August 03 2018 | Contributed by Elias Neocleous & Co LLC

Corporate Tax, Cyprus

Shell and letter-box companies
Tax factors
Fundamentals of substance and ways to enhance it

Recent developments have underlined the need for businesses to have real substance in order to operate and benefit
from tax residence in Cyprus. Lack of proper substance may not only lead to the denial of benefits under double tax
agreements or EU directives, but may also mean that the company is unable to operate a bank account in Cyprus.

Shell and letter-box companies

On 14 June 2018 the Central Bank of Cyprus issued a circular to credit institutions that it regulates, advising them
against opening new bank accounts or continuing existing accounts with companies that are regarded as so-called
‘shell’ or ‘letter-box’ companies. These guidelines are due to be incorporated into the Central Bank’s Anti-money
Laundering Directive in the near future.
A ‘shell’ company is defined in the circular as an entity which is not publicly traded and which:
• has no physical presence in its country of domicile, apart from a mailing address;
• has no established economic activity, little to no independent economic value and no documentary evidence to
the contrary;
• is registered in a jurisdiction in which companies are not required to file independently audited financial
statements; or
• has a tax residence in a jurisdiction recognised as a tax haven or has no tax residence.

‘Physical presence’ implies having real management located within a country, carried out by individuals possessing
the knowledge and experience needed to run the business. The existence of employees is another factor indicating
physical presence. While it may be necessary and useful for other reasons, representation by means of nominee
services provided by agents (eg, lawyers or corporate service providers) does not constitute physical presence.
The guidelines stipulate that trading companies with no effective place of business and management, and hence no
substance, will not be permitted to maintain bank accounts in Cyprus. Further, trading companies incorporated in
jurisdictions recognised as tax havens must become tax resident in an appropriate tax jurisdiction in order to
continue banking in Cyprus.
These restrictions do not apply to holding companies which own investments in shares, intangible or other assets,
including real estate or ships, companies undertaking group financing activities or acting as group treasurer or
companies established to facilitate currency trades, asset transfers or corporate mergers, provided that their
beneficial ownership is identifiable and they demonstrate that they are engaged in legitimate business.
Banks may opt to engage in a business relationship with a shell-company client, but must be able to justify their
decision and record this justification in the client file. They will need to follow a risk-based approach in dealing with
such clients. Banks are required to carry out a review of their customers to identify such companies, and must inform
the Central Bank by 31 July 2018 of the results of the review and whether they intend to continue their business
relationship with the entities concerned.

Tax factors

In addition to pressures from the banking authorities, tax authorities around the world are becoming increasingly
assertive and sophisticated, and are ready to challenge what they perceive to be abusive structures and arrangements.
With increased transparency and automatic exchange of information, Cyprus companies which do not have real
substance run tax risks, including the risk of:
• having their Cyprus tax residency status questioned;
• losing the benefits of Cyprus tax residence; and
• becoming liable to tax elsewhere.
A company lacking sufficient management and capital may be entirely disregarded by foreign tax authorities, running
the risk that – in addition to any taxes payable by the company in Cyprus – its income is imputed to the beneficial
owners in their own country and taxed there. The availability of a notional interest deduction in Cyprus incentivises
companies to increase their capital and economic substance, and to benefit from reduced taxation on new equity.
Companies with transactions with related parties increasingly face transfer pricing challenges, making transfer
pricing a compliance priority for entities carrying out cross-border transactions. Under the detailed transfer pricing
rules introduced in 2017, companies must demonstrate real substance in Cyprus in the form of adequate management
and capital.

Fundamentals of substance and ways to enhance it

The key pillars of substance are sufficiency of management and capital.
‘Sufficient management’ means having adequate corporate governance arrangements and directors with the skills,
knowledge and experience to run the business, who demonstrably make the important business decisions in Cyprus.
They must spend adequate time on the business of the company and must have real decision-making powers. They
must not be directed by company shareholders, but rather should act independently in the interests of the company.

Depending on the size of the business, the existence of an office in Cyprus, facilities and employees can be key to
enhancing substance. The operation of bank accounts, accounting and HR functions should take place in Cyprus. The
company may also actively take part in the local business community by joining:

• the Chamber of Commerce;
• the Cyprus International Businesses Association; or
• similar bodies.

The optimum degree of presence will be determined by the needs of the business. For example, if a holding company
holds only one investment and the only decision is to declare a dividend once a year, or if a financing company has
only one loan which is assessed once a year, the physical presence required is much less than for a larger business.
‘Sufficiency of capital’ means that the company has enough capital buffer to assume the risks of its operations.
Therefore, the company is not a mere conduit or proxy, and the profits or losses from the operations evidently belong
to it alone.

Any decisions made to enhance substance in Cyprus may also have an effect in other jurisdictions. Consequently,
these issues should be considered altogether, in the context of the entity or the group of which it is a part.
For further information on this topic please contact Michalis Loizou at Elias Neocleous & Co LLC by telephone (+357
25 110 110) or email ( The Elias Neocleous & Co LLC website can be accessed at

The materials contained on this website are for general information purposes only and are subject to the
ILO is a premium online legal update service for major companies and law firms worldwide. In-house
corporate counsel and other users of legal services, as well as law firm partners, qualify for a free

Michalis Loizou
Elias Neocleous & Co LLC