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Exemption from SDC on deemed distributions for non-resident shareholders

The Cyprus Inland Revenue Department has issued a circular (2011/10) introducing a significant change in practice which will benefit international companies in Cyprus.

Under the so-called "deemed distribution" rules, resident companies which have not distributed at least 70% of their after-tax profits attributable to Cyprus-resident shareholders within two years of the end of the year in which the profits were earned are required to pay special defence contribution ("SDC tax") at 17% on the amount by which actual dividends distributed to resident shareholders within the two (2) year period fall short of the 70% threshold. A lower rate of 3% SDC tax is payable by companies operating as collective investment schemes.

The deemed distribution rules do not apply to the proportion of profits attributable to non-resident shareholders.

The new circular now makes clear that profits attributable to resident shareholders which are ultimately attributable to non-resident shareholders should also be excluded from the deemed dividend calculation.

Companies in Cyprus are generally required to submit an annual return on form IR.623 for the purpose of calculating deemed dividends. In cases where the entire share capital of a Cyprus resident company is ultimately owned by non-residents, the directors of the company may make a declaration to this effect, have it certified by the company's auditors or lawyers and forward it to the tax authorities. When the declaration has been accepted by the tax authorities the company will no longer be required to make returns for deemed distribution purposes. Sample forms of declaration and certification are appended to the circular.

If part of the share capital is ultimately owned by Cyprus residents an annual return must still be submitted, but the profits ultimately attributable to non-resident shareholders will be excluded.

As a result of the change in approach set out in the circular many companies will no longer need to pay dividends in order to avoid being caught by the deemed distribution provisions, allowing value to be retained in the company and giving maximum scope for exit planning, especially in the light of the fact that gains on most securities are exempt from tax in Cyprus. Furthermore, there will be significant administrative savings as many companies will no longer need to complete returns for deemed distribution purposes and indirect non-resident shareholders will no longer need to submit claims for repayment of SDC.

The circular has immediate effect and the new approach applies to all years for which companies' tax affairs have not been finalised.
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