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Introduction
Cyprus has steadily strengthened its tax framework in line with evolving international standards on transparency, substance, and anti-avoidance. Through a series of legislative and policy reforms, the country has signaled its clear commitment to responsible tax practices and global cooperation.
An integral part of this evolution is the introduction and recent expansion of withholding tax (WHT) measures targeting payments to jurisdictions deemed high-risk from a tax perspective. These developments mark a continued shift toward reinforcing substance and tackling aggressive tax planning.
Cyprus’s Evolving Approach to Substance and Anti-Avoidance
As a result of the General Anti-Abuse Rules (GAARs), Cyprus has already incorporated the anti-avoidance provisions of the EU Parent-Subsidiary Directive GAAR (Directive 2015/121/EU – PSD GAAR) into domestic law, effective from 1 January 2016. This gives the tax authorities the power to disregard artificial or fictitious transactions and to withhold the corporate tax exemption on dividends received by companies in Cyprus from elsewhere in the EU if the dividend is treated as a tax-deductible expense in the accounts of the company paying it (so-called “hybrid mismatches”). Such dividends will instead be taxed as normal business income at the standard corporate rate of 12.5%.
By adopting key initiatives such as the OECD’s Base Erosion and Profit Shifting (BEPS) Action Plan, the EU Anti-Tax Avoidance Directive (ATAD), and the Multilateral Instrument (MLI), Cyprus has reinforced its commitment to combating aggressive tax planning and promoting tax cooperation.
The ATAD, which Cyprus has transposed into domestic law, introduces a comprehensive set of rules aimed at curbing tax avoidance practices within the EU. These include Controlled Foreign Company (CFC) rules designed to attribute income from low-taxed foreign subsidiaries back to the parent company, exit taxation provisions that tax unrealized capital gains when assets are transferred out of the tax jurisdiction, and measures to counter hybrid mismatches that exploit differences in tax treatment between jurisdictions. Cyprus implemented the first wave of ATAD provisions, including interest limitation rules, CFC rules, and GAARs, from 1 January 2019, with exit taxation and hybrid mismatch rules phased in subsequently.
Further, Cyprus has implemented measures requiring entities providing financial assistance to demonstrate economic substance. Cyprus was an early adopter of the OECD MLI, ratifying it on 23 January 2020. The instrument of ratification was published in the Official Gazette on 22 January 2020. The MLI entered into force for Cyprus on 1 May 2020, enabling the swift implementation of multiple treaty-related measures designed to prevent treaty abuse and enhance the effectiveness of tax treaties. The MLI introduced critical treaty-based anti-abuse provisions, most notably the Principal Purpose Test (PPT) (Article 29), which seeks to disallow tax treaty benefits where one of the principal purposes of an arrangement or transaction was to obtain such benefits. The PPT is designed to avoid penalizing structures with legitimate business objectives; the OECD clarifies that the presence of treaty benefits alone is insufficient to trigger denial if the arrangement has a core commercial rationale, such as operational presence, investment considerations, or regulatory alignment.
Cyprus has introduced a two-phase WHT regime on outbound payments to protect its tax base. Phase I (effective 31 Dec 2022) imposes WHT on dividends (17%), interest (17% from 1 Jan 2024), and royalties (10%) paid to associated entities in jurisdictions listed in Annex I of the EU list of non-cooperative jurisdictions for tax purposes. Phase II (effective 1 Jan 2026), under Laws 47(I)/2025 (amending The Income Tax Law (118/(I)/2002)) (Income Tax Law) and 48(I)/2025 (amending the Special Defence Contribution Law (117(I)/2002)), extends these rules to low-tax jurisdictions (corporate tax below 6.25%), applying 17% WHT on dividends and disallowing deductions for interest and royalties.
Law 49(I)/2025 (amending The Tax Assessment and Collection Law of 1978 (Law 4/1978)) (TAC Law) introduces an obligation to retain appropriate supporting documentation for such payments and penalties for non-compliance, while reinforcing anti-avoidance provisions. Cyprus must also renegotiate tax treaties with these jurisdictions within three years of their classification as low-tax or EU non cooperative, under amendments to the Income Tax Law. Both phases apply to permanent establishments and are supported by a GAAR empowering tax authorities to disregard artificial arrangements.
Broader Tax Framework and International Cooperation
Cyprus’s approach is underpinned by the “substance over form” and “business purpose” doctrines, enabling tax authorities to reclassify artificial or fictitious transactions. The domestic GAAR, incorporated through amendments to the TAC Law in line with EU Mutual Assistance Directive 77/799/EEC, apply to both local and cross-border transactions involving residents and non-residents.
Additionally, Cyprus participates actively in international information exchange frameworks and has restructured preferential regimes, including its IP Box, to meet substance and anti-abuse criteria. While it is anticipated that Cyprus will soon issue formal guidelines on substance, its actions align with the standards set by the EU’s Intergovernmental Code of Conduct Group on Business Taxation (CoCG) for determining substance and combating harmful tax measures.
Collectively, these steps reinforce Cyprus’s commitment to ensuring that treaty benefits are only available to genuine economic activities and real business presence, positioning the jurisdiction as fully cooperative and transparent in the evolving global tax landscape.
Conclusion
Existing and new structures will need to ensure and display the by now known, globally accepted “substance” requirements. Cyprus tax resident companies must ensure that their interests are protected via the application of the relevant objects and purposes of the international treaties and requirements imposed therein. Failure to adhere to these requirements may result, inter alia, in recharacterisation of incomes, loss of treaty benefits, double taxation, enhanced rates of WHTs —including the recently expanded WHT on outbound payments to companies in EU non-cooperative and low-tax jurisdictions—monetary penalties/prosecutions, and the application of CFC rules.
In light of these developments, clients are advised to review their structures and assess how and to what extent these changes may impact them.
Author
Elena Christodoulou