Basic non-resident (offshore) structures have ceased to be effective in reducing taxes for Swedish taxpayers because of anti-avoidance legislation that Sweden has introduced over the past few decades. But for Swedish residents – both companies and individuals – owning shares that would generally attract substantial capital gains on resale, a Cyprus company can offer a highly effective tax deferral mechanism.
Under general principles, individuals are only taxed on the income that they receive or earn. For example, a shareholder is taxed when he/she receives a dividend but is not taxed on any profit that a company decides to retain. To prevent such profits going untaxed when the beneficial owners of a foreign legal entity are Swedish residents, Sweden has enacted ‘Controlled Foreign Companies’ (CFC) anti-avoidance legislation that will attribute the income and gains of the foreign legal entity to the Swedish shareholder (taxpayer), whether that is an individual or a Swedish company.
As a ‘rule of thumb’, a foreign legal entity that is resident in a ‘no tax’ or ‘low tax’ jurisdiction and that is owned by a Swedish taxpayer will likely be treated as a CFC. The current CFC rules in Sweden are also underpinned by EU law following the transposition of the Anti-Tax Avoidance Directive 2016 (ATAD) into Swedish law as of 1 January 2019.
Accordingly, a Swedish shareholder will hold an interest in a CFC if the following two conditions are met:
- At the end of the income tax year (the calendar year for individuals) they hold, directly or indirectly, 25% or more of the capital or voting rights in a foreign legal entity (e.g., a company); and
- The income of the foreign legal entity is deemed to be subject to low taxation.
The 25% test is quite complicated but, to take a simple example, if a Swedish shareholder holds 24% of the ordinary shares in a foreign legal entity, then this condition would not be met (assuming there are no other ‘associated’ people or enterprises that hold shares in that company). If the 25% test is not met, the foreign legal entity will not be classed as a CFC even if it is not taxed at all.
Turning to the second condition, the income of a foreign legal entity is deemed to be subject to low taxation if either the income is not taxed at all or it is subject to a rate of tax that is 55% lower than the Swedish corporate tax rate, which is currently 20.6%. This means if it is subject to tax at a rate of 11.33% or higher, it will not meet this condition even if a Swedish taxpayer owns all the shares.
Even when both these conditions are met, Sweden has a ‘whitelist’ (found as an appendix to chapter 39a of the Income Tax Act) that provides an exemption from the CFC rules for income (or certain types of income) from listed countries. Malta, for instance, was removed from its whitelist, which means that all types of income from Malta could fall within the scope of the Swedish CFC rules.
A further exemption from the CFC rules also applies to income of a foreign legal entity that is resident within the European Economic Area (EEA) if the Swedish shareholder can demonstrate that the foreign legal entity is established and engaged in real economic activities in the other country. This second exemption remains available for Malta companies.
Unlike many countries, Sweden does not exempt active income (e.g., trading income) accruing to a foreign legal entity from its CFC rules. Therefore, if the two conditions are met and neither of the two exemptions apply, the CFC rules will attribute all income and gains to the Swedish shareholder. Sweden does however provide a tax credit against Swedish tax to account for any foreign tax paid by a CFC.
If CFC rules apply, any income and capital gains accruing to a foreign legal entity or trust will need to be reported by the beneficial owner on his/her Swedish tax return for the year in question. And, with the OECD Common Reporting Standard (CRS) now in place worldwide, the Swedish Tax Agency can expect to receive information on an annual basis from foreign revenue authorities on any Swedish taxpayers with non-compliant foreign structures.
However, a Cyprus company can offer a highly effective tax mitigation proposition for Swedish taxpayers, both companies and individuals.
A Cyprus company is taxed at a rate of 12.5% (shortly to rise to 15% in line with the global minimum tax rate) and the Cyprus government offers generous tax reliefs and exemptions for companies, which means the effective rate of tax may be considerably lower. Cyprus generally does not tax capital gains. By way of contrast, Sweden taxes individual taxpayers at a flat rate of 30% on their domestic and worldwide gains, while their income (domestic and worldwide) is taxed at rates up to 52.9%. Swedish companies are subject to tax of 20.6% on income and 30% on gains.
If a Swedish taxpayer, whether an individual or a company, holds all the shares in a Cyprus company, its profits should not be taxed in Sweden unless distributed to the Swedish shareholder. The Cyprus company will not be classed as an CFC because it is subject to a 12.5% rate of corporation tax, which is above the 11.32% tax rate threshold of Sweden’s CFC regime.
Cyprus is also on Sweden’s CFC ‘whitelist’. This means that even if the effective rate of tax in Cyprus is lower than 11.33% because, for example, some or all the income is tax exempt in Cyprus, then Sweden’s CFC rules will still not apply.
In many ‘onshore’ jurisdictions, a transfer of assets that are pregnant with gains to a foreign legal entity would crystallise those gains for tax purposes, even if the foreign legal entity does not actually pay for the assets. This is because anti-avoidance legislation generally deems the company to have made a payment that is equal to the market value of the assets at the date of transfer.
Sweden does not have such a rule. This means that Swedish residents who hold non-cash assets, such as shares, can transfer them to a Cyprus company without triggering a gains tax charge in Sweden, while Swedish income tax can be deferred until such time as a distribution is made. If the assets are later sold by the Cyprus company, there will be no capital gains tax (CGT) in Cyprus and potentially no CGT in the country where the asset is situated.
If the Swedish shareholder chooses to re-locate to a lower tax country, such as Portugal, then any distribution can be deferred until he/she is no longer tax resident in Sweden. Further, if the shareholder successfully applies for Non-Habitual Resident (NHR) status in Portugal, then he/she can enjoy a tax exemption (with progression) for foreign-source income, including capital gains, interest, dividends, as well as other investment income, providing certain conditions are met.
NHR status can be requested by anyone who meets three requirements. You must live abroad, not have been a resident in Portugal within the last five years and want to move to Portugal. To be considered a resident, you must remain in Portugal for 183 days a year or have your primary home there. In other words, Swedish residents migrating to Portugal can not only defer tax in Sweden but avoid it completely.