From Cyprus With Love: Investing in Russia through Cyprus

Private client practitioners often ask why Cyprus, being one of the smallest countries in Europe, consistently ranks amongst Russia’s largest foreign investor countries as well as amongst the largest recipients of Russian investments. In 2008 alone €2 billion was transferred by foreign investors out of Russia into Cyprus. As much as 18% of all foreign direct investment into Russia in 2006 originated from Cyprus. Why, therefore, are Cyprus companies routinely being used as investment vehicles for investment into Russia? Although historically Russia and Cyprus have always been affiliated due to the shared religion and their common cultural heritage stretching back to the Byzantine Empire, since the early 1990s, mutual economic interests appear to prevail over shared religious and cultural convictions.

This article outlines the favourable tax position for foreign investors as the main factor which has influenced the establishment of this special economic relationship and briefly addresses the question of whether Cyprus’ domestic taxation regime complies with international standards of regulation.

Tax Optimisation

Put simply, foreign investors in Russia use Cyprus holding companies extensively because the double taxation agreement (“DTA”) currently in force between Russia and Cyprus offers the best provisions in comparison to the provisions of DTAs between Russia and the competitors of Cyprus in the market for tax efficient solutions. In that regard, income received in Cyprus from a Russian company in the form of dividend is subject to (i) 5% withholding tax if the Cyprus resident beneficial owner has directly invested in the capital of the Russian company not less than USD $100,000, and (ii) 10% withholding tax in all other cases. No withholding tax is imposed for income received as interest or royalties.

In addition, Cyprus provides an extremely favourable and flexible tax regime which, amongst others, has the following benefits:

· Cyprus law provides for a uniform corporate tax rate of 10%;

· Zero withholding tax is imposed on dividend payments out of Cyprus;

· Dividends are exempt from income tax;

· Profits from the disposal of any securities are exempt from income tax and capital gains tax, unless the company owns immovable property in Cyprus;

· Provided interest is received in the recipient’s ordinary course of business or in close relation thereto will be taxable as any other trading income at 10%;

· No tax on capital gains or income on the liquidation of the Cyprus holding company;

· Cyprus is a signatory to favorable DTAs with more than 40 countries;

· The absence of “thin-capitalisation” rules, and minimal interest margins renders Cyprus an ideal jurisdiction for the establishment of financing companies.

Regulation

Criticisms that Cyprus is a non-compliant jurisdiction are misguided or outdated. Its accession to the EU in 2004 has increased not decreased its appeal to investors as a regulated jurisdiction. In this respect, it has fully transposed the acquis communautaire into its domestic law, and in fact in some cases it has led to tax savings such as from the application of the EU Parent/ Subsidiary Directive, the Interest/Royalties Directive and Mergers Directive.

Law 72(I)/2008 (the “Law”) provides for the exchange of information relating to tax matters between Cyprus and other countries with which Cyprus has signed a DTA. The Law provides that the requesting state should provide the Cyprus authorities with specific details of the reason for the request of information and such information shall not be provided if the requesting State lacks corresponding enabling provisions for the provision of information in its local legislation. Crucially, privileged client information is effectively protected since the powers to disclose such information can only be exercised once the written consent of the Attorney General of the Republic, who is independent of the government apparatus, has been expressly obtained on a case by case basis. Consequently, this consent requirement creates a high procedural hurdle that the tax authorities have to overcome before confidential client information will be disclosed and arbitrary “fishing” exercises of individual tax officials are thereby prevented.

As a result of the above changes Cyprus has been removed from the so-called “black lists” of non-compliant jurisdictions issued by, amongst others, Italy and Spain. Further, on 7 October 2010 during President Dmitry Medvedev’s visit to Cyprus, a Protocol was signed amending the Russia-Cyprus double tax treaty which has been in effect since 2000. The principal result of this is that once internal ratification procedures are completed, Cyprus will be removed from the Russian “blacklist” of non-compliant jurisdictions. Finally, since April 2009 Cyprus has been on the OECD’s “White List” as a regime complying with OECD’s tax standards.

In conclusion, Cyprus has not relied on sentiment and shared culture for a place in Russia’s future. Russia has the globe beating a path to her door. This special economic relationship has been established because Cyprus has delivered tremendous opportunities to investors investing in and out of Russia for investment and growth and has given them an efficient springboard into Europe, USA, the CIS and, recently, India.

Iakovos Panagi

Associate, Cyprus Law

+7 495 981 0208

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This article is not intended to be a substitute for legal advice or a legal opinion. It deals in broad terms only and is intended to merely provide a brief overview and give general information.

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