Cyprus placed on Russian tax ‘blacklist’

— Impact “not damaging” because of loopholes

 

The Finance Ministry in Moscow has placed Cyprus on a black list of jurisdictions deterring Russian companies from registering here and then repatriating their dividends tax-free back home.

Despite this negative development, experts told the Financial Mirror that the impact is not that great, since foreign companies investing in Russia through Cyprus subsidiaries are exempt from the rule, leaving many loopholes to be utilised.

The amendment to the Russian Tax Code came into effect on January 1 introducing a tax exemption on dividends earned by Russian companies through foreign subsidiaries under certain conditions. This exemption does not apply to foreign organizations registered in territories seen as having beneficial tax treatment or that are not required to disclose and provide information on financial operations.

The move is seen as an attempt by the authorities in Moscow to boost their tax revenues and forbid a Russian company from paying the 10% tax rate in Cyprus and then repatriating the profits to avoid paying the 24% corporate tax in Russia.

As at the end of September 2006, the total amount of accumulated investments in Russia was $130 bln out of which $28 bln or 21.6% came through Cyprus.

 

— Exemptions

 

The draft list was first published on June 18, 2007 and included 59 jurisdictions, such as the offshore Caymans, Maldives and British Virgin Islands that provide beneficial taxation, as well as some European countries with high tax rates (Belgium, Luxemburg and Ireland). In essence, this was the same list as that attached to Directive 1317-Y of the Bank of Russia of August 7, 2003.

The list subsequently changed. All the US territories, Belgium, Ireland, Luxemburg, Portugal, Barbados and some others were removed and the list was reduced to 41.

The speed with which Luxembourg, Belgium, Ireland and Austria got off the list, has given rise to speculation that once again, Cypriot officials were caught napping and either did not see the Russian move coming, or as is the case most of the times, could not be bothered to act.

Finance Minister Michalis Sarris was unavailable for comment.

Phidias Pilides, Managing Partner of PricewaterhouseCoopers, and Chairman of the Cyprus-Russia Association as well as the organisation in charge of attracting investments to Cyprus has described the move as “unfortunate”, since competitor countries such as Holland and Switzerland were taken off the list. 

Pieris Markou, Head of Tax Services Deloitte, Cyprus told the Financial Mirror that in recent years Cyprus has seen a tremendous growth of Russian companies expanding abroad and playing an important role in the global markets. Many such companies are seeking listings on global financial markets.

“The above exemption of dividends is an attempt by the Russian government to encourage the flow of income back to Russia. With the inclusion of Cyprus on such a black list, it is inevitable that overseas investments by Russian multinationals would find their way to other jurisdictions and leave Cyprus as a second choice,” said Markou.

He added that the Cyprus government as well as the private sector has been very active in its attempts to exclude Cyprus from the black list but as yet without any success. “I am confident that the efforts will continue, but we understand that the problem does not lie with the specific provisions of our tax legislation but are more in connection with the exchange of financial information between the Cypriot and Russian authorities,” he said.

 

— Not a crisis

 

“As an international business center, Cyprus has faced the problem of being included on black lists before. As far as we know efforts are now being made from many sides in order for Cyprus to be excluded from the list,” said Peter G. Economides, Chairman of the international tax consultants Totalserve Management Ltd.

“We anticipate that these efforts will be successful in view of the excellent relations that exist between Cyprus and Russia. We are of course concerned about the fact that Cyprus is on the black list but this is not such a major problem and in our view it is not a crisis in the making,” added Economides.

He explained that the positive aspect of the whole issue is that most Cyprus- registered companies are not subsidiaries. “In fact, most Cyprus companies are Cyprus holding companies that receive dividends from Russia as opposed to paying dividends to Russian companies, and therefore completely avoid taxation.”

“The problem that arises is that maybe certain dividends from countries like The Netherlands will be completely tax exempt in Russia, given that Holland is not on the black list, which will give them an advantage over Cyprus. In our opinion, even if Holland is not on the black list and our efforts to remove Cyprus from the list take time to bear fruit, there are still ways to get around this problem, such as, for example, using a Dutch company as an intermediary company, thus avoiding taxation.”

 

— Keep the Treaty

 

Angelos Gregoriades, Senior Tax Partner at KPMG told the Financial Mirror that while the Cyprus government should intensify its efforts at the highest level to be removed from the black list, the authorities should not to aggravate the situation by allowing the Russians to renegotiate the Cyprus-Russia tax avoidance treaty.

“The treaty is very good and at all costs it should not be allowed to be renegotiated,” Gregoriades said, adding that the development does not have a damaging impact since foreign companies who set up subsidiaries through Cyprus and channel investments to Russia and then receive dividends are not affected by the move.

He suggested that the Cypriot authorities should instead try to redefine the interpretation by the Russian authorities of the whole tax issue, copying the success with which other EU countries got off the list.

 

— Too many loopholes

 

Russian experts, however, do not believe the new black list will be that important, because the major companies which are close to the Kremlin and are mainly enjoying the income privileges, do not as a rule use shady offshore schemes, according to a report carried by RIA Novosti.

The amendments to the Tax Code will set zero tax on the profits from income companies receive on their shares in other companies (meaning their subsidiaries).

Until recently, the rate was 9% for Russian companies and 15% for foreign ones. Exemption from these payments was granted at the request of President Putin, who instructed the ministry to create stimuli for large companies to register at home.

Valery Tutykhin from the law firm John Tiner and Partners, told RIA Novosti that the ministry had made at least two blunders while drafting the list: it forgot to include the very obvious offshore zones, the Seychelles and Barbados. However, it is of no practical importance in any case.

“Because of the proviso requiring at least a 500 million rouble stake in share capital, only major companies affiliated with the state would be able to use the privilege, but they are unlikely to use some obscure offshore territory to register,” the lawyer said.

His forecast is that major investments in the foreseeable future will be channelled mainly through Luxembourg, the Netherlands, Austria and Britain, which are not on the ministry’s list.

As for Cyprus, the expert added, although on the list, it will remain attractive for Russian businesses, because the ministry’s instruction will in no way affect the present tax-optimizing schemes involving local companies. It will not cancel the very convenient Russia-Cyprus agreement on avoiding double taxation either.

In addition, according to Ernst & Young partner Pyotr Medvedev, the limitation on using Cyprus to channel dividends is easily avoidable. For example, a Cyprus company can pay dividends to a Dutch one, while the latter will transfer the money to Russia where it comes under the zero tax application.