated by international treaties of Ukraine with the country of residence of the income recipient.

On November 8, 2012, a Convention on the Avoidance of Double Taxation was signed between Ukraine and the Republic of Cyprus, ratified by the Law of Ukraine. According to Article 10 of the Convention, dividends paid by a company resident in one state to a resident of another state may be taxed in the country of the recipient. They may also be taxed in the state of the payer, but at a reduced rate: 5% if the beneficial owner of the dividends holds at least 20% of the company’s capital or has invested no less than 100,000 euros, and 15% in other cases.

Thus, de jure, the legislation stipulates that the payment of dividends to a resident of the Republic of Cyprus can be made at a reduced rate of 5%.

At the same time, in practice, everything is not so straightforward.

Ukrainian tax authorities, during audits of resident enterprises, often conclude that non-residents are conducting activities on the territory of Ukraine without registering a permanent establishment. In such cases, tax authorities assess additional liabilities, asserting that the resident taxpayer must withhold 15% of the income tax paid to the non-resident.

Permanent Representation: Legal Basis

According to Article 5 of the Double Taxation Conventions, a permanent establishment is a place of business through which a non-resident’s business is carried on in whole or in part. Such places include:

• office, branch, factory, warehouse;
• mine, quarry, facility for extracting natural resources;
• any other place where entrepreneurial activities are carried out.

At the same time, activities that are purely preparatory or auxiliary in nature do not create a permanent establishment. Such activities include:

• storage or display of goods;
• gathering information;
• procurement of goods or other auxiliary functions.

The main activity that generates profit and constitutes an important part of the business is considered as the activity of a permanent establishment. In contrast, auxiliary activities only perform a supportive function and do not create obligations for registration.

According to the OECD Model Convention recommendations, the decisive criterion is whether the activity at a specific location is substantial for the enterprise. Therefore, to distinguish between core activities and preparatory or auxiliary activities, it is necessary to keep in mind that:

• preparatory or auxiliary activities were carried out for the benefit of the foreign company itself, and not at the expense of third parties;
• the main activity is usually perceived as the activity that is essential and important based on the content of the organization’s commercial goals and objectives;
• preparatory activities precede the commencement of the main activities of a non-resident in the territory of Ukraine;
• Auxiliary activities ensure the process of conducting the main economic activities by a non-resident, are carried out simultaneously with the main activities, but are not considered part of the main activities.

For enterprises, it is important to clearly distinguish between core and auxiliary activities. In the event of an audit, it should be confirmed that the activities of a non-resident do not create a permanent establishment. If the activities are auxiliary in nature, this should be documented to avoid the risk of tax reassessment.

Therefore, determining the status of a non-resident’s activities is crucial for the correct application of tax regulations and avoiding double taxation.

What do tax officials pay attention to?

The main arguments used by regulatory bodies can be summarized in the following theses:

• the main activity of the representative office is identical to the activity of the non-resident (parent company) as defined in the statutory documents of the non-resident.
• the nature of the non-resident’s activities indicates that the sole purpose of registering the company is to distribute dividends.
• the funds transferred to the non-resident are “transit” funds and, within a short period after being credited to the account, are transferred to the accounts of third parties;
• authorized and/or trusted persons of a non-resident are citizens of Ukraine who reside permanently in Ukraine, carry out activities here, receive payments, etc.;
• the analysis of the decisions/protocols of the non-resident indicates that such decisions were signed by persons under powers of attorney who are citizens of Ukraine and are directly or indirectly related to the resident;
• the presence of corporate dependence of a non-resident on another non-resident legal entity controlled by a citizen of Ukraine;
• conclusion of contracts or signing any documents on behalf of such a non-resident dividend recipient by the actual beneficiary (individual);
• absence of employees and substance in the non-resident;
• the actual (real) management of a non-resident and a resident by the same individuals (group of individuals);
• the payment of dividends in non-cash form, in particular through further reinvestments;
• the acquisition of a share from the charter capital of a resident company by a non-resident was carried out by a third non-resident party;
• conclusion of contracts by officials or related parties of a non-resident / signing documents as representatives of a non-resident;
• the absence of any other source of income for the non-resident, except for dividends from the resident;
• absence of evidence of any economic activity by the non-resident;
• do non-residents have any obligations regarding the further transfer of the received income to another non-resident;
• a non-resident is restricted in the right to independently determine the further economic fate of the specified income;
• a non-resident does not have the authority to determine the further economic fate of such income, that is, they are not the beneficial (actual) recipient of the income;
• the “technical” nature of the activities of non-resident companies
• the presence of only one certificate confirming residency status is not a basis for applying a reduced rate.
• the resident is a related party to the non-resident (considering the common beneficiaries), and the activities carried out by the representatives of the non-resident in Ukraine cannot be considered auxiliary;
• the founders of the non-resident / KBV are citizens of Ukraine;
• non-resident directors do not receive a salary;
• the non-resident does not have personnel, the functions of the company are performed by its directors and secretary. In fact, the functions are carried out on the territory of Ukraine – in terms of the acquisition and sale of corporate rights and the management of corporate rights;
• the type of activity of the non-resident is investment management and financing. The company’s assets consist exclusively of investments in legal entities established under the laws of Ukraine.
• all income of a non-resident is income sourced from Ukraine;
• all contracts for the acquisition and sale of corporate rights were concluded in Ukraine.

How to avoid additional charges?

To avoid receiving additional assessments from the tax authority or to increase the chances of successfully contesting such assessments, specialists from FEDORYSHYN & PARTNERS recommend ensuring the following conditions of the non-resident’s activities before transferring dividends:

1) the presence of other income for a non-resident, apart from dividends from residents of Ukraine;

2) the presence of substance, employees, real wage payments;

3) analyze the signatories of documents on behalf of the non-resident – whether they are connected to the resident;

4) ensure that funds received from a resident are not transferred from a non-resident’s account for at least 6 months;

5) ensure that a non-resident engages in activities that are not similar to those of a resident.

The implementation of the mentioned points does not guarantee the avoidance of additional assessments by tax authorities, but it provides a real chance of obtaining a positive court decision when appealing such assessments.