Rethinking Tax Reform in Cyprus

As Cyprus embarks on a critical journey of tax reform, it is essential to adopt a comprehensive perspective that integrates not only corporate and income taxes but also Value Added Tax (VAT) and the broader principle of tax justice. Our recent presentation at an international tax conference underscored these key dimensions, advocating for the inclusion and adoption of VAT reform and tax appeal measures in enhancing Cyprus tax system. This article aims to explore the necessity of simultaneous VAT reform and the potential benefits of a more equitable tax system via actionable proposals to drive to a truly holistic tax reform.

The Imperative for VAT Reform

VAT serves as a cornerstone of revenue generation for EU member states, governed by a regulatory framework that permits certain flexibilities. Cyprus, as a member of the European Union, possesses the unique opportunity to tailor its VAT policies to better serve its economic landscape. The ongoing discussions surrounding tax reform must prioritize VAT, particularly as we channel investments into burgeoning sectors such as shipping, fintech, real estate, technology, education, and healthcare.

With VAT being an EU harmonised legislation, there might be some limitations on revisiting the Cyprus VAT system yet the EU Directive avails optional, discretionary measures and permissible EU VAT aspects subject to domestic interpretation. Such strategic VAT harmonisation can simplify our system, enhance revenue generation but also foster an environment conducive to innovation and investment.

A Call for VAT Reforms in enhancing our tax system

Zooming in EU best practices, there are VAT upgrades that can be utilised in Cyprus as well. By way of practice examples,  the following proposals may reform VAT in a manner that aligns with EU regulations while simultaneously promoting economic growth and investment in Cyprus:

• Option to Tax (VAT) for Real Estate: With Cyprus having implemented as from late 2017 a unique EU VAT obligation to tax on commercial rents where tenants have a 90% VAT recovery right, subject to opt-out, this can be ideal timing to move on real estate transactions. Transitioning to an option to tax model, where taxpayers can select to subject immovable property transactions to VAT, would allow depending on specific circumstances of each taxable person to opt in VAT and utilise input VAT recovery.  This can impact property sales and leasing empowering suppliers with greater flexibility and stimulate activity in the real estate market inclusive key fields such as student accommodation, commercial and residential leases. A starting point could be a flexible option to tax for commercial rents (subject to similar 90% VAT recovery with current obligation) with the potential to apply on different rental transactions the use of reduced VAT rates, where permissible by the VAT Directive.
• Targeted Taxation Option for Financial Services: The option to tax may be extended also to selected financial services, creating an attractive environment for companies in fintech sectors hosted in Cyprus. By conducting a thorough examination of this potential, activities may be identified for such an opt to VAT inclusion restricting liquidity issues for businesses and providing a friendly VAT environment for operational structuring.
• Revising the Policy behind the VAT Grouping Regime Application: An immediate reform is necessary for the practical implementation of the VAT grouping regime which already exists in our law. Presently, holding and financial businesses are excluded from joining VAT groups, which undermines our aspirations to be a headquartering destination. By allowing these entities for instance to participate under certain conditions in mitigating excessive governmental revenue leakages, VAT Grouping where transaction between related entities will be disregarded with a group entity acting for VAT reporting on behalf of the others will be a useful administrative facilitation business tool. Such measure would facilitate better cash flow management for businesses and promote a more cohesive - consistent corporate structure.
• Implementing Postponed Accounting for Imports: Cyprus is one of only fourEU member states that do not offer a form of postponed accounting for VAT on imports. This is  a mechanism where EU member states may provide that in designated circumstances, VAT on importation does not need to be paid to the customs officials at the time the goods are released from customs control but instead by the person for whom the goods are destined through periodic VAT return. Implementing postponed accounting would alleviate cash flow pressures on VAT-registered businesses importing and need to pay VAT real time rather at a later stage of VAT return reporting. This measure may enhance liquidity for businesses but also streamline administrative processes related to VAT compliance. This measure nature can be easily implemented and can be the first one to undergo implementation even within the year contributing to Cyprus potential to become a hub for products processing.
• Promoting Sustainability through Reduced VAT Rates – Input VAT recovery: In alignment with global sustainability goals, we may consider applying a reduced VAT rate for photovoltaic panels and green equipment whereby permitted by the EU VAT Directive. This rate flexibility already harmonised by other member states can be a mitigation measure to upcoming green taxes. In parallel, with lifting restrictions on Input VAT for Green Vehicles, such move would align with Cyprus' commitment to reducing carbon emissions and promoting sustainable practices across various sectors. Taxable persons may be able to recover VAT without facing restrictions on input VAT for ‘green’ saloon cars.

Tax Justice Revisit?

Beyond recommended aspects of VAT reform, it is essential to consider the broader implications of tax justice for an effective tax dispute resolution mechanism to be in place. A transparent and fair tax system can attract foreign investment, and per the recent EY Attractiveness Survey, foster certainty duly considered by current and prospective investors.

There are relatively quick actions that can be instantly taken for tax justice given that the Cyprus tax appeals system already possesses a designated Tax Tribunal. An immediate reform could be upscaling the independence of the Tribunal via the appointment of its own tax and VAT advisor and availing a tailored budget in carrying its functions as a hierarchical tax review body. With Tribunal procedural rules immediately updated to ensure strict deadline adherence on process requirements, evidence and tax cases admissibility clarified quick fixes can be easily achieved.      

As regards medium-term steps required to boost tax justice upgrade with simple tax appeal system developments, below could be some considerations:

• Faster Appeal Decision-Making: With the purposeful recent introduction of Tax Objections Panel, within the tax authorities, composed of a fresh team to evaluate disputed assessments crucial next item is to revisit time-span of decision making. Open objections for long (even by statutory limit of 3 years in direct tax aspects) infringes tax system trust and certainty, thus, a much earlier decision - making can be exceptionally beneficial. Similarly, having the Tax Tribunal to decide within a year from appeal process, given the tax values at stake a shorter decision would be a plus for our system. The example from Portugal Arbitration Court resolving 20% of Portuguese tax disputes in an average time of 4 - 5 months, can be a best practice for a Cyprus future appeal system consideration.
• Need for Transactional Substance review over Administrative legality: While all available dispute resolution mechanisms (even the Administrative Court) avail the chance for an independent review on the tax – VAT substance of each dispute, legality points on comprehensive investigation and good administration might delay the process due to need for re-examinations. It is of importance in tax disputes to have a conducted hearing (not occurring over an Admin Court Appeal) so as transactions, contracts, figures, computations, invoicing can undergo review by an independent body.
• Appeal Process Re-engineering – Tax Tribunal Upgrade: Such substance review can be achieved through a codified process of taxpayer hearing with prescribed deadlines and filing requirements.  An idea for fast implementation could be the reform of Tax Tribunal process, within the parameters of admin and constitutional law, so as to have a procedure where a hearing occurs, the filings are digitalised, decision issued earlier than a year. Even utilise, post legislation amendment, the upgrade to host proceedings in English for a business-friendly appeal approach. Steps will be needed for independent advisory support to be provided to the Tax Tribunal for such a process re-engineering.
• Uniformity and Extension of Tax Aspects subject to appeal: Developing the tax appeals mechanism permits the inclusion of other new taxes into a new consistent system inclusive customs, excise, green, digital and tonnage taxes. Deadlines and areas of taxes that can be appealed may be revisited so as there is uniformity in terms of the options to challenges assessments available to taxpayers.   

Time to Add VAT and Tax Justice in Reform

The proposed addition of VAT reform and tax justice system upgrades represent a significant opportunity for Cyprus to holistically tax modernize. As we move forward, it is essential for stakeholders to engage in constructive dialogue and promote collaboration among policymakers so as to supplement currently discussed reform with VAT measures and justice process simplification and flexibility. Given the current final consultation stage of tax reform proposals, this is proper timing to initiate a phase 2 to capture VAT and justice.

Conclusion

In conclusion, VAT and tax justice addition to an immediate next round of reform would have numerous  benefits for the tax system improvement holisticity. The simplicity of the above proposals implementation can constitute an incentive for instant consultation that we are convinced stakeholders are eager to contribute towards materialisation of a realistically Cyprus tax framework upscale.