Employing a holding company as a family investment company: how does it compare to a family trust?

Introduction
Employing a holding company as a family investment company
Family trusts
Comment

Introduction

The EU Anti-tax Avoidance Directive (2016/1164/EU) has been transposed into Cypriot legislation and is:

• retrospectively effective as of 1 January 2020 with regard to hybrid mismatches, exit taxation and tax residency mismatches; and
• effective as of 1 January 2022 with regard to reverse hybrid mismatch arrangements, which exploit the different tax treatment of an entity or instrument under the laws of different jurisdictions.

Given the strengthening of the rules on corporate tax avoidance, individuals must consider better estate protection strategies and undertake legitimate tax and tax avoidance planning. Cyprus trust legislation allows for the establishment of trusts with advantageous tax regime and asset protection features. Family trusts are deeply embedded in estate planning, but the Cyprus holding company may also be utilised as a family investment company (FIC) as an alternative to a family trust. Therefore, is the FIC an ideal alternative tax and succession estate planning structure?

Employing a holding company as a family investment company

Characteristics of FICs
An FIC is a private company that invests rather than trades. In particular, an FIC holds the family's long-term investments (eg, share portfolios or property) and the shareholders and directors are typically members of the family. For example, parents, being the original asset owners, often set up an FIC with at least two classes of share; the parents typically hold a class of shares with voting rights but no rights to dividends or any return of capital, whereas the children hold the other class of shares with no voting rights but full entitlement to dividends and any return of capital (on the necessary corporate approvals). The parents are usually the directors of an FIC although a third party may also act as a director on the approval of the parents, especially where the parents do not reside in Cyprus. An FIC, as any other Cyprus holding company, will be governed by the memorandum and articles of association, which will be publicly available, and any agreement made by the shareholders, which has the benefit of being private.

An FIC's governing documents should be tailored to meet individual circumstances and include provisions covering, among other things:

• the distribution of profits;
• the return of capital;
• the appointment of directors;
• pre-emptive rights; and
• share transfers.

Establishing an FIC
By way of an example, Mr and Mrs E are UK nationals who have decided to relocate or spend significant time in Cyprus after the Brexit transition period and establish an FIC as an asset protection tool or family investment vehicle. The FIC can be fully incorporated with 100% foreign ownership as no restriction exists on the nationality or residency of the company's shareholders.

In establishing an FIC in Cyprus, the following criteria should be met:

• The assets belonging to the FIC must be clearly determined and the directors must be clearly identified and disclosed to the relevant regulatory authorities. The directors, or the majority of the directors, of the FIC must reside in Cyprus for the purposes of establishing proper management and control in Cyprus.
• The FIC must have its registered office in Cyprus. Depending on the FIC's banking facilities, additional substance in Cyprus or abroad may be required.
• An accurate valuation of the FIC's assets must be carried out according to their fair market value. In exchange, the shareholders must receive shares (instead of assets) that equate to their respective ownership value.

Advantages of FICs
The key advantages of setting up an FIC are as follows:

• FICs can employ non-EU foreign nationals who wish to work in Cyprus. Such employees need only file an application with the Civil Registry and Migration Department for a temporary residence and employment permit which will typically be valid for one to two years and will be renewable. The immigration sector manages applications and issues residence permits to third-country nationals (ie, nationals of countries outside the European Union or the European Economic Area) who are either in Cyprus or abroad at the time of the application.
• Employees will essentially have the rights of EU citizens. As such, their family will be allowed to live and reside freely in Cyprus.
• In their efforts to implement tax treaty-related measures in order to eliminate base erosion and profit shifting (BEPS), 67 countries, including Cyprus, have formally agreed and signed the BEPS Multilateral Instrument. FICs can take advantage of the equal playing field and stable economic environment that these measures bring.
• Corporate taxation exempts income from dividends.
• Withholding tax facilitates the exemption of dividend distribution to foreign shareholders.
• As of 2015, Cyprus tax law has allowed for new corporate equity to be eligible for a tax reduction through the notional interest deduction regime. This tax reduction is one that the FIC can apply to and benefit from.
• FICs enjoy Cyprus's low corporate tax rates at 12.5% out of net trading profits.

Further, companies established in Cyprus can enjoy tax credits for withholding tax on income received in Cyprus, representing a type of tax relief. These credits also apply to other taxable income.

A UK family that wishes to preserve and invest family wealth for its children can, provided that it meets these requirements, relocate to Cyprus and establish an FIC which will have the above advantages. Moreover, foreign entrepreneurs may feel more comfortable employing individuals from their own country due to language barriers and cultural differences.

Finally, incorporating a company in Cyprus is straightforward and quick and opening a corporate bank account is generally easy.

Family trusts

Family trusts are controlled by the trustees who may or may not be members of the family. The trustees will hold the assets of the trust fund for the benefit of the beneficiaries following the settlor's wishes. According to the traditional trust structure, the trustees will have discretionary power. This implies that the trustees will have discretion over whether payments are carried out and the amount and recipient of such payments. However, such matters are regulated through the trust deed itself and the letter of wishes. Also, the trust deed will govern the trustee's powers and responsibilities and such document is private, accessible only to the individuals concerned. The trust will be governed by the International Trusts Law (69/1992). The procedure for establishing a Cyprus international trust is remarkably straightforward and can be arranged relatively quickly.

Establishing a family trust
At present, trusts established, construed and governed by Cyprus law should be registered with the Cyprus Bar Association, the Institute of Certified Public Accountants of Cyprus or the Cyprus Securities and Exchange Commission according to Section 25A(1) of the Fiduciaries Law, as amended in 2013.

According to Article 2 of the International Trusts Law, for a trust to qualify as an 'international trust', the following conditions must be satisfied:

• The settlor, either an individual or a legal entity, must not be a Cyprus resident in the year preceding the trust's formation. The settlor may be a Cyprus resident following the trust's formation.
• The above rule applies to beneficiaries except where they are a charitable institution.
• At least one trustee must, from the trust's formation, have been a permanent resident of Cyprus.
• The trust assets can include immovable property located in Cyprus or abroad.
• Beneficiaries of the trust, who are Cyprus residents, are liable to pay tax only in Cyprus. Non-resident beneficiaries are not subject to tax on the payments which they receive from a Cyprus trust.

Comment

The family trust has traditionally been viewed as the default option for estate planning and asset protection. An FIC is essentially a private company limited by shares which may be employed as an alternative to a family trust. FICs are flexible and can be tailored to meet a family's particular circumstances or requirements; they can create different classes of share which allow family members to have different rights of control, income and return of capital with the ability to change the structure over time. The question of which one to opt for depends on individual family circumstances, objectives and investment strategies. The good thing is that families have the option of setting up a trust or an FIC and can choose the best option based on their overall way of life. If a family is looking to combine asset protection, low tax and relocating to Cyprus, either of these vehicles would be suitable.

For further information on this topic please contact Angelos G Paphitis or Andrea Psara at A G Paphitis & Co by telephone (+357 25 73 10 00) or by email (angelos.paphitis@agplaw.com or andrea.psara@agplaw.com). The A G Paphitis & Co website can be accessed at www.agplaw.com.