George Panayiotou: By reforming the tax system, Cyprus can help redistribute the tax burden more equitably across different income groups

George Panayiotou, Head of the Direct Taxation Department at K. Treppides & Co Ltd, analyses how the upcoming major tax reform can address inequality and suggests key strategies for companies wishing to successfully navigate Cyprus’ complex tax landscape.

A major reform of Cyprus’ tax system is under way, aiming to reduce tax inequality, among others. The current 17% Special Defence Contribution by Cypriots is viewed by many as creating unfair competition. What is your take on the matter?

The 17% Special Defence Contribution has, indeed, been a significant bone of contention in the current tax system. It applies uniformly to all Cyprus tax-resident domiciled individuals, regardless of their income level, which means that it is not a progressive tax. As such, it could be seen as creating unfair competition among taxpayers, who are all taxed at the same rate.

It could also be claimed that it disproportionately impacts lower-income individuals, who pay the same rate as higher-income individuals, exacerbating income inequality among locals. Furthermore, some local investors (i.e. Cyprus tax-resident domiciled individuals), also see it as unfair competition, leading to economic distortions between them and foreign investors based in Cyprus (Cyprus tax resident non-domiciled individuals) who may not be subject to the same tax due to the favourable ‘non-dom’ regime. It should be emphasised, though, that the ‘non-dom’ regime exempts foreign investors from the Special Defence Contribution for a single purpose: to make Cyprus an attractive destination for foreign capital. While this regime has successfully attracted foreign investment, it may create the perception of tax inequality among Cypriot taxpayers (domiciled vs non-domiciled). Since taxes are a source of income for Cyprus’ budget, the Government may consider exemptions for domiciled tax residents, particularly if they can demonstrate that their derived income has been reinvested in the Cyprus economy.

Addressing the 17% Special Defence Contribution on actual or deemed dividends is crucial for enhancing tax fairness. By reforming the tax system, Cyprus can help redistribute the tax burden more equitably across different income groups. This aligns with the broader goals of tax equity and social justice, ensuring that all taxpayers contribute a fair share relative to their ability to pay.

What other aspects of the current system need to be addressed to reduce tax inequality?

It is crucial to review and adjust tax allowances and credits to benefit lower-income groups significantly. Regularly adjusting tax brackets for inflation prevents ‘bracket creep’ – where inflation pushes taxpayers into higher tax brackets without a real increase in their income.

In terms of corporate taxation, there should be an effort to align effective corporate tax rates more closely with the statutory rate or introduce tax incentives to a wider group of companies, reducing discrepancies between large multinational corporations and smaller domestic businesses. An example is the Cyprus IP Box regime that provides incentives only to companies developing certain types of intellectual property, while tax incentives could be provided to corporations that invest their funds into society by creating innovations or jobs for skilled and unskilled workers.

At the same time, the regressive nature of VAT can be mitigated by exempting or reducing rates on essential goods and services that constitute a larger portion of lower-income households’ expenditures.

In property taxation, introducing progressive property tax rates instead of the current regressive rates is essential. Providing support and incentives for small and medium-sized enterprises (SMEs) to formalise and comply with tax regulations and reinvest their profits into the business, is critical. Addressing these aspects comprehensively would help reduce tax inequality in Cyprus, ensuring a fairer and more balanced tax system that supports sustainable economic growth and social equity.

What are the implications for Cyprus of introducing a minimum corporate tax rate of 15% on large multinational enterprise (MNE) groups operating in the EU?

This will undoubtedly bring changes to Cyprus’ business environment but maybe not to the extent of other EU jurisdictions. While the immediate impact may include increased tax revenues and compliance costs, the long-term effect will likely involve a shift in foreign investments with these groups gravitating to other jurisdictions where they have more substance, since Cyprus will lose its competitive tax advantage. It will therefore need to adapt by enhancing its value proposition, focusing on its strategic strengths and promoting genuine economic activities. This transition could position Cyprus as a resilient and attractive hub for high-value investments and operations in the global market.

What tax planning strategies would you recommend for businesses navigating an increasingly complex tax landscape and how can K. Treppides & Co Ltd assist?

It is essential for CEOs, Financial Controllers and tax teams to be regularly updated on the latest tax laws, regulations and compliance requirements – our firm assists clients by offering their staff opportunities to participate in tax seminars and stay current through our tax journals and updates. To minimise errors and ensure tax compliance, we recommend utilising tax software and tools updated in real-time to reflect changes in tax laws. Tax advisors can provide invaluable insights and proactive strategies and companies should engage a team of qualified tax advisors which, like our firm, specialises in different areas of taxation on a retainer or a project basis. At the same time, an advisory board of internal and external tax experts should be set up to provide ongoing guidance and strategic advice on complex tax matters – our firm can act as an Advisory Body that evaluates available strategies and analyses tax implications.

Developing a robust tax strategy is critical, and this should include analysing the tax implications of business decisions, identifying tax credits and incentives and planning for the tax compliance structuring of transactions. Companies should also conduct scenario analyses to understand the potential impact of different tax changes on their business so as to be prepared for various tax outcomes.

To aid in compliance and tax audits, companies must ensure the meticulous documentation of all financial transactions and tax filings and maintain a tax compliance calendar to keep track of important filing deadlines, payment due dates and other compliance obligations to avoid penalties and interest.

For businesses operating internationally, it’s essential to understand the tax regulations in all operating jurisdictions, including those related to transfer pricing, VAT, withholding taxes and local compliance requirements. They should also leverage international tax treaties and agreements to minimise double taxation and optimise global tax positions.

For risk management, companies should conduct regular tax risk assessments to identify and mitigate potential risks, including evaluating the tax implications of new business initiatives, mergers and acquisitions and cross-border transactions. Meanwhile, they should also formulate contingency plans and a clear strategy to address potential tax disputes and audits.

Companies should ensure clear and regular communication between the tax department and other business units, so tax considerations are integrated into business decision-making processes, and maintain open lines of communication with tax authorities and stakeholders to facilitate compliance and address any tax-related issues promptly.

Finally, it is critical to align your tax strategy with your overall business strategy, ensuring that tax considerations are integrated into broader business planning and decision-making processes. By implementing these strategies, businesses can better navigate the complexities of the evolving tax landscape, ensuring compliance while optimising their tax positions and minimising risks.

(This article first appeared in the July issue of GOLD magazine. To view it click here)