Tax havens of Cyprus reveal their secrets

09.12.2010 — Analysis

The first association that springs to mind when Russians hear the word Cyprus is taxation offshore rather than vacation at the seaside. Once being very popular in this country, beach-related rest was hit hard when Cyprus joined the European Union and restricted flow of Russian citizens with the "Schengen" fence. Recently, business people felt aggrieved - the presidents of Russia and Cyprus signed a protocol that put an end to the mystery that used to accompany Russian capitals exported to the island.

The program "To Russia with Hedman Partners" is continued by Vadim Dynin, Director of RusBusinessNews, and Olga Lashkul, senior lawyer of the Hedman Partners office in Ekaterinburg, who are discussing why the authorities of Cyprus decided to step out from the "black list" of the Russian Ministry of Finance.

- Olga, could you explain high interest to the protocol recently signed between Russia and Cyprus. As I see it, this protocol adjusted the provisions of the existing Agreement on Avoidance of Double Taxation?

- The protocol signed by heads of two countries changes conditions of the aforesaid agreement. It is significant for Russian and Cyprus as well as for third countries because the document proves another time existence of a teething global tendency to exchange taxation information between the countries and, consequently to fight offshore arrangements. Starting from 2009 when European Union member-countries and USA proclaimed "a crusade" against offshore there have been signed more than 300 such agreements. The Nicosia Protocol, in fact, continues this chain.

- It has been history-long tradition that companies of Cyprus have been distinguishingly popular with Russian entrepreneurs. What is the reason?

- This popularity is not surprising: in 1998 the Agreement on Avoidance of Double Taxation was signed between Russia and the Republic of Cyprus. Mind you, before 2004 Cyprus had the offshore zone status: the corporate tax (profit tax) was equal to 4.5% for non-resident companies; furthermore, tax-related information was almost unavailable to other countries, which added to appeal of this jurisdiction. Cyprus lost its status of a full-featured offshore zone when it joined the European Union, having set the established rate of corporate tax in the amount of 10%. In 2008, there were a few changes related to disclosure of tax information, thus, contributing to the fight against the offshore system.

At the same time, the 10% rate of aforesaid tax was one of the lowest in Europe, and Cyprus companies are still used for optimization of tax deductions, business restructuring, shielding from raiders and as holding, financial, and investment companies.

Cyprus is one of the leading countries in investment made in Russia's economy. The President Dmitry Medvedev states that the total amount of the accumulated investment with participation of the Cyprus jurisdiction is equal to more than 50 billion US dollars. And everybody knows that this investment has Russian roots, and Cyprus companies helped them to come into being.

- Why do entrepreneurs having business in Russia often use companies registered in foreign jurisdictions?

- Besides such plus-sides as information and corporate protection, such companies starting from 2008 can take advantage of the preferential tax treatment that takes effect in Russia for dividends received by Russian entities both from Russian and foreign companies. Such dividends in certain cases can have a 0% profit tax. However, this rule has some rather odd exceptions: for example, this 0% rate is not applied to dividends that are received from the company that is entered by the RF Ministry of Finance into the so-called "black" list, which actually includes offshore zones with favorable tax treatment and confidential tax information. In other words, these are the jurisdictions that are used by business to evade taxation - or for "tax optimization" as it is called by tax advisors and company managers. Without going into detailed conceptual discussion regarding difference between evasion and optimization, I would like to point out that Cyprus also happened to be in this unflattering list; therefore, favorable taxation could be forgotten.

- But we can understand the Russian Ministry of Finance: purity of capital of Cyprus companies is highly doubtful, isn't it?

- Certainly, and these doubts have ground. Black listing became a serious problem for Cyprus. Negotiations about signing of an additional Protocol to the International Agreement on Avoidance of Double Taxation took a long time. Though the parties reached consensus on most of the issues back in spring 2009, the protocol in its final version was signed only on October 7 this year. It is expected to be ratified by the countries and take effect from January 1, 2011, after which Cyprus will be crossed out from the offshore "black" list.

-What concessions did the Cyprus government authorities have to make to gain untarnished reputation from the perspective of Russian taxation authorities?

- The changes dealt with information exchange, which now will be performed in compliance with the standards of the OECD Convention standards, where OECD means the Organization for Economic Cooperation and Development. The access limits in disclosure of information were more clearly defined. Even though one of the contracting states does not need some information about a tax-payer, this fact should not prevent the other contracting state from collecting and disclosure of such information.

Now taxation authorities of Cyprus are able to request any registers, accounting, financial and other information that is held, controlled, owned or falls within the competence of any person.

- Are there any restrictions on the nature of the requested information?

- Yes, there are. As before, the information that is held confidential in compliance with the law of the negotiating state cannot be requested for disclosure. However, the fact that by laws of one of the states information is deemed as a professional secret (information received by banking institutions, other financial organizations, registration agencies) cannot be the reason for refusal of its submission. You should only remember that the Cyprus authorities can give such information upon approval by the Prosecutor General.

- As is known, in order to optimize taxation, real property that is in the Russian Federation is often registered with a Cyprus company. Does this practice still take place?

- This practice also was discussed during protocol negotiations. New rules were adopted in relation to selling of shares by companies that own real property in the other contracting. At present, the Agreement on Avoidance of Double Taxation provides exemptions from taxes payable in the Russian Federation, which are applicable to the income that was received by shareholder of a Cyprus company from selling of shares, regardless of the fact whether the company has or does not have real property in Russia, provided that the shareholder who disposes shares is a resident of Cyprus.

Pursuant to the provision set forth in the signed Protocol the income received by a resident of one of the contracting states from selling shares of the company that has half of its assets as real property located in the other contracting state can be taxed in accordance with the legislation of the country where this real property is located. This provision will take effect in 2015. However, there are exceptions: the provision of the Protocol does not apply in the event of restructuring of a company or if shares of the company are traded on the stock exchange, or when the seller is the Pension Fund or an insurance fund of one of the contracting states. In this case, incomes are taxed by the state where the company is a resident.

- What else would you recommend entrepreneurs to pay attention to if they have business with participation if Cyprus companies?

- There is an increase in the amount of investment that allows receiving dividends applying the minimum 5% for the tax deducted in Russia from the source of payment - from 100,000 US dollar equivalent to 100,000 euro equivalent. It can be caused by changes in currency exchange rates. Zero rates of the tax deducted by the source of income payment, will remain unchanged in terms of interest and royalty. Moreover, changes have been made in the dividend and share concepts. Today, dividends also include payment on shares of mutual invest funds and other instruments of collective investment, and the concept of share includes depositary receipts.

Besides, the Protocol complemented Article 4 "Resident": if it is impossible to determine the location of the company's effective management, it will be defined in each specific case under agreement with authorities of Cyprus and the Russian Federation.

Exemption from taxation of the income from international transportation services will be provided if a company is able to prove actual effective management performed from the Cyprus territory; being simply a resident will be not enough for this.

- Does the Nicosia Protocol have any effect on companies that are registered in other states?

- Yes, this document also sets the limits for application of benefits provided for in the Agreement on Avoidance of Double taxation. Restrictions were also introduced for application of these benefits by companies, which are from other jurisdictions, provided they are tax residents of Cyprus and Russia, if government authorities come to conclusion that using such companies was required only for receiving benefits stipulated by the agreement.

- Olga, what is your opinion about the changes?

- The Cyprus President Dimitris Christofias said that the Protocol eliminated areas that could cast shadow on money cleanness. There some other interesting comments about this: "closing down of the Cyprus tax haven", "end of the Cyprus offshore", "Cyprus economy has been badly hit". However, I think that the new regulations were far from being out of the blue for Russian business community: the similar Protocol was signed by governments of two countries in April 2009. The revision of the business structure with using Cyprus companies has already started; some businessmen are relocating their companies to other jurisdictions, which do not have agreements with Russia similar to Cyprus; some prefer to build their business in such way that there will be no fear of disclosing of information about the final beneficiary of the company. I do recommend those companies that have not adjusted their business to oncoming legal realities to embark on the process in the very near future.

The analysis of the existing structures and contemplated projects, advice on taxation and corporate legislation in foreign jurisdictions - it is just very few examples of a wide range of services that the international law company Hedman Partners will be happy to offer through its offices in Russia and in Europe.

Finally, I would like to remind that effectiveness of the reached agreements will be seen only with lapse of time. However, as one Roman philosopher noted, "no wind will be favoring for a person who does not know which haven he is sailing to". Tax havens are not an exception.