Substance Requirements

Aligning Taxation with Activity

To combat harmful tax regimes, the OECD’s BEPS Action Plan emphasizes the need for substantial activity in any preferential regime. The substantial activity requirement forms an integral part of the second pillar of the BEPS project, aimed at ensuring taxable profits are not artificially shifted away from value-creating countries. The OECD guidelines aim to address tax-driven operations that lack substantial activity. Numerous preferential tax regimes allow taxpayers to benefit from tax-driven operations without engaging in substantial activities.

Key Factors in Assessing Harmful Regimes

Determining whether a preferential regime is potentially harmful involves considering several factors. The substantial activity factor is one of the primary considerations. Other key factors include: (i) imposition of no or low effective tax rates on geographically mobile financial and service activities, (ii) ring-fencing the regime from the domestic economy, (iii) lack of transparency, and (iv) absence of effective information exchange regarding the regime. A regime must first meet the criteria of imposing no or low tax rates to be considered potentially harmful. While not classified as a potentially harmful regime, the Republic of Cyprus, an EU member, complies with OECD guidelines and is deemed largely compliant with international transparency standards.

Understanding Permanent Establishment

Article 5 of the Model Convention regarding Taxes on Income and Capital defines permanent establishment as a fixed place of business. It encompasses various entities such as management offices, branches, offices, factories, and workshops. However, facilities used solely for storage, maintenance of stock, or purchasing goods, as well as preparatory or auxiliary activities, are not considered permanent establishments.

Meeting Substance Requirements in Cyprus

For a Cyprus company to comply with substance requirements, it must take certain steps. These include maintaining an office, appointing local directors and employees registered with the social insurance department, operating within Cyprus, and opening a bank account with a local institution. These measures help establish a permanent establishment for a Cyprus company.