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Farewell to Cyprus: the Breakdown of the Double Taxation Agreement with the Island
August 8, 2020 23:22


The news that the Russian Ministry of Finance decided to break the agreement on the avoidance of double taxation with Cyprus, although it sounded like a bolt from the blue, was not entirely unexpected. Alexander Tokarev, Director of Tax and Legal Consulting at KPMG in Russia and the CIS, tells what   those who have enjoyed the advantages of the Cypriot tax system should do now.

As a bolt from the blue, the news came on Monday that Russia was denouncing the current double taxation agreement with Cyprus. Not that such an ending was unpredictable - back in March, Russian President said that Russia would unilaterally terminate the agreement with transit countries that would not agree to an increase in income tax rates at the source of payment.

But enough time has passed since then, and the finance ministries of Russia and Cyprus have repeatedly discussed amendments to the agreement. The first round of negotiations started on June 25, and two days before that, a page appeared on the Russian portal for the consideration of regulatory legal acts on the development of a bill to denounce the double taxation agreement with Malta. Moreover, the text of the bill itself is still missing. It is unlikely that this was a coincidence, most likely, the Ministry of Finance of the Russian Federation wanted to demonstrate to its colleagues from Cyprus the seriousness of its intentions using the example of a jurisdiction that is less significant for Russian holding structures.

During June-July, the finance ministries of the two countries discussed the list of persons to whom benefits (for them, the dividend rate, for example, can be reduced to 5% or 10%, and on interest on loans - to 0%) under an agreement on the avoidance of double taxation will still apply. The list of such persons was shrinking each time, round after round Cyprus was losing its attractiveness in terms of tax structuring. That is why the news of the complete breakdown of the double taxation treaty has had the effect of a bomb. According to the Ministry of Finance of the Russian Federation, the proposals of the Cypriot colleagues will contribute to the tax-free withdrawal of significant financial resources from the Russian Federation through Cyprus, and, accordingly, Russia cannot accept them. The Finance Ministry has enough time to denounce the agreement. In order for the tax agreement with Cyprus to expire from next year, it is necessary to send a notification to the island authorities by December 31 of this year. For Luxembourg and Malta, this deadline expired on June 30 this year.

If the agreements between Cyprus and Russia cease to be valid from next year, dividend payments from the Russian Federation to Cyprus will be subject to income tax at the source of payment at the rate of 15%, and other income (interest and royalties) at the rate of 20%. Thus, other incomes, such as royalties and payments for renting ships, will also be affected. Cyprus is a popular jurisdiction not only for holdings and financial companies, but also for owners of intellectual property rights and ship owners. The existence of an agreement with Cyprus was of paramount importance for them.

When leaving Cyprus, it should be borne in mind that the island has recently introduced an exit tax, and retrospectively - from January 1, 2020.

Now, when moving from Cyprus, there may be an obligation to pay tax on the difference between the market value of the asset and its tax value. Special attention will be required if there are issued loans and intellectual property on the balance sheet of a Cypriot company.

If the existing structures with Cyprus apply the benefits of the double taxation agreement, there is an opportunity to think about the distribution of income while the agreement is still in force. It is necessary to prepare the necessary documentation in favor of confirming the status of the Cypriot company as the actual recipient of the income.

Several strategies can be considered for the future:

Leaving Cyprus for another foreign jurisdiction. Here it should be borne in mind that there are not so many countries that would give similar tax advantages. Moreover, there is no guarantee that such a country will not soon receive a “letter of happiness” from the Ministry of Finance of the Russian Federation, like Malta or Luxembourg.

A "cross-cutting" approach. If the company has previously applied a “pass-through” approach (where a Cypriot company is recognized as a transit company, and taxes are charged on payments as if they were paid to the final recipient directly, and not through a chain of companies), then the break of the agreement with Cyprus should not affect it. However, if previously the exemptions were applied under the agreement, and now the possibility of applying a “pass-through” approach is being considered, it is important to take into account historical tax risks. After all, it will be necessary for the Cypriot company to recognize itself as a transit company, which can be used by the tax authorities when challenging the right to benefits in the past.

Leaving Cyprus for the Russian Federation. This strategy is now of particular interest to businesses, and many companies have already changed their tax residency to Russian. Such a structure is very popular within the framework of joint ventures, since it makes it possible to use foreign law, as well as benefits in the distribution of dividends from Russian subsidiaries in favor of a foreign holding company that is a tax resident of the Russian Federation. Here it is necessary to take into account the plans of the Ministry of Finance of the Russian Federation to limit the right to use such a tax benefit. Initially, it was proposed to cancel it altogether, but the option to make it temporary, until the end of 2023, is currently being considered.

It is possible to consider the option of a complete transfer to the so-called special administrative regions (SAR) - Russian "offshores" on the islands of Russian and Oktyabrsky. Under this option, there are no plans to restrict the right to benefits on dividends received from Russian companies.

Moreover, the government has approved a number of measures that will make the SARs even more attractive. For example, extending the 5% withholding tax rate to non-public international holding companies, which is a positive development, especially if the criteria for them are also revised.

Author: Anna Dorozhkina

Tags: Russian international Russian business Russian companies   

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