Cyprus is a well established international financial centre and a primary gateway for investments into and from Europe, particularly from Eastern Europe and Russia. It has earned this position largely due to a favourable tax regime which is EU neutral and non protectionist, affording equal advantages across the board to EU and non EU investors. In combination with an attractively low corporate tax rate of 10 per cent per cent and a good network of double tax treaties, strategically located investors in treaty partner jurisdictions such as Russia, who choose to structure their holdings and investments through Cyprus can significantly maximize their after tax returns.
Strategic ties to Russia continue to play a major role in the success of the Cyprus tax model and Russia has shown its resolve to stand by Cyprus’ side by extending, in December 2011, a €2.5billion loan to Cyprus on particularly favourable terms. According to informal sources, the Financial Times has reported that Russian deposits in Cypriot banks today amount to more than €10bn. The below case study will demonstrate some of the principal tax reasons Russian investors use Cyprus to structure their investments.
Harneys recently advised a Russian individual (‘RI’), a major investor in the Russian heavy metal manufacturing industry, on a proposed restructuring of his shareholding in an underlying group of Russian companies of which he was the sole direct shareholder (‘RusCo’) with the purpose of maximising the tax efficiency of the corporate structure and with a view to a prospective sale of part of the operations.
The estimated value of this transaction was US$0.5 billion.
The following step plan details the structuring of the transaction, highlighting the tax benefits of using Cyprus.
A Cypriot holding company (the ‘CHC’) was set up by RI. It is important to note that in order to access the double tax treaty network of Cyprus, a company incorporated in Cyprus should also be Cyprus tax resident. This means that the management and control of such company should take place in Cyprus.
In order to secure the tax residence of the CHC, RI set up an office in Limassol and moved three persons from management from Russia to Cyprus, hiring another two administrative staff. The board of the CHC was comprised of three directors, all residents of Cyprus, ie, spending at least 183 days per calendar year in Cyprus. Board meetings and key management decisions all took place in Cyprus.
As shareholder of RusCo, RI then contributed 100 per cent per cent of the shares of RusCo to the CHC in return for further shares in the CHC. The Cyprus Companies Law allows for corporate reorganisations of this type and the Cyprus tax laws incorporate provisions for tax-free corporate reorganisations in line with the EU Mergers Directive. The various forms of permissible reorganisations include exchanges of shares of the type undertaken by RI. Significantly, stamp duty (otherwise applicable at 0.2 per cent per cent of the value of the transaction) is exempted in qualifying reorganisations. Hence the exchange of shares was carried out with no tax implication and no stamp duty levy.
The structure now changed so that RI became the shareholder of an increased number of shares in CHC, and CHC in turn became the shareholder of RusCo.
Cyprus attaches capital duty at a rate of 0.6 per cent per cent on an increase in authorised share capital. This can be avoided by issuing shares at a premium as the duty attaches only to the nominal value of the shares.
Profits derived by the manufacturing operations of RusCo were to be sent as dividends to the sole shareholder, CHC. In accordance with the double tax treaty between Cyprus and Russia (and recently confirmed by the Protocol to the treaty), dividends payable from Russia to Cyprus are subject to five per cent per cent withholding tax in Russia provided the investment exceeds €100,000. In the present case, the investment threshold was met and therefore dividends sent by RusCo to CHC were subject to a five per cent per cent withholding tax in Russia.
The Cyprus Income Tax law provides for an exemption of dividends received by Cyprus resident corporate taxpayers, irrespective of the holding period or percentage. Dividends are also exempt from 20 per cent levy of Defence Tax if the dividends emanate from a company which is subject to tax in its jurisdiction of residence at a rate which is not substantially lower than the Cyprus tax rate of 10 per cent or failing this, if the company sending the dividend is not engaged in over 50 per cent of its activities in producing investment income. Investment income has been interpreted to include (portfolio) dividend income, license income, interest income (unless the dividend paying company is a financial institution or a group financing company), rental income from immovable property and certain capital gains.
Since RusCo was engaged in active manufacturing operations, the exemption was applicable and the dividends received in Cyprus by CHC were not subject to any tax in Cyprus.
By virtue of the domestic law provisions, Cyprus does not levy any withholding tax on payments of dividends to non-residents wherever they may be situated and regardless of the existence of a double tax treaty. Therefore dividends distributed by CHC to RI who is a non Cyprus resident shareholder were not subject to any withholding tax in Cyprus.
Cyprus Income Tax law provides for a tax exemption from profits realised by Cyprus companies upon the sale of securities (securities being shares, bonds, debentures and other rights and titles on such assets), irrespective of the holding period, number of shares held or trading nature of the gain (capital losses resulting from the sale of securities are not tax deductible). Therefore the sale by CHC of 30 per cent of the shares in RusCo to a purchaser situated in the British Virgin Islands did not attract any income tax in Cyprus as a trading gain.
As far as capital gains are concerned, a gain arising on the sale of the shares held by CHC in RusCo is taxable, in accordance with the double tax treaty between Cyprus and Russia, in the jurisdiction of residence of the seller. As Cyprus does not tax capital gains, (other than on the disposal of immoveable property situated in Cyprus or shares representing immoveable property situated in Cyprus), there was no incidence of capital gains tax in the sale of 30 per cent of RusCo by CHC. The position remains unaltered by the recent Protocol other than in the case of property rich companies where the taxing right will migrate, as from 2017, to the jurisdiction where the immoveable property is situated.
By tapping into the Cyprus tax system and double tax treaty network, RI was able to restructure his holding and sell part of it without incidence of any tax, other than the five per cent withholding tax payable in Russia on distribution of a dividend to CHC. Five per cent is the lowest withholding tax rate on dividends sent from Russia and the treaty with Cyprus features this rate. In fact the withholding tax rates on dividends, interest and royalties were confirmed on all three counts in the recently ratified Protocol to the double tax treaty between the two jurisdictions which allays any fears of an impending increase in the foreseeable future. With the Protocol having provided a secure footing for the tax and business relations of Cyprus and Russia, the former remains the jurisdiction of choice for many Russian investors seeking a reliable route to maximizing their net returns after tax.
British Virgin Islands, Cayman Islands Anguilla, Cyprus, London, Luxembourg, Hong Kong, Shanghai, Singapore, Montevideo, São Paulo and Vancouver.