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New Protocol Amends for Cyprus & Poland DTT
On 22 March 2012, Cyprus and Poland signed a Protocol amending certain provisions of the Double Taxation Treaty (DTT) in order to further stimulate the development of business relations between the two countries. This long-anticipated Protocol introduces a number of important changes to the tax regime between Cyprus and Poland that will come into effect once the text is ratified by the Parliaments of both countries (until then, all the provisions of the current DTT shall remain in force). It should be outlined that following the entering into force of the Protocol, the withholding tax on dividends subject to certain conditions can be as low as 0%. Furthermore the new WHT on Interest can reach 5% and Royalties 5%. Taxand Cyprus and Taxand Poland discuss the extent to which the protocol is likely to enhance business opportunities between the two countries, and the impact that this may have on multinationals.
The main changes within the protocol are the following:
The current DTT provides for a 10% withholding tax (WHT) on dividends paid out from a company resident in Cyprus to its Polish shareholder and vice-versa. The new Protocol makes this beneficial arrangement even more favourable. In the case of a shareholder / beneficial owner being a company (other than a partnership), which holds directly at least 10% of the capital of the company paying the dividends for an uninterrupted period of 24 months, the WHT is 0%. This means that even in cases where the recipient of dividends does not fulfill the requirements under the EU Parent-Subsidiary Directive, they are able to benefit from the amended provisions of the DTT to reduce / eliminate any tax obligation.
Should either individuals or businesses not meet the above requirements, the applicable WHT is 5%.
Since companies registered in Cyprus are often used as intra-group financing vehicles, they are expected to benefit substantially from the amendments brought by the Protocol regarding interest payments. The current DTT provides for a 10% WHT on payments of interest made from a tax resident of Poland to a tax resident of Cyprus and vice versa. The new Protocol reduces this WHT to 5% if the recipient, as the beneficial owner of the interest, is a resident of the other contracting state.
The Protocol maintains the beneficial 5% WHT as provided in the current DTT, but in line with recent amendments in the OECD Model Convention, it takes account of the requirement that the recipient also be the beneficial owner of the income in order to enjoy the reduced tax rate.
Another noteworthy change in the Protocol is the inclusion of the term 'beneficial ownership'. It can be seen in the new provisions on dividends, interest and royalties (above). In recent years there has been some confusion over the definition of beneficial ownership. Recent case law in various countries seems to support the perception that the legal owner of the income is also its beneficial owner and this approach seems to justify the use of holding companies and thus encourages tax planning.
However, the OECD introduced a draft paper discussing the possible introduction of a distinction between "legal ownership" and "economic ownership". Although the OECD paper is still a draft, if this approach is adopted, the tax authorities would be able to pierce the corporate veil in every single case claiming suspicion of tax avoidance. As a consequence of the OECD draft, Polish and Cypriot structures will need to be revised in order to ensure that substance is maintained within them. 'Substance' in this instance, is defined as the introduction of a solid corporate infrastructure which will ensure that the management and control of the company is located in Cyprus, i.e. supporting the Cypriot residency status of the company. Furthermore, additional substance-enhancing measures will need to be taken e.g employing staff, registering with local business associations, etc.
The most controversial new provision seems to be related to the taxation of directors' fees. One of the key advantages for Polish taxpayers resulting from transactions with Cyprus had been the beneficial taxation of directors' fees derived in Cyprus, i.e. exemption of this income derived in Cyprus (based on local Cypriot tax law provisions) and as exemption from taxation in Poland is available under the DTT, in practice such income has been exempt from taxation in both countries. Unfortunately, the relevant provision of the DTT has been often subject to abuse. For instance, the directors' fees provision was often used to distribute sums of money which were presented as a salary of a company's director, when in reality, they should in most cases have been distributed as a dividend, and thus subject to tax. In order to combat these cases, the new Protocol amends the relevant provisions stating that any directors' fees and other similar payments derived by a resident of a contracting state in her / his capacity as a member of the board of directors/supervisory board, shall be subject to taxation only in the state of residence of the director. As a result, the taxation rights on directors' remuneration are shifted from the source country to the country of residence of the Director, subjecting Polish residents to a Polish tax burden of 19%.
Exchange of Information
Following the general trend for combating tax evasion and in line with increased transparency regarding cross-border payments, the Protocol introduces a detailed procedure on the exchange of information between the two countries.
Avoiding of Double Taxation
The current DTT provisions allow for a decrease of the Polish tax paid on dividends, interest and royalties in accordance with the tax payable in Cyprus. The new Protocol abolishes the latter, and provides that the decrease of the Polish Tax shall be applicable on the tax which was paid in Cyprus, i.e. the elimination of so-called "tax sparing", which provided for, for example, the reduction of the applicable tax rate in Poland from 19% to 9% in the case of dividend income paid from Cyprus to a Polish tax resident (who was entitled to deduct from the Polish tax a 10% withholding tax which could be, but in practice is not, imposed in Cyprus).
It is expected that when the above change shall come into force, dividend income of a Cypriot company received by Polish tax residents shall be subjected to a rate of 19%.
The new Protocol, expected to come into force on 1 January 2012, should be seen as an instrument aimed at enhancing the business relations between Poland and Cyprus. As noted above, the most important changes are the introduction of the beneficial ownership principle and the substance considerations. Furthermore, the abolition of the directors' fees "loophole" will make structures between Poland and Cyprus more transparent and free from exploitative tax planning.
A major benefit of the Protocol is that it actually goes further than the Parent Subsidiary Directive, expanding on the circumstances where 0% WHT shall be applicable to dividends. Multinationals with interests in Cyprus and Poland should assess whether your current structures are compliant with, and benefitting from, the new Protocol.
Your Taxand contacts for further queries are:
T. +357 22 699 222
T. +48 22 324 59 00
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