Cyprus has been a member of the European Union since 2004. The country has long been known for its low corporate income tax rate and absence of withholding taxes on payments of interest, dividends and royalties paid to non-residents. This attractive tax environment, coupled with an extensive network of double tax treaties and favorable corporate laws and freedom of capital within the EU, has made Cyprus a center for multinationals establishing holding companies, investment funds, trusts and other special purpose entities.
The financial stress in Cyprus is different from that in other EU countries. It does not stem from a sovereign debt crisis and deep government deficits. Rather, the financial crisis arose from the investments that a number of Cypriot financial institutions made in Greek bonds and other assets with severely depressed valuations. In an effort to stabilize these banks, the Eurogroup of finance ministers, along with the International Monetary Fund, has agreed to a €10 billion package of assistance for Cyprus. As part of the package, the Central Bank of Cyprus placed significant withdrawal restrictions on depositors which are gradually being relaxed by decrees issued on a weekly basis by the Central Bank of Cyprus. In a recent relaxation, the restrictive measures for branches and subsidiaries of qualifying foreign banks in Cyprus were lifted completely, with the result that these banks are now fully exempt from the capital controls in connection with transactions of their international business clients.
Laiki Bank is being folded into Bank of Cyprus in a reorganization of the banking system achieved through the freshly passed Banking Resolution Laws, and it is anticipated that Bank of Cyprus will be adequately recapitalized and the remaining restrictions on withdrawals will be lifted in a relatively short period. Laiki Bank depositors have seen all their deposits over €100,000 converted into shares while at Bank of Cyprus, depositors having over the protected amount of €100,000 have seen 37.5 percent in funds converted into bank shares, and potentially 22.5 percent more, depending on what experts determine is needed to replenish the bank's reserves.
It is worth noting that more than 50 affected parties, both local and foreign, have filed legal challenges to the new laws based on the resolution measures agreed by the Eurogroup and Cyprus.
The changes to the Cyprus tax regime are not expected to affect current structuring, particularly as far as holdings are concerned. There has been an increase in corporate tax from 10 percent to 12.5 percent, which seems not significant enough to disturb existing trading structures. And the slight rate increase does not affect holding structures at all, because dividend income, subject to the generous participation exemption criteria, will remain tax free. The defense tax on interest income has increased from 15 percent to 30 percent but there are still ways of structuring around this which can achieve the corporate 12.5 percent rate on such income rather than the higher bracket tax.
For now, the low corporate tax rate environment, absence of withholding taxes and capital gains tax, and favorable treaties with Russia and other countries are all unaffected. Also not affected is the relatively recent IP Box regime, which features a very attractive income tax rate of 2 percent for captive entities which license their IP to affiliates.
Multinationals and investors with key affiliates in Cyprus are encouraged to review their banking and financial operations in that country with a view to protecting and securing their interests and making informed choices. At this stage, it seems premature to consider restructuring existing operations that are still giving proven tax benefits. Only if Cyprus does move to alter its business-friendly tax regime should multinationals contemplate a change.
For more information, please contact Eric D. Ryan.
* Emily Yiolitis is a partner with Harneys Westwood & Riegels and managing partner of its Cyprus office. You may reach her at Emily.Yiolitis@harneys.com.
This article, originally published in April 2013, was updated on June 5, 2013 to reflect the latest developments.