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Since the last regular report, Cyprus has achieved some progress in the area of taxation.

In the field of indirect taxation, the standard Value Added Tax (VAT) rate of 8% was increased to 10% as of 1 July 2000. Furthermore, the House of Representatives approved in June 2000 a VAT Bill which includes substantive alignment with the Community VAT acquis, inter alia, for the abolition of the special VAT provisions in favour of international business enterprises, which was identified as a short-term priority in the Accession Partnership, and a refund scheme for foreign taxable persons not established within Cyprus. However, the entering into force of the Bill, which is not expected until sometime during 2001, is dependent on a Decision of the Council of Ministers pending the adaptation of the existing VAT computerised system to the new Bill.

Since the end of 1999, the excise duties on domestic produced spirits and petrol have been increased. In addition, excise duties have been introduced on gas oil, kerosene and imported spirits whereas the import duty on imported alcoholic beverages has

been decreased. The specific duty on cigarettes was increased in June 2000, bringing the duty level close to the Community’s minimum excise duty incidence of 57%. Whereas no concrete progress is to be reported in the field of direct taxation, it should be noted that Cyprus has undertaken a commitment towards OECD to eliminate harmful tax practices by the end of 2005. That political undertaking is interpreted to be valid as well as with regard to the – political - obligations stemming from the Code of Conduct for Business Taxation and therefore must be seen as “indirect” but substantial progress. It is however, to be noted that the rollback obligation of harmful tax measures under the Code of Conduct is set at end of 2002 at latest.

No further developments since the previous year can be reported in the area of direct

taxation and administrative co-operation and mutual assistance.

As regards the administrative capacity, a new section has recently been established at Customs Headquarters for the promotion of the harmonisation effort and the effective implementation of the acquis on excise duties. In addition 53 VAT officers have been recruited and trained. The new officers have been deployed to the field of control.

Overall assessment

Although Cyprus has undertaken several measures to further align its legislation with the acquis, there are some discrepancies in several essential areas between Cyprus’ legislation and the acquis, therefore further efforts are required.

Regarding indirect taxation, VAT was introduced in Cyprus in 1992. Two VAT rates are applied, a zero rate and a standard rate of 10%. The main difficulties for Cyprus in terms of the acquis relate to the application of rates. The substantive use of the zero rate raises some concern, since full alignment in this area is most likely to have a significant impact on consumer prices. The pursuit of VAT harmonisation by dimishing the zero-rate extension was identified as a short-term priority. Although it has recently been decided to increase the standard VAT rate from 8% to 10% the gap between that and the EC standard rate of 15% remains very large. There are concerns as to whether Cyprus will be able (both on political and economical grounds) to introduce the necessary adjustments in a reasonable timeframe, especially if it has to be accompanied by –politically- sensitive adjustments of rates also in other areas (reduced rates VAT, excises, taxation of off-shore companies).

The VAT Service, with a separate structure within the Department of Customs and Excise, administers VAT in Cyprus. Although it is a modern tax administration further efforts are needed to ensure Cyprus’ capacity, including that of computerisation, to implement, control and enforce the acquis. The administrative system of control of VAT is based on central administration with local control.

Some substantial efforts have been made since the last regular report, however, the excise legislation of Cyprus remains different in several essential areas from that of the acquis. This is in particular the case regarding the taxable scope, the duty level and the level of duty rates. The continued use of protective measures in the form of in

particular the Temporary Refugee Levy, results in imported goods being taxed more heavily than similar domestically produced products. Abolishing such discrimination has been identified as short-term priority in the Accession Partnership. Although it is fully recognised that efforts have been initiated to align the excise legislation, a more complete assurance for the remaining parts should be pursued.

The Department of Customs and Excise of the Ministry of Finance is the authorised government body for the administration of excise duties. Further efforts are required with regard to the introduction of a tax warehouse system.

In the field of direct taxation, the special regime for offshore companies in Cyprus needs to be addressed. (There are about 42,000 registered offshore companies in Cyprus, which employ 3000 non-Cypriots and 2500 Cypriots. It is estimated that they brought some 200 million CY Pounds in foreign currency to Cyprus in 1999, roughly 4.4% of the GDP.)

The Department of Inland Revenue is the competent authority for the administration of direct taxation. Currently, the Department employs around 600 employees. Its systems are computerised for the issuing of income tax returns, raising of assessments and collection of taxes.

In the area of administrative co-operation and mutual assistance, Cyprus will have to introduce harmonised legislation on the VAT Information Exchange System (VIES) and develop the existing infrastructure to apply this system. Cyprus already has a computerised system for the collection and processing of VAT returns. In order to be able to meet the new demands concerning administrative co-operation and mutual assistance, Cyprus will have to further reinforce its tax administrative structures and control procedures. The establishment of a strategy for the modernisation of the tax administration is an essential starting point.