Back

Chapter - 6
Cyprus

1.    Constitutional and legislative perspective of the taxation system

1.1.    The Republic of Cyprus was set up in 1960 to replace British colonial rule in Cyprus. Inevitably the framework of our taxation system is based largely on the British model. Cyprus has a unitary system of Government and all tax revenues are managed centrally. Local authorities have restricted powers to raise taxes on immovable property.

1.2.    Constitutionally, all revenues and moneys, however raised, shall be paid into the Consolidated Fund of the Republic. However, due to exigencies created as a result of the Turkish invasion and occupation of northern Cyprus, some revenues raised by specific laws are paid into Special Funds and managed through specific budgets.

1.3.    For the purpose of this project, all revenues are viewed unitarily, because there is no distinction from an audit viewpoint and, in any case, they are based on the same object of tax as other taxes.

2.    Extent of Government Revenues

2.1.    Government revenues are collected under some 310 subheads of the budget. Responsibility for collection and classification is placed on the director of each department or service. The budget codes allow the classification of revenue under eight headings and, excluding grants and loan proceeds, it amounted, in 1995, to Cy£l .059 million (Exchange rates for different currencies vis-a-vis the US $ as on 31s' March, 1997 are indicated in Appendix 1 (Pg. 475)) as follows:

3.    Audit Mandate

3.1.    In Cyprus we have no separate audit law. The powers and duties of the Auditor General derive from the Constitution. The wording of the Constitutional provisions gives the Auditor General wide powers to perform any audit he considers appropriate and in particular affords the right of access to all books, records and returns relating to any account audited. Accordingly he has the right of access to individual assessment files and we consider that no revenue audit may be complete without such access. However, we have no right of access to the records of taxpayers or to question taxpayers. In the case of Customs and excise audits, this obstacle is partly overcome through liaison with the Department by arranging joint visits to factories and bonds with officers of the Department.

4.    Audit Procedures and Methodologies

4 1.    Planning

4.1.1.    Prior to commencement of an audit, the audit team and the audit manager go through the audit program and permanent files and discuss the various tasks that need to be carried out. This is done so as to identify and focus attention to the most important areas that may be looked at in the time available. The audit program covers all the activities of the auditee and includes substantive testing of documents and compliance testing of controls as well as observation and Surprise Surveys of cash and inventories.

4.1.2.    Due to the vast population of files and documents generated by the revenue departments it is not proper to place any significant reliance on detailed substantive testing and more emphasis is given to:

1. Compliance testing of internal controls.
2. The system and procedures of tax administration.
3. The method of selecting files or records for detail audit.

4.1.3.    The Audit Office is also actively involved in the development and implementation of internal control systems in liaison with the auditees. Along these lines, in the case of Customs and Excise, customs officers are posted on a permanent basis to the tobacco factories, soft drink bottlers and breweries so as to oversee production and collect excise taxes promptly.

4.2.    Inland Revenue Department.

4.2.1.    Tax audit in Cyprus has a comprehensive coverage and includes appraisals of financial and administrative controls, compliance and regularity, examination of individual tax files, efficiency of tax collection, systems in operation, fraud, special investigations etc. It is repetitive and is carried out half yearly. Most of the work is performed at Headquarters but brief visits are made to district tax offices. It can also be described as continuous in as much as the auditors involved are constantly in touch with developments and changes to the systems and procedures, either through copy letters or by attending relevant meetings.

4.2.2.    There is also a follow up system for pursuing implementation of audit suggestions and the audit activity is monitored and supervised closely by senior officers, in order to ensure that the audit work is conducted and completed as planned.

4.2.3.    The audit work is conveniently broken down into functional sectors as follows:

1. Income based assessments (income tax, corporation tax, special contributions, defence contributions).
2. Property based assessments (Estate Duty, Capital Gains Tax, Immovable property Tax).
3. Collection and accounting.

4.2.4.    Each sector has its own characteristics and peculiarities and due consideration is given to this predicament.

4.2.5.    Income based assessments- The tax-files population is very large and only a small number of files come under examination. Because of the dissimilarities between cases, the use of random sampling techniques for selecting cases for examination will not yield the desired results. Instead judgment sampling methods are used and more effort is devoted to large and important cases, where the revenue impact is high and. Due consideration is also given to third party relevant information.

4.2.6.    In examining the income tax files the auditor will primarily see that:

• Income Tax returns and other documentation are submitted promptly and action is taken against defaulters.
• Temporary and provisional assessments are timely raised.
• The chargeable income is computed correctly by reference to facts and Laws.
• Appeals are settled without undue delay.
• The assessments raised are processed through the EDP system as scheduled.

4.2.7.    Income based assessments can be divided into two main categories:

1. assessments relating to salaries and wages, and
2. assessments relating to profits and other income.
   Category (b) is further subdivided into two groups:

• where the tax returns are supported by audited accounts; and
• where the tax returns are not supported by audited accounts.

4.2.8.    Employees Assessments The audit of assessments based on salaries and wages is relatively simple and less weight is given to this area. The auditor ensures that, by reference to the tax return and any other information contained in the file, any other income, such as rents, interest, dividends, pensions, second job, benefits in kind etc., is brought to charge, the deductions allowed and credits given are consistent with the Law and Regulations and the computation of tax is correct.

4.2.9.    Taxation of Profits Where the Tax Return is supported by audited accounts three steps are followed. The first step is to review the accounts to ascertain that they portray a reasonable picture and they do not include any expenses not legally deductible. In this respect a number of tests is applied to the figures and reference is made to other economic indicators and information available and comparison with similar businesses is made. Apart from checking the arithmetic of the figures, the aim is to establish whether the assessor took all reasonable steps to test the figures and gathered and reviewed all material information, before determining the case and that where material discrepancies arose he referred the file for investigation. The second step is to examine the computation of capital allowances for correctness and compliance with the law and the third step to examine the arithmetic accuracy of the tax computation and the assessment.

4.2.10.    In the majority of cases Tax Returns are not supported by audited accounts and the assessments are largely estimated. In an effort to bring to charge income that otherwise might escape taxation, the Income Tax Authorities obtain every six years, from each tax-payer in this group, a capital statement on the basis of which additional assessments may by raised. The philosophy of this method is that any accretion to capital in any given period, unless otherwise explained, is derived from profits. To this accretion are added the educational expenditure for children, taxes and life insurance's premiums paid, improvements to fixed assets, travelling abroad, gifts made, a reasonable amount for living expenses, having regards to the individual's size of family, financial and social standing etc., and any capital receipts or profits not taxable are deducted.

4.2.11.    In these cases the auditor must ensure that the capital statements are examined promptly and that the assessor has taken all reasonable steps to gather and review all material facts and information before determining the case. No two cases are exactly the same and a lot of value judgment on the part of the assessors is involved. The auditor should not be absolute and must understand clearly the mechanisms and discretionary powers conferred upon the authorities. If the discretion exercised is based on facts and information available the decision cannot be questioned. In this connection clear guidelines must exist to provide for better administration and to avoid abuse of powers. It must be pointed out that the S Al has not been very successful in challenging exercise of discretionary powers.

4.2.12.    Audit of property based assessments. Immovable property tax is levied on the market value of the property at base date 01/01/1980. Capital gains tax is levied on the gains arising from the disposition of such property. Both taxes are levied at fixed rates and for their administration a property master file was created. Due to their nature these assessments are easier to audit and the audit focus is mainly on the system of the file maintenance and updating. Regarding the immovable property tax, the base values were computed by the Department of Lands and Surveys and one of the audit tasks is to ensure that the original assessments, raised on valuations declared by the tax-payers, are revised by reference to the official valuation which was completed 12 years later.

4.2.13.    As regards Capital Gains Tax, the values at base date are computed by reference to the general valuation at 1.1.80 or to cost thereafter augmented by the increase in the cost of living index and the disposal values are as declared by the tax-payers but the authorities have the power to compute a different market value as at the date of disposition, if there are grounds suggesting that the sale declared was not made at arm's length. Evidently the discretionary powers conferred^ upon the Commissioner are too great. Land valuation, however, cannot be weighed on a scale and a lot of judgment is involved.

4.2.14.    The auditor would not ordinarily question a judgment that could reasonably flow from the facts available. If, however, the necessary facts were not collected or the facts collected were irrelevant to the case or the conclusion drawn was such that no reasonable person could draw, the decision taken is questionable. In this respect SA1 takes advantage of information obtained from auditing the Department of Lands and Surveys, by comparing declared sales values or contracts for sale, of the same property, available in the two departments. From such comparisons Audit frequently comes up with large discrepancies which are duly reported for remedial action.

4.2.15.    One particular aspect that needs care is whether the gain is a capital gain or a trading profit in which case it should be charged to income tax at higher rates. One deciding factor for the distinction is the frequency of land dealings.

4.2.16.    Audit of Collections. The collection of taxes levied is the final act of a long process and in many cases, of hard work by the assessing staff. If there is no collection a lot of effort goes to waste. The basic objectives of the audit are to ascertain that:

• The collection procedures framed under the law and regulations are adequate to secure prompt collection and allocation of revenue and that these procedures are observed.
• The taxes levied are collected promptly.
• The calculation of interest of overdue amounts is correct.
• The facilities granted are adhered to.
• The amounts collected are properly accounted and classified to the budget heads correctly.
• The legal action reserved by the law and regulations against defaulters is taken promptly.
• The EDP system is updated promptly and correctly with collections, and
• Any abandonment of revenue is fully justified.

4.2.17.    Understandably the transactions involved are voluminous and the audit work is done on a sample test basis. The sample is relatively small but such that general conclusions may be drawn. On the basis of the audit findings, suggestions are made for bettering the collection procedures and for amending the collection law, where necessary.

4.3.    Department of Customs and Excise

4.3.1.    Customs Duties and Excise Taxes Due to the diverse activities, the large volume of transactions and the different locations of the Department it is not possible to achieve a satisfactory level of assurance by detailed substantive testing. For this reason more emphasis is given towards ensuring that proper controls are employed to minimise the risk of loss of revenue due to irregularities, intentional or unintentional. Thus during the audit the procedures and the controls laid down by management are closely scrutinised and appropriate recommendations are made where weaknesses are identified. Development and implementation of controls are ongoing.

4.3.2.    The Audit Office contributes both through the audit recommendations and through direct involvement with management in the design of control systems. The aim of such systems is to enable the collection of all revenue in an efficient manner in accordance with the law and with the minimum disruption to commercial activity. Detailed substantive testing is carried out to a limited extent, in such areas as classification and valuation of goods, for extra assurance. The same approach is employed in the audit of non-revenue generating activities such as temporary importation of duty free goods and drawbacks.

4.3.3.    The bulk of audit work is carried out in routine, half-yearly visits to all District Offices. Surprise cash surveys are also regularly carried out at the District Offices as well as stock takes at various bonded warehouses. Additionally, tobacco, spirits and soft-drinks factories are visited regularly for verification of the excise taxes.

4.3.4.    Various areas where weaknesses were identified have been the subject of performance audits discussed in paragraph 4.3.8.

4.3.5.    Value Added Tax VAT is a self-assessed tax and therefore it is difficult to verify. Unless proper control is exercised the likelihood of false declarations occurring will be high. If properly administered it can be an effective tool in detecting income tax evasion. It is therefore very important to implement an effective system of internal control which, together with the safeguards incorporated in the legislation, will act as a strong deterrent against irregularities. The Audit Office was actively involved in the design of the internal control system during the set-up of the VAT department.

4.3.6.    Experience in other countries, particularly the UK, has shown that the control visit at the taxpayer's premises is the most effective tool against irregularities, including fraud. On average all taxpayers should be visited for one working day every 3-4 years. High risk and high yielding taxpayers should be visited more frequently. Furthermore, staff should be continually trained for this very demanding task which typically involves a lot of work to be done in very limited time.

4.3.7.    In Cyprus, unfortunately, control visits have not been carried out to the required level due to staff shortages (only 9.3% of registered taxpayers have been visited so far). For the same reason arrears of revenue have been increasing and reached Cy£8.1 million at 31/12/95 (4% of VAT revenue for the year). It should be noted, however, that despite these problems VAT revenue has increased steadily since its introduction in 1992 which indicates that proper procedures and regulations have been laid down.

4.3.8.    Performance Audits. Performance audits are conducted in areas where weaknesses and inefficiencies are identified during the financial audit. In the last five years such audits covered Bonded Warehouses, Reliefs to repatriated citizens, Reliefs to Driving Schools and Property Taxes. The methodology in performance auditing in broad terms is the following:

• At the preparatory stage a detailed study of the pertinent Laws and regulations is carried out so as to assess their adequacy and identify any weaknesses or loopholes.
• Relevant financial and other data are collected through interviewing key personnel, questionnaires and reviewing files.
• Weaknesses and inefficiencies are identified and detailed recommendations formulated.
• Audit findings and recommendations are discussed with management and a draft report is prepared for written comments by management.
• A final report in prepared.

4.3.9.    A Steering Committee is usually appointed with the responsibility of monitoring and advising the audit team The final reports are also communicated to the House Finance and Public Accounts Committees for any action they consider necessary. In the case of the Driving Schools audit, for instance, it was established that a number of schools were formed only on paper with the aim of acquiring duty free vehicles and that in many other cases the vehicles were used otherwise than for training of drivers. Parliament acted promptly upon these findings by abolishing the relevant relief allowed by the law to driving schools.

5.    Audit Planning

5.1.    We do not have the luxury of financial independence and the resources available to our SA1 are those decided by the Ministry of Finance and voted on by the House of Representatives. The work of the SA1 is allocated to our twelve working sections mostly on a functional basis and this allocation is almost rigid. Thus in spite of the fact that all sections have to audit some revenue, the big revenue departments, Inland Revenue and Customs and Excise, are each allocated to one section.

5.2.    Our eighty or so audit officers are allocated to sections and they usually are rotated every five years. In allocating the staff, care is taken to allocate to the revenue sections officers who possess the right qualifications and aptitudes for the job. Audit programs are reviewed annually at a senior level but in practice only few changes are made leaving the staff with sufficient flexibility and initiative.

6.    Audit Reporting

6.1.    Audit findings are summarised by the officer in charge and discussed with the Audit Senior. The next step is to discuss the findings at length with the appropriate authorities of the auditee. At this level any invalid observations are eliminated and where possible the auditees' agreement of the facts and of the recommendations is obtained. The letter containing the findings and the recommendations is sent to the Director of the Department and copied to the Director General of the supervising Ministry. Audit letters, apart from the facts, usually contain only negatives but care is taken to include also important positives.

6.2.    Unavoidably the audit letters contain names of taxpayers and there is always some risk of violating the secrecy provisions of the Income Tax Lax. To minimise this risk our letters to the Inland Revenue are treated as confidential. The auditees must, within three months, reply in writing stating what action they propose to take, their agreement or possible disagreement with the facts or recommendations and any other views they consider appropriate to express.

6.3.    All serious issues that need urgent attention are communicated quarterly to the Minister of Finance and copied to the President of the Republic and to the appropriate Parliamentary Committees.

6.4.    Finally, the important findings are included in the Annual Report which is presented to the President of the Republic and to the House of Representatives. Irrespective of the action taken by the Public Accounts Committee in relation to the Annual Report the Council of Ministers have established a procedure at executive level, for discussing and dealing with the serious issues reported.

7.    Information Technology Audit Techniques

7.1.    Our capabilities in the field are still at the development stage. The previous IT system employed by Inland Revenue Department was insufficient, somehow unreliable and unable to provide sufficient and robust controls in relation to assessments, collections and refunds.

7.2.    In 1987 the Government commissioned the development and installation of a complex tax administration system covering all activities of the Inland Revenue Department which will also have interface capabilities with other systems for retrieval and validation of information. The system is not yet fully developed but at the appropriate stage the SA1 requested to have its own line facilities with the system and it is hoped that proper IT audit techniques will soon be developed and used.

8.    Human Resource Management

8.1.    The audit personnel systematically receive training, aiming at developing auditing skills and generally broadening knowledge and capabilities. Thus they attend lectures and seminars on relevant topics, including taxation laws computer applications, fraud awareness etc. The SAI does not keep data of revenue realised as a result of audit but we estimate that such revenue is many times greater than the cost of revenue audits both for Inland Revenue and Customs and Excise. In two Income tax cases investigated and reported during the past three years by the SAI, the additional revenue realised was equal to the total annual budget of the SAI.

9.    Basic Laws of Taxation

9.1.    At present the principal laws of taxation are:

9.2.    Some of the direct taxes do not strictly meet the generally accepted principle of the definition of direct taxes.

10.    Department of Inland Revenue

10.1.    Organization

10.1.1.    Responsibilities. The Department is responsible for the implementation of the following laws:

• Income Tax and Corporation Tax
• Estate Duty (repealed with effect from 01 /04/1997)
• Defence Contributions (all types of incomes other than emoluments)
• Special Contribution for Refugees (The law was repealed with effect from 01/7/92 but it still applies to unassessed incomes arising prior to repeal and to collection)
• Capital Gains Tax
• Immovable Property Tax
• Stamp Duty
• Tax Collection.

10.1.2    Organizational Structure. The land is divided into five administrative districts in each of which the Department has established a District Office. All District Offices have responsibility for all taxation laws except Estate Duty which is managed centrally.

10.1.3.    The head of the Department, located at Headquarters, is the Director (Commissioner of Inland Revenue) who has retained for himself line responsibility for Administrative Services, Internal Audit and Estate Duty. Beneath the Director function three Chief Revenue Officers sharing line responsibility for:

10.1.4.    District Offices, Investigations, Legal, Studies and Research, Training, Data processing and Tax Collection.

10.1.5.    District Offices Each District Office is headed by an officer in charge who is a principal Assessor (qualified Accountant). The work of each District Office is divided into sections headed by section leaders. At present the following sections are in operation:

• Registry and Administration
• Investigation
• Self Employed and Corporations
• Objections (appeals)
• Private Employees
• Civil Servants (Nicosia only)
• PAYE (Pay-As-You-Earn)
• Immovable Property Tax and Capital Gains Tax
• Tax Returns and Data Processing.

10.2.    Income Tax and Corporation Tax

10.2.1.    Administrative provisions. For the due administration of this Law, the Director shall be the Commissioner of Income Tax who shall do all such acts, as he may deem necessary or expedient, for the purpose of carrying into effect the provisions of this Law.

10.2.2.    The Commissioner may authorise any other officer of the Department of Inland Revenue to exercise such powers and perform such duties in respect of the administration of this Law, as the Commissioner may direct.

10.2.3.    Official secrecy Every person having any official duty or being employed in the administration of this Law shall regard and deal with information and all documents, returns and assessment lists relating to the income of any person as secret and confidential and shall make and subscribe a declaration to that effect in a form prescribed before a Judge of a District Court.

10.2.4.    A person having information or possessing or having control over or access to any document, return or assessment list relating to the income of any other person shall not at any time communicate or attempt to communicate such information or anything contained in such document, return or list otherwise than for the purposes of this Law:

10.2.5.    Provided that the Minister of Finance may authorise any such information or anything contained in any such document, return or list to be communicated to such person or persons as he shall specify.

10.2.6.    Comments:

1. Auditors engaged in the audit of Inland Revenue must also comply with the above provisions.
2. In cases where information in tax files suggests that a person may have contravened any other law or acted fraudulently or criminally, the SAI usually obtains the Minister's authority for communicating that information to the appropriate authorities.
3. In the past, SAI considered that absolute secrecy is against public interest and aids tax frauds. In this respect, it suggested that assessment lists should be open for publication, but this suggestion was turned down.

10.3.    General Powers of the Commissioner

(a)    Power to require particulars to be furnished The Commissioner may, by notice in writing, require any person to furnish him with such particulars as he may require for the purposes of the Law with respect to the income of such person or to attend before him and give evidence on oath or otherwise with respect to his income and to produce any accounts, books or other documents in his custody or under his control relating to such income.

(b)    A ccounts prepared and certified by practising A ccountants - A uditors Any accounts and any computations of chargeable income produced to the Commissioner or accompanying any return of income submitted to the Commissioner may, at the Commissioner's discretion, not be considered if they have not been prepared and certified by an independent accountant practising in the Republic, duly authorised by the Minister of Finance to prepare accounts and computations for income tax purposes. The Minister of Finance in issuing such authorisation may impose such conditions as may appear necessary or advisable for the purpose of ensuring preparation and submission of accounts showing a true and correct statement of the profits or losses of a trade, business, profession or vocation:

Provided that the Minister of Finance may at any time withdraw such authorisation from any practising accountant or member of a firm of such accountants, if an accountant's competence or conduct in the matter of preparation of accounts and computations of chargeable income justifies such an action on the part of the Minister of Finance.

(c)    Certain undistributed profits to be treated as distributed Where it appears to the Commissioner that with a view to the avoidance or reduction of tax a limited company controlled by not more than five persons has not distributed to its shareholders as dividend profits of a year or of any other period for which accounts have been made up which could be distributed without detriment to the company's business or to the maintenance, expansion or development of that business, he may treat a portion of up to 65% of such undistributed profits as distributed by way of dividend to the shareholders owning shares as at the date of the holding of the annual general meeting at which the relevant accounts have been approved or as at the end of such other period for which accounts have been made up, and the persons concerned shall be assessed accordingly.

(d)    Loans to directors or shareholders of a Limited Company. Whenever a limited company controlled by no more than five persons grants loans or other monetary facilities to its directors or shareholders, including their next of kin up to the second degree, the Commissioner may regard such loans or facilities as interest bearing and adjust the income of the company accordingly.

(e)    Books to be kept Every person engaged in any trade, business, profession etc. from which he derives taxable income shall keep such books and records as may be necessary for the purpose of ascertaining the income of such person. Such books and records shall be kept for a period of at least seven years from the completion of the entries or transactions to which they refer, unless the Director notifies the interested person otherwise. The Director shall have the right to inspect and check all the books and records which he has required to be kept and may obtain extracts or copies of such books or records for the purposes of the Law.

(f)    Powers of the Director during stock-taking Notwithstanding any other power conferred upon him by the Law, the Director shall, where there is reasonable suspicion that the correct quantities and prices of the goods of a trade or business are not entered into books of account, have power to audit the correctness thereof and he may require that an agent specially authorised by him in this respect be present during the stock-taking of such goods.

(g)    Power of the Director for search etc. Where there is reasonable cause to believe that an offence in contravention of the Law has been or is being committed, the Director has power, with the sanction of the Court, to search premises or persons for the purpose of finding legally admissible evidence regarding the commission of the offence.

(h)    Certain transactions to be disregarded Where the Director is of the opinion that in respect of any year of assessment the income of any person is reduced by any transaction which in his opinion was artificial or fictitious, he may disregard any such transaction and assess the persons concerned on the proper income.

(i)    Compounding of offences The Director may compound any offence contrary to the provisions of the Law and may, before judgment, compound any proceedings thereunder on such terms and conditions as he, in his discretion, thinks proper, with full power to accept from the person liable a payment in money not exceeding the maximum penalty incurred or alleged to have been incurred under this Law for such offence.

10.3.1.    Comment:

10.3.2.    In the SATs opinion, this absolute discretionary power conferred upon the Director, is incongruent with public accountability and therefore it does not operate in the best interest of the State. During the first 3 5 years of independence, only one case was brought to Court by the Director and, in any case, an out of Court settlement was reached.

10.3.3.    The argument of the Director that, through compounding, heavier pecuniary penalties are imposed and the cases are dealt with more expeditiously, thus avoiding prolonged and costly legal proceedings, is valid but, in the SAl's opinion, the benefits of deterrent, through adverse publicity available where Court proceedings are instituted, are lost and, moreover, absolute powers are always liable to being abused.

10.3.4.    Regulations The Council of Ministers may make Regulations generally for the carrying out of the provisions of the Law and for such other matters, as are required or authorised by the Law to be prescribed, and may also make Regulations with respect to any matter or thing in respect of which it is expedient to make Regulations for the carrying out of the provisions of the Law. Such Regulations become effective from the date they are published in" the Official Gazette.

10.3.5.    So far, Regulations were made in a number of respects but, in some other important matters, either the Regulations made are inadequate or no Regulations were made.

10.3.6.    Administrative Rules For the proper administration of the Law, the Director issues Administrative Rules and other instructions containing delegation of authority and other procedural guidelines. In order to be effective, all rules concerning methods of computation of incomes from certain sources, personal allowances, rates applicable, in computing capital allowances on fixed assets etc., must be published in the Official Gazette

10.3.7.    All Rules issued by the Director, through established practice, are copied to SA1 for official use in its auditing work.

10.4.    Machinery Provisions

10.4.1.    Tax Returns Every person having chargeable income in any year of assessment must, within the prescribed limits, submit to the Director a Tax Return and the non-dispatch to him of a Tax Return form by the Director shall not be a defence for not making a declaration. Under Cyprus legislation husband and wife are taxed separately and therefore they must submit separate declarations.

10.4.2.    Assessments The Director has power to:

1. Accept the Tax Return and make an assessment accordingly.
2. Refuse to accept the Tax Return and, to the best of his judgment, determine the chargeable income and make an assessment accordingly

10.4.3.    Where a person has not delivered a Tax Return and the Director is of the opinion that such person has chargeable income he may to the best of his judgment determine such income and assess such person accordingly.

10.4.4.    Temporary Assessments - Self Assessment For the purpose of collecting taxes on incomes, other than emoluments for which PAYE provisions operate, in the year in which incomes arise legal provisions were introduced in 1979. Accordingly, every person liable must, before August 1, submit a computation of his estimated chargeable income for the current year and of the tax thereon. Where such a person neglects to submit his computation the Director may raise a temporary assessment based on the last tax assessment raised. The temporary tax is payable in two instalments in the same year.

10.4.5.    Where the temporary income declared falls short of the 3/4 of the final assessment a penalty equal to 10% of the shortfall tax is chargeable.

10.4.6.    Where the temporary tax proves to be in excess of the final tax the excess is refundable with interest calculated from the date the temporary tax was paid.

10.4.7.    Rectification of omissions and under-assessments Where it appears to the Director that any person having chargeable income has not been assessed or has been under-assessed, the Director may, within six years from the expiration of the particular year of assessment, assess such person on the proper amount of tax or additional amount of tax, by applying the provisions of the law applicable in the respective year of assessment. Where the omission or under-assessment is due to fraud or wilful default on the part of the tax payer the time limit of six years is increased to twelve years.

10.4.8.    This is an important control. Before the expiration of each tax year the authorities raise assessments on all cases unassessed or under­ assessed for the sixth year preceding the current year of assessment.

10.4.9.    Appeals Any person who disputes an assessment made upon him has the right of appeal. If at the appeal procedure the Director is not satisfied and determines the assessment, the taxpayer has the right of recourse to the high Court.

10.4.10. Deduction of tax at sourceCertain types of income are subjected to withholding tax. The main categories are:

1. All salaries and wages are subjected to tax at source by the employers under a Pay-As-You-Earn system The tax so deducted must be accounted to the Inland Revenue by the end of the month following the month of deduction. Delays carry heavy penalties. Under our system the tax deducted is approximate and the final tax is determined by assessments. After each calendar year, all employers must submit, to the Director, a list of all employees showing the gross pay, the tax deducted and other details.
2. Dividends Through recent legislation all company dividends are subjected to deduction of tax at source at 20% and such tax deducted is accounted to the Inland Revenue. At the option of the taxpayer dividends may or may not be aggregated with other income. In the case of aggregation the tax so deducted is available as a tax credit against the final tax.
3. Payment to a nun resident in respect of royalties, film rentals, Interest, foreign entertainers etc. Subject to Double Taxation agreements, any person making a payment to a non resident in respect of income derived in Cyprus, must withhold tax at specified rates and account the tax withheld to the Inland Revenue.

10.5.    Main taxing provisions

10.5.1.    Basis of Assessment. The tax year coincides with the calendar year. From the year 1979 onwards the assessments are based on the income, from whatever source, of the current year. Previously the preceding year basis was in force.

10.5.2.    Income liable to tax The aggregate income of any person from all sources accruing in or deriving from or received in the Republic is liable to tax at the rates provided. The chargeable income does not include gains of a capital nature and comprise of the following:

• Gains or profits from any trade, business, profession or vocation
• Gains or profits from any office or employment including benefits in kind
• The annual value of immovable property used for residence
• Dividends and interest
• Pensions and annuities
• Royalties, premiums and rents or other profit arising from property
• Profits from farming and animal breeding
• Any other annual profit or gain

10.5.3.    Income exempted The, main categories of income exempted from income tax are:

• The official emoluments of the President of the Republic including the pension or other benefit deriving from the presidential office.
• The representation allowances paid to Ministers and MPs
• Certain categories of pensions
• Lump sums received by way of retiring gratuity or death gratuity
• Income arising from educational scholarships
• Capital sums accruing from life policies and provident funds
• The income of physical persons derived from Government Bonds
• The first £600 of interest received by an individual from deposit or saving accounts with a Commercial Bank or Cooperative Society.
• The first £1 .200 of dividends received by an individual from shares of a public company
• The income of any religions, charitable or educational institution of a public character
• The income of any registered cooperative society or any cooperative savings bank
• The non commercial, industrial or business income of local authorities
• The emoluments of foreign diplomatic and consular representatives
• 60% of the profits imported into the Republic from the rendering of professional services abroad
• 90% of the profits and dividends imported into the Republic from the carrying on a business abroad by an individual or by a corporation in which Cypriot residents have at least 15% equity
• The dividends received by any person from shares in a manufacturing company that commenced business after 6.4.1987 if the said company produces certain goods, specified by regulations, not previously manufactured in the Republic. This exemption runs for 10 years from the date the company commences business
• 30% of the agricultural, stock breeding or fishery income of any individual residing in a rural area and having his main activity in agriculture, stock breeding or fishing. The maximum exemption is £3.000 p.a.
• Interest on foreign capital imported into the Republic and deposited with any commercial Bank
• Interest from deposits with the Housing Finance Corporation.

10.5.4    Main deductions allowed

(a)    For the purpose of ascertaining the chargeable income of any person there shall be deducted all outgoings and expenses wholly and exclusively incurred in the production of the income. Such deductions include:

• Expenses for repairs and renewals of fixed assets
• Ordinary annual employers' contributions to employees' provident or pension funds, social insurance funds etc.
• Bad debts
• Any expenditure on scientific research
• Any expenditure on patents or patent rights.

(b)    The following expenses are allowable deductions, irrespective of whether they are incurred for the production of the income or not:

• Donations or contributions made for educational, cultural or other charitable purposes to the Republic or a local Authority or to any charitable institution therein approved as such by the Council of Ministers up to the amount of twenty thousand pounds and fifty per cent of any amount exceeding twenty thousand pounds.
• 30% of the sum expended by an individual for the acquisition of first- issue-shares in a public company
• 40% of an individual's monthly savings under the Housing Savings Scheme of the Housing Finance Corporation. The annual savings permitted are restricted to 25% of the individual's annual income
• 20% of the rental income arising to individuals (in lieu of repairs and maintenance)
• Loan interest up to £500 per annum in respect of funds raised for the acquisition of a dwelling used by a person or his children for private residence.
• Expenses made for the repair, restoration or preservation of a building for which a preservation order was made or of an ancient monument as defined by the antiquities law.

(c)    Capital allowances In ascertaining the chargeable income of any person engaged in a trade, business, profession or vacation, a deduction of a reasonable amount for the exhaustion and wear and tear of property arising out of the use and employment of such property in the production of the income is allowed. The rates applicable for the various categories of assets and the method of calculation are contained in Rules made by the Director.

10.5.5.    In addition, in the case of certain new assets acquired, an investment allowance at rates specified by the law is available in the year they are first used for the production of the income.

10.5.6.    Relief fur Double Taxation The law provides for double taxation relief in respect of tax paid or payable in a reciprocating country with which Cyprus has entered into and ratified a double taxation agreement. So far double taxation agreements were ratified with 26 countries.

10.5.7.    Personal Allowances The following personal allowances are presently in force:

1. Child allowance £500 for every child under the age of 16 or if over 16 attending a secondary school or serving in the National Guard. £1.500 for every child attending full time tertiary education in the Republic but the tax saving is restricted to £300.
2. Spouse : A married person living with his/her spouse is entitled to an allowance of £500 but if both spouses have taxable income the allowance is apportioned between the two in the proportion of their net income.
3. Age : Persons over the age of 65 receive an allowance of £1 .500 but the tax saving in restricted to £300.
4. Life Assurance Premiums etc. The following payments, subject to a maximum deduction equal to 1/6th the total chargeable income, are allowed in full:

• Premiums in respect of a life policy on the life of the assured or his/her spouse securing a fixed or determinable capital sum at death. Allowable premium restricted to 7% of the capital sum assured.
• Premiums or contributions paid to an Insurance Company under an annuity contract approved by the Commissioner securing to the payer a life annuity in old age.
• Contributions to Social Insurance funds, pension funds.and provident funds approved by the Commissioner.
• Where a life policy is surrendered within six years of the contract date a portion of up to 30% of the premiums is chargeable in the year of surrender.

10.5.8.    Special mode of Taxation Certain types of incomes are computed and taxed by specific provisions. The main sources of such income are:

• Farming, stock breeding and fishing
• Insurance companies - General business
• Insurance companies - Life business
• Shipping companies
• Offshore companies
• Foreign employees of offshore companies or of companies operating in an industrial free zone
• Profits from the export of certain locally produced goods
• The income of non residents arising in the Republic from royalties, patents, rights etc.
• The rental income of non residents arising in the Republic from the show of cinematographic films
• The income of non residents arising from activities in the Republic in the field of entertaining including theatre, music, athletics etc. where their stay in the Republic is below six months in any year (excluding trainers and footballers).

10.5.9.    Rates of tax The present rates of taxation are:

10.6.    Defence Contributions

10.6.1.    With a view to raising the necessary funds required for strengthening the defence capabilities of the Republic the Government introduced, in 1983. special legislation imposing compulsory contributions on all incomes from whatever source including benefits in kind etc. The contributions raisedi together with any penalties and interest for late payments are deposited in a special fund and managed by a specific budget.

10.6.2.    Administrative Responsibility. The Director of Social Insurance is responsible for the implementation of the Law relating to emoluments and pensions and the Director of Inland Revenue has responsibility for all other incomes.

10.6.3.    Computation of chargeable income All incomes other than emoluments and pensions are computed by reference to Income Tax law but certain allowances and deductions are not permissible.

10.7.    Capital Gains Tax

10.7.1.    Capital Gains Tax was introduced in 1980 in order to tax gains, not falling into the income tax net, arising from the disposition of immovable property including shares in companies the assets of which consist mainly of immovable property. The rate of tax is 20%.

10.7.2.    Exemptions Gains from the following dispositions are exempt:

• Conveyance of property of a deceased to its beneficiaries.
• Gifts of property by a parent to his children, gifts of property between spouses or between relatives up to the second degree.
• Gifts of property to a company the shares of which are held by relatives up to the second degree and this status continues to remain unchanged for at least five years from the date of the gift.
• Gifts of property to the Republic or to a charity approved as such by the Council of Ministers.
• Compulsory acquisitions of property.

10.7.3    Allowances

• Individuals are entitled to a life allowance of £10,000 arising from the disposition of any property or £15,000 arising from the disposition of agricultural land if the main occupation of the disposer is farming. This allowance is deducted from any chargeable gains until extinction.
• The first £50.000 of gain arising from the disposition of a dwelling house used by the disposer for at least five years as his main residence provided that it stands on an area of land not exceeding 1500sq.metres.
• Capital losses are available for set-off against future gains.

10.7.4.    Computation of Gains The base cost of properties acquired before the commencement of the law is the value determined by the general valuation made by the Department of Lands and Surveys as of 1.1.1980 augmented by any increase in the cost of living index. The cost of properties acquired after 1.1.1980 is the actual acquisition cost augmented by any increase in the cost of living index.

10.7.5.    Declarations and assessments The disposer must within one month from the disposal but in any case before conveyance make a proper declaration and pay the tax estimated by him. The Director may at any time and irrespective whether a declaration was made or not raise on assessment and demand payment of the tax.

10.8.    Immovable Property Tax

10.8.1.    Until 1979 local authorities had powers to raise limited amounts of taxes on properties on a local basis. While these powers were retained, in 1980 the Government introduced new legislation through which the state raises taxes on immovable property on a total ownership basis.

10.8.2.    Exemptions The law exempts certain properties and owners the main of which are:

• Public cemeteries.
• Properties used exclusively for religious, ceremonies.
• Properties owned by public educational institutions.
• Properties owned by the State.
• Public hospitals.
• Properties owned by local authorities or public enterprises on certain conditions imposed by the Council of Ministers.
• Properties occupied by Turkish Forces or situated in slump areas.
• Properties belonging to foreign states and used by their diplomatic services or as official residence of the Diplomatic representative, on a reciprocal basis.

10.8.3.    Declarations Any owner liable to tax had an obligation to make a proper declaration of his property and pay the tax thereon by a certain date. Subsequent additions or deductions to property must also be declared within prescribed limits.

10.8.3.    Value of property The taxable value of the property is the value which in the opinion of the Director could fetch in the open market as at 01/01/1980 The difficulties encountered in assessing taxable values were removed by the completion of the general valuation made for the purpose by the Department of Lands and Surveys at base date 01/01/1980.

10.8.5.    Computation and payment of tax The first £100.000 of taxable properties are exempt. Thereafter the properties are taxed progressively at 0,2% to 0,35% and the tax is due on 30th September. Late payments carry interest at 9% p.a. To secure payment of the tax there are legal provisions prohibiting conveyance of properties where the tax in unpaid.

11.    Department of Customs and Excise

11.1    Organization

11.1.1.    Responsibilities The Department is responsible for the implementation of the laws relating to Customs and Excise Duties and Value Added Tax.

11.1.2.    Organizational Structure The Department operates a Head Office and four District Offices which are conveniently situated near the ports and airports through which all imports and exports are made. Matters dealt with by Head Office include:

• Staff administration and training
• International and public relations
• Monitoring of offshore companies and expatriate personnel
• Administration of reliefs to privileged persons and other entities
• Temporary importation of duty free goods by British SB.A. personnel
• Tariff clarification and valuation of goods
• Investigation of cases of illegal trade (drugs smuggling, smuggling of goods from the Turkish-occupied areas etc.)
• Legal matters; follow up of court cases
• European Union matters
• Accounting for revenues nationwide
• Internal audit

11.1.3.    Matters dealt with by the District Offices include:

• Examination of goods against documents, customs clearance and collection of duties and excise taxes. All documents pass from a second check by a different person
• Warehousing of goods prior to customs clearance
• Monitoring of Bonded Warehouses operated by the private sector
• Administration of drawbacks of duties and excise taxes
• Collection of excise taxes. 11.2 Legal Framework

11.2.1.    Customs and Excise Laws (1967-1989) The following is a brief description of the provisions included in the Law and Regulations of the Customs and Excise Department.

• For every cargo (plane or ship) there must be an import declaration
• The importer of any goods must submit proper customs clearing documents and pay the appropriate duties prior to release. There are exemptions for certain goods under certain circumstances, e.g. local goods re-imported and goods to be re-exported.
• Goods imported unlawfully will be confiscated and appropriate penalties will be levied on the importer.
• Goods may be deposited in authorized Bonded Warehouses for certain specified periods of time prior to their Customs clearance.
• Detailed provisions regarding the production of tobacco, spirits, beer and hydrocarbon oils.
• Detailed provisions regarding the drawback of duties and taxes paid in certain circumstances.

11.2.2.    The director of the department is also the Commissioner of value added tax and is responsible for the newly formed VAT department. The main operations of this department are:

• Registration/deregistration.
• Processing of VAT returns and reconciliation with actual receipts made through the commercial banks.
• Investigations, policy development and control visits.
• Systems development and implementation.
• Staff training.

11.2.3.    Customs and Excise Duties Law This is otherwise known as the Customs and Excise Tariff. It is voted into Law annually and is drawn up in accordance with the Brussels Harmonized Nomenclature System. It specifies the customs duties payable on every type of goods imported into the country. Under the regime currently in force, goods imported from European Union countries attract reduced preferential rates and goods from all other countries standard rates. An additional temporary refugee levy (TRL) is also charged which is channelled into the Relief Fund for Displaced and Affected Persons of the Turkish invasion of 1974. The Tariff also specifies the excise taxes payable on certain imported goods (motor vehicles, cigarettes, spirits etc.) and lists certain privileged persons, bodies, authorities and other organizations who, under certain circumstances, enjoy partial or total reliefs from duties and taxes. This is a very extensive list (more than 200 different cases of reliefs are included) and a lot of time and effort is taken up in their administration by the department. Some examples are goods bought by charities and local authorities, furniture and fittings bought by churches and mosques, vehicles and office equipment bought by offshore companies and household effects for their expatriate personnel, motor vehicles bought by foreign persons retiring in Cyprus etc. The Tariff also includes special provisions for the Forces of the United Kingdom stationed in the Sovereign Base Areas under the Treaty of Establishment of the Republic of Cyprus.

11.2.4.    Regulations and Directives These are issued by the Director of the Department and serve to elaborate on issues that arise from the interpretation of the law and from the operations of the Department in general. They cover topics such as:

• Temporary importation of goods (samples, exhibits, private motor vehicles etc.).
• Processing of goods under temporary importation.
• Inspection of parcel post.
• Valuation of imported goods.
• Production, marketing and warehousing of tobacco.
• Production of soft drinks.
• Working hours and overtime rates.
• Personal reliefs.
• Customs agents licenses.
• Free trade zones.

11.2.5.    Value Added Tax Law (1990) The Value Added tax law was drawn up in line with corresponding laws in force in the countries of the European Union (particularly the United Kingdom). Its main provisions are summarized as follows.

• All deliveries of goods or services in the Republic made by a person liable to value added tax, and all imports of goods into the Republic are subject to value added tax.
• Registration for VAT purposes is compulsory for all persons/businesses with an annual turnover exceeding £1 2.000. This amount may be revised by the Council of Ministers.
• A fine of £50 per day may be imposed on any person who fails to register.
• A tax return has to be filed and the due tax paid within 30 days of each three-month tax period.
• Certain goods or services are taxed at 0% and in some cases totally exempt. Some examples are:

(a)    Zero rated:

• Foodstuffs other than for catering purposes
• Non-bottled water
• Medicines, newspapers, periodicals and books
• Public transport
• Children's clothes and footwear

(b)    Exempt:

• Leasing of immovable property
• Import of gold by the Central Bank
• Financial and banking operations
• Hospital and medical care
• Postal services
• Insurance and re-insurance
• Immovable property
• Accounts must be kept and tax invoices issued in the manner provided by relevant regulations issued by the Council of Ministers.
• Books and records supporting the accounts must be kept for at least seven years.
• The Commissioner of VAT may estimate the tax due by any person who doesn't keep the necessary records and documents taking into consideration all known information.
• A 10% penalty is levied on overdue tax. Interest at 9% pa. is charged in addition to the penalty if the tax is overdue for more than 30 days, whereas goods with a total value equal to three times the due tax may be confiscated after 60 days.
• The Commissioner has the right to enter and search any place of business in discharging his statutory duties.
• Deliveries of goods or services by central and local government agencies and Statutory Bodies, in their normal course of business, are not subject to value added tax.
• Sales of agricultural and farm products by the producers are not subject to VAT.
• Any person may submit an objection to the Minister of Finance in relation to any decision, order or notification made by the Commissioner, within 30 days from its issue.
• Any fraudulent tax evasion is punishable with a fine of up to three times the amount of due tax and/or imprisonment of up to five years.
• Any tax obligation may be pursued by the Government through the Court.

12.    Interpretation of Tax Laws

12.1.    The structure of the SAI does not include a legal department and any lawyers in its personnel are employed in a different capacity. Therefore it is not in a position to offer advice on the interpretation of laws. However auditors have a good working knowledge of tax laws and are in a position to interpret and apply legal provisions.

12.2.    Where SAI disagrees with the interpretation of laws made by the executive it seeks legal opinion from the Law Office which acts as adviser to all government departments and services. Most frequently the Law Office vindicates the opinion of the SAI. Legal opinions offered by the Law Office are binding on all government departments and services including SAI.

13.    Landmark Judgements

13.1.    All judicial pronouncements in court cases are communicated to SAI and classified according to subject matter. These pronouncements are available to audit personnel and for easy reference a directory is maintained and updated.

14.    Fiscal Reforms

14.1.    All taxation laws, and more particularly the Income Tax Laws are used as vehicles for pursuing certain socio-economic objectives. These objectives are decided by the government in consultation with a consultative economic Committee representing a wide sector of organizations and in many cases a political hue is attached. Once the objectives are decided they are pursued through tax reforms in the nature of tax incentives.

14.2.    So far the policy of the SAI was not to question policy decisions and therefore it refrained from attempting to analyse and evaluate the degree of achievement of stated objectives through tax reforms.

14.3.    In the case of incentives introduced in the Customs Laws the SAI analysed and reported the position obtaining in three separate programmes. As a result of this work legislative changes were introduced.

15.    Tax Expenditure

15.1.    There is no costing system of tax expenditure schemes in operation.

16.    Collection and Accounting

16.1.    The System of collection employed by each Revenue Department depends, to a large extent, on the legal provisions relating to the due date of the tax. The following systems are employed:

(a)    Taxes and other revenue due before or at the time the transaction takes place

These include Customs duties, excise and VAT on imports, property transfer tax and other fees, licence fees etc. In this case electronic cash tills are employed and details of the collection are printed on the relevant documents. The daily collections are credited to a suspense account and classified and cleared by crediting revenue through adjustment vouchers every month.

(b)    Excise duties on locally manufactured cigarettes, beer, alcoholic drinks, soft drinks etc.

The manufacturers are required to make regular lump sum payments which are credited to individual gross payments accounts kept manually by each customs officer posted to the factory. No goods can be released unless there are sufficient deposits covering the excise duty. On the release of the goods the amount of the duty is debited to the gross payment account and credited to revenue.

(c)    VAT other than tax collected by customs at the point of clearance of goods

The law imposes an obligation on all persons liable to register with the authorities indicating the yearly volume of business. (There is no obligation to register if the volume of business is below £12.000 per annum). All persons liable are required to make quarterly declarations of their VAT obligation and pay the tax through a Commercial Bank. The Commercial Banks submit a stamped copy of each declaration to VAT headquarters which are used for updating the computerised payers' accounts.

The Commercial Banks transfer the weekly collections to the Central Bank for the credit of the appropriate accounts and in addition they deliver to VAT headquarters details of their weekly collections on a floppy diskette which provides the means for updating the payer's accounts.

Where persons liable send their declarations directly to VAT authorities without payment of the tax, the declarations are again processed through the computerised system which produces monthly statements of arrears and the collection procedure is initiated.

The major problem arises from the change of trading circumstances of persons registered as liable who subsequently do not achieve the expected volume of £1.000 per month or they cease trading. In these cases no declarations are submitted and the system automatically calculates their potential liability and loads all penalties and charges. As of 31.12.95 the arrears from this category amounted £14 million but on the basis of past experience which suggests that only a small portion is recoverable this amount is not included in revenue arrears at year end.

(d)    Taxes payable at a future date after assessment

These comprise almost all taxes administered by the Department of Inland Revenue: income tax, corporation tax, defence contributions, estate duty, capital gains tax, immovable property. In this case a more sophisticated system is required to provide for proper control, follow up, calculation of interest and other penalties, legal proceeding against defaulters, payment facilities, issue of management reports and accounting. The system is centrally managed and district Offices are served by line terminals linked to cash registers.

The previous computerised system was inefficient and presented a number of problems. The new tax administration system currently being developed aims at solving many problems and at providing a better and more efficient service. The installation and development of this system is expected to be completed in 1997.

At present all collections of the Department are initially credited to the Government general account. The collections are classified monthly and credited to revenue votes through adjustment vouchers.

17.    Arrears of Revenue

17.1.    The arrears of Revenue as of 31.12.95 amounted to Cy£224.6 million and can be summarised as follows: