News › Taxand’s Take Article
Germany-Cyprus: New Double Taxation Agreement on Income and Capital Signed
On 18 February 2011, a New Agreement for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion on Income and Capital was signed between Germany and Cyprus. The New Agreement is based on the 2003 OECD Model. The 2011 Agreement will eventually replace the existing Agreement (DTT) in force between the two Contracting States since 1977. In a nutshell, it aims to have a more beneficial effect on the tax treatment of dividends; it incorporates rules on the exchange of information and introduces a clearer status on shipping activities as well as introducing new terms, such as beneficial ownership. A follow up Protocol has also been introduced to be integral part of the Agreement making extensive reference to the principle of the exchange of information. Taxand Cyprus and Taxand Germany discuss the new agreement and the likely impacts on multinationals with business activities in these two countries.
Permanent Establishment (P.E) - Art. 5
The definition of a P.E. remains the same as in Article 5(1) of the current DTT. However, under the new Art.5(3), the period for a building site or a construction or installation project or any supervisory activity to be considered a P.E. is 12 months which is a more realistic approach to the current term of more than 6 months. An expanded scope of preparatory and auxiliary character allows for a combination of activities , aiming to endorse a number of activities of preparatory and auxiliary character that may take place in the same fixed place of business without resulting in a permanent establishment.
Immovable Property - Art. 6
With regard to immovable property the taxation follows the situs principle; new changes include a) clearer definition on which type of income falls under the provisions of this article (i.e income derived from a resident of a contracting country situated in the other contracting state, may be taxed in that other contracting state) and b) the definition of immovable property is expanded to include more fields of activity such as income from agriculture and forestry.
Shipping Inland Waterways Transport and Air Transport - Art. 8
More detailed provisions are incorporated in the new Agreement, in terms of profits. Specifically, a new provision is extended to the profits arising out of the operation of boats, in addition to ships, in both cases being the place of effective management. Also, a definition of what "profits" entail is incorporated to the text, including the occasional rental of the ship or aircraft and the use or rent of containers, trailers and ancillary equipment, provided that these activities pertain to the operation of ships, boats and aircrafts. The above profits also apply to activities of joint business and an international operating agency.
More favourable withholding tax rates on dividends are introduced, encouraging the set up of subsidiary companies in Cyprus.
Specifically: "dividends may be taxed in the Contracting State of which the company paying the dividends is a resident, and according to the law of that State, but if the beneficial owner of the dividends is a resident of the other Contracting State, the tax so charged shall not exceed 5% (currently 10%) of the gross amount of the dividends if the recipient is a company which owns directly at least 10% (currently 25%) of the capital of the company paying the dividends;"
In the past the taxation of income at the level of companies differed for income used to issue dividends and income kept within the company. Since 2001, however, the taxation of corporate income was amended in a way that - regardless of the utilisation - the corporate income now is taxed the same. At the same time a favourable tax regime for dividends was introduced, through which dividends were partly tax exempt (so called partial income procedure).
As a result the provision in the treaty concerning a cap on dividends was no longer required.
The term "beneficial owner" is also introduced and it replaces the term of "recipient".
Article 11 on Interest introduces the beneficial owner concept (instead of resident, as it is currently). Specifically, interest arising in a contracting state and beneficially owned by a resident of the other contracting state shall be taxable in that other state. The provision also elaborates on the definition of interest and it makes specific reference that penalty charges for late payment shall not be regarded as interest. Needless to say practical issues arise, such as what if the resident is in one of the respective countries and the beneficial owner is tax resident of a third country. Time and case law will indicate how this will be interpreted and implemented.
The same approach as interest is followed in terms of where royalties shall be taxed, presenting some questions regarding its interpretation. Again, the word "recipient" is replaced in the article by the common law phrase beneficial owner. Art.12.4. gives a good understanding of the country where royalties arise (i.e. the country of the payor). The provision goes on to clarify the situation of royalties arising in a P.E. According to the new provision, if the payer of the royalties, whether he is a resident of that country or not, has a P.E. related to the royalties paid, then the royalties will be taxed in the country where the P.E. is situated.
Capital Gains - Art.13
In terms of capital gains, there is a new provision referring to profits arising out of shares connected to immovable property. Also, the provision sets a minimum percentage, where at least 50% of the value of the shares is connected to immovable property situated in another country. In this case, the profit may be taxed where the property is located.
With regard to the taxation on capital gains arising out of the alienation of ships or aircraft, there is a new provision as a follow up to Art. 8 mentioned above, which provides that these profits are taxed only in the contracting state where the effective place of management is situated.
Exchange of Information - Art. 25
A new provision is incorporated into the text of the Agreement regarding the exchange of information. Hence, the relevant authorities of the countries involved may at any time require information and personal data on a taxpayer, if it is considered necessary. Any information received by the authorities shall be treated as confidential. In the case of Cyprus Authorities, Cypriot Law 72(I)/2008 on the Collection of Taxes, provides that the Director of the Tax Authorities shall only supply foreign tax authorities (signatories of a DTT) with information if he has received substantial details about the concerned person and the reason for the request of information. This provision seems to have been put in place to ensure that the foreign tax authorities do not engage in "fishing expeditions" without having any real evidence against the person under investigation. As a further control mechanism, the Cypriot Law provides that the Director of the Inland Revenue shall only supply information if he has obtained the written consent of the Attorney General of Cyprus.
An interesting point added by the follow up Protocol is that the receiving authority shall bear liability in accordance with its domestic laws in relation to any person suffering unlawful damage as a result of the supply under the exchange of data. The Protocol remains silent as to what the consequences will be where there is an issue of unlawful damage. It also fails to determine what such damage entails.
Furthermore, any personal data that is to be erased shall be done once both competent authorities are satisfied that this data will be of no use any longer.
The concept of beneficial owner, originating from the common law environment, is introduced in the present Agreement. The concept is used more and more in the Double Tax Treaties text and it raises discussions within the tax, legal and economic forum. Already, there have been numerous reactions as to the interpretation of the term based on the source country and its legal system. The big issue is its understanding and interpretation by each Contracting State. Currently, there is a misunderstanding between civil law and common law jurisdictions on the approach that shall be given to the term. Does it have a legal or an economic connotation? The introduction of the beneficial ownership connotation indicates a shift to the substance over form approach and shows the attempt of the States to prevent economically unrealistic tax structures. Although this approach seems in line with OECD, not all countries follow this approach in their national tax laws resulting in differences when interpreting the beneficial ownership. If at some time there is a common understanding and an international fiscal meaning of the term, among the contracting states, we will be in a better position to understand, which country taxes the dividends, royalties and interest paid, as in practice, under the new approach, a recipient does not necessarily mean that they will also be the beneficial owner of the income. Finally the introduction concerning the exchange of information is characteristic for Agreements concluded by Germany in the recent past. In the absence of a level of information exchange as provided for by the OECD Model, Germany may deny tax benefits to taxpayers. Exchange of information clauses also appear more and more often in agreements concluded by Cyprus too. Exchange of information is becoming a standard practice across the Globe in bilateral agreements.
Your Taxand contacts for further queries are:
T. +357 22 699 222
T. +357 22 699 222
T. +49 6196 592 24810
More news from Taxand Germany:
We are interested to hear your opinion on this key piece of tax news. Join our LinkedIn Group and share your ideas. With tax professionals in nearly 50 countries you can understand the impact of tax issues affecting multinationals today.