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Confidentiality changes boost Cyprus tax treaty effortsby Rutger Kriek (rutger@consulco.com), September, 2008, http://www.consulco.com A new exchange of information law should help Cyprus as it tries to extend its network, believes Rutger Kriek of Consulco The favourable Cypriot tax system combined with the access of Cypriot companies to the relevant EU directives and Cyprus' broad double tax treaty network, make Cypriot companies efficient tax structuring vehicles in cross-border business operations. At 10%, the country has the lowest general corporate income tax rate within the EU, the broadest tax exemption system for holding company income in the EU and generally no withholding taxes. Cyprus' double tax treaty network Cyprus has double tax treaties (DTTs) in place with (at least) 43 independent states. Certain treaties stand out for their specific attractions. Good examples are Cyprus' agreement with India, providing Indian capital gains tax protection in case of the sale of shares in Indian companies by Cypriot companies, the DTT with Russia, and the agreement with Ukraine, which upholds the DTT agreed on October 29 1982 between the USSR and Cyprus. Cyprus' DTT with Ukraine under circumstances provides for no withholding tax on dividend, interest and royalty payments between the two countries. It also may provide for protection from Ukrainian capital gains tax on the sale of shares in Ukrainian companies by Cypriot companies. India The Indian government has recently tried to persuade Cyprus to change the capital gains tax article in the Cyprus-India DTT, concluded in 1994, but the Cypriot government has not been willing to concede to the Indian demands. Russia On January 1 2008 a new federal law, introducing amendments to the Russian Tax Code entered into force. The new law introduces a participation exemption on dividends received by Russian companies. To qualify for the participation exemption, certain requirements need to be met, one of which is that the subsidiary paying the dividend to the Russian company should not be a resident of a state included in the list of states or territories with a low tax regime and/or not exchanging information. On November 13 2007, the Russian Finance Ministry compiled a list of countries (a blacklist) that did not satisfy Russia's requirements for information exchange on Russian business activities. Cyprus was put on the blacklist. Cyprus' blacklisting in Russia should not have too big an impact on the health of Cyprus' financial services industry, because Cypriot companies, in the vast majority of the structures that include both Russian and Cypriot companies, act as parent companies of Russian subsidiaries instead of vice versa. However, many representatives of this industry obviously considered this development as detrimental. The governments of both countries are negotiating the deletion of Cyprus from Russia's blacklist. The Cypriot government's aim is to be deleted from Russia's blacklist by the end of this year. Cyprus may be expected to be in a good position to achieve this goal, since the country has in the meantime changed its confidentiality legislation. Ukraine In March 2007, Ukraine and Cyprus agreed on a new DTT. The new agreement would replace the 1982 DTT between Cyprus and the USSR, which Ukraine (and Cyprus) decided to uphold after the USSR had ceased to exist. The maximum rate of withholding tax under the new DTT would be 5% for dividends, if the receiving company holds directly at least 25% of capital of the paying company. The maximum rates for withholding tax on interest and royalties would be 10% in general. However, the Ukrainian parliament rejected the new DTT last June by a narrow margin of only three votes, so the old treaty between Cyprus and the USSR continues to apply to the relationship between Cyprus and Ukraine. It is expected that in autumn this year the Ukrainian government will attempt to have the current DTT terminated by the Ukrainian parliament. At the same time, the Cypriot government wants to change the new agreement (Cyprus did not officially sign it). The importance of the Russian and Ukrainian DTTs for Cyprus' financial services industry should not be underestimated. Cyprus is one of the biggest foreign investors in Russia and Ukraine. A significant percentage of the newly incorporated companies in Cyprus still has a connection with the Russian and Ukrainian market, though after the accession of Cyprus to the EU the number of West-European and US investors incorporating Cypriot companies has increased rapidly. Germany and other EU countries Germany has recently informed the Cypriot government that it intends to cancel the existing DTT between the two countries, unless the Cypriot Government makes it possible to exchange confidential information on non-residents with other countries. France and Italy, countries with which Cyprus already has DTTs, have expressed their dissatisfaction about Cyprus' limited possibilities to exchange information with foreign authorities as well. Denmark, the Baltic countries (Estonia, Latvia and Lithuania), the Netherlands, Portugal and Spain have expressed their reluctance to conclude new DTTs with Cyprus (Cyprus does not have any agreements with these countries) for the same reason. Comparison with competing jurisdictions This reluctance demonstrated by countries to conclude DTTs with Cyprus is reflected in the number of DTTs with new countries concluded by Cyprus over the last five years, compared to those concluded by traditional holding company countries such as the Netherlands and Luxembourg. Luxembourg managed to agree 22 new DTTs in that period. The Netherlands concluded 14, though it should be remembered that the Netherlands already has an impressive DTT network that does not require such significant improvement. In the same period Cyprus managed to conclude a disappointing amount of only five new DTTs. Cyprus' new DTTs included those with small countries such as San Marino, the Seychelles and Lebanon, which are not likely to add a significant contribution to the growth of Cyprus' financial services industry. Action taken by Cyprus The pressure exerted on Cyprus by other economies has made the Cypriot government decide to introduce new legislation to give the tax authorities more opportunities to comply with demands from foreign countries for exchange of information. The new legislation was passed by the Cypriot parliament at the beginning of July this year. The law allows the director of the Cyprus Inland Revenue to demand and receive from any person books, records or other information in possession of that person, to comply with the provisions of DTTs, for the purpose of exchange of information regarding any individual or company,. In principle, the director may demand any information he deems necessary, regardless of banking or other professional secrecy. The director may only exercise these powers after written approval from the attorney general of the Republic of Cyprus in each specific case. The director of the Inland Revenue can not provide any information required by a state with which Cyprus has entered into a DTT, unless the state requesting the information can reciprocate as far as exchange of information to Cyprus is concerned. Impetus for new agreements With this legislation in hand, the Cypriot government should actively strive to conclude new DTTs and to maintain (and, if possible, improve) the attractions of its treaty network. The Cypriot government believes that the industry depends too much on Russia and the Commonwealth of Independence States and that it should diversify. One can imagine that Cyprus' negotiating position is not always easy, because as a small economy, it does not represent big multinational investors like countries such as the UK and the Netherlands, and because of Cyprus' perceived, though unjustified, reputation as a tax haven. However, Cyprus' starting point in negotiations should always be to achieve a result at least equal to that of other typical holding company jurisdictions such as the Netherlands, Luxembourg, the UK and the UAE. In this regard it is disappointing that the recent renegotiation of the DTT between Cyprus and Ukraine, concluded in 2007, has led to a result, which would make it less favourable than for example, the agreement between the Netherlands and Ukraine. The Cypriot financial press considers it a positive development that Cyprus now has as minister of finance, Charilaos Stavrakis, who used to be the chief executive officer of the country's largest commercial bank. Because of this experience, he is expected both to understand the financial services sector and to be aware of the importance of this industry for the country. Stavrakis wants Cyprus to become a prestigious, regional financial services centre and also recognises that, to realise his objective, he needs to cooperate with the business community and listen to its suggestions, which is what he has been doing. Of course, Cyprus' DTT network is already strong and extensive and is still comparable to the networks of countries such as Ireland and Luxembourg in terms of size and attractiveness. In addition, Cyprus's membership of the EU, which gives Cypriot companies access to EU directives often even makes access to DTTs superfluous. These directives (if their conditions are met) should apply without the existence of a DTT between the countries of establishment of the contracting parties. However, there is no reason for Cyprus to rest on its laurels by simply looking at the growth figures of the financial services industry. The country does need more DTTs to diversify and so create optimal conditions for its financial services industry to grow. Extra credibility The new legislation offering the Cypriot Inland Revenue broader authority to exchange information with foreign countries should have a positive impact on the growth of the country's financial services industry. It broadens the opportunities to conclude new DTTs and it adds to the country's credibility and reputation as a trustworthy and stable EU member state. Rutger Kriek (rutger@consulco.com
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