1.VAT Impact of non-business activities
As a general term, a Holding Company is defined in the applicable tax legislation as a company that holds shares in one or more companies. There are however different types of holding companies such as Pure Holding Companies and Mixed Holding Companies.
A Pure Holding Company is one that only holds shares and has no other activities.
A Mixed Holding Company is one that, in addition to the holding of shares, performs other activities as well, e.g. financing, supply of services, etc.
As it is difficult to determine the VAT status of a Holding Company, the activities of a Holding Company should be carefully evaluated in order to decide if they qualify as an “economic activity” and hence fall under the scope of Cyprus VAT.
Pure Holding Companies, whose basic role is to purchase shares for long-term investment, receive dividends, protect itself and its subsidiaries from buyouts and sale of shares, however, on a non-recurring basis, cannot be regarded as taxable persons for VAT purposes.
Mixed Holding Companies, on the other hand, may be considered as taxable persons for VAT purposes. Therefore, any potential VAT obligations, e.g. VAT registration, filing of VAT returns, etc., may arise.
It is also worth noting that, in case a Holding Company is involved in the “Active Management” of its subsidiary, then it may qualify as a taxable person.
“Active Management”, is when the Holding Company is not involved only in the holding of shares and/ or the exercise of the rights as a shareholder, but rather provides other services to its subsidiaries such as administration, accounting, etc., having as a result the issuance of invoices from the Holding Company to its subsidiaries, i.e. a consideration is charged for such services.
Important Note – In case dividends received from the subsidiary company are re-invested as a loan and this loan bears interest, then it would not qualify as an economic activity for VAT purposes (however it requires to be a direct link between the dividends and the loan granted).
2. Right to deduct input VAT of Holding Companies
A Holding Company has the right to claim input VAT (i.e. VAT charged on the supply of goods and services either locally or from another member state and VAT charged at the customs for imported goods), if these goods and/ or services were used to carry out taxable transactions, out of scope transactions however being taxable if these were carried out in Cyprus, or exceptional financial transactions to non-EU clients (such as granting of loans, sale of securities, banking services, etc.).
A Holding Company does not have the right to claim input VAT (as described above), if such VAT relates to, amongst others:
- Expenses for private purposes;
- Accommodation costs of directors;
- Entertainment expenses (excludes said expenses if relate to employees and directors);
- Saloon cars;
- Exempt supplies;
- Expenses directly connected with long-term holding activities (with the exemption in cases where the Holding Company is actively involved in the management of its subsidiaries) Etc.
In the case of Mixed Holding Companies, the concept of “Direct and Immediate” link applies. This concept is required to be established in order to identify the amount of Input VAT that is allowed to claim. In general Input VAT which relates to transactions subject to VAT is recoverable. Input VAT which relates to exempt transactions cannot be recovered.
The below steps serve as a guideline on the recovery of input VAT:
- Step 1 – Direct allocation of input VAT to specific transactions
- Step 2 – Direct allocation to a specific group of activities
- Step 3 – Allocation of input VAT which is common between business and non-business activities
3. Common VAT recovery
Mixed Holding Companies are required to allocate input VAT initially between business and non-business activities and then between business activities that have the right to claim input VAT and business activities that do not have the right to claim input VAT.
Allocation between business and non-business activities
When it comes to services there is no mention in the legislation the method that a Company may use to apportion the common expenses between business and non-business activities, however it is required to lead to fair and reasonable result and should be used consistently. Also justification is required as to why the method chosen is the appropriate one.
There are however two main methods when it comes to the apportionment of services, the Balance Sheet and the Profit & Loss methods (other methods may also be used but these need to be considered on a case by case basis).
When it comes to goods, based on the announcement on the Official Government Gazette, the following methods may apply:
- Fixed percentage based method
- Turnover based method
- Expenses based method
- Time-spent based method
- Transactions-based method
- Area based method
Allocation between activities
Pro-rata ratio method can be used for the second level of apportionment (i.e. allocation between activities with the right to claim input VAT and activities with no right to claim VAT). Any other method can be used as long as it leads to fair and reasonable results. Written approval by the VAT authorities is always suggested before proceeding.
Inefficient structures may have as a consequence inevitable VAT costs. Hence careful planning is required in order to avoid any unpleasant surprises.
C. Savva & Associates Ltd is always happy to assist in the correct structuring of your Companies and provide advice in all VAT and Tax matters. For further information please contact Charles Savva at email@example.com.