Russia scrapping the Cyprus Double Tax Treaty

by | Aug 5, 2020 | Cyprus Tax

Russia scrapping Cyprus Treaty for double taxation is an interesting development and a clear indication that Russia is not happy with Cyprus. After-all the underlying reason of a treaty for the avoidance of double taxation is to promote trade and investment between the contracting states. Russia’s finance minister said that, (Russia) will be scrapping the Cyprus Double Tax Treaty. The Cyprus Double Tax treaty has been the cornerstone of economic relationships for the last 30 years. To read more about the developments on this please consider this Cyprus-Mail article.

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The absence of a double tax treaty, will affect holding and financing structures. Whereas IT and trading companies will be lesser affected.

Financial service professionals have been bombarding social media and other new’s outlets of an “End to an Era“, however in many ways, the global financial services industry has moved away from structuring for tax for many years now. Entrepreneurs, CEO’s, business and investment funds look for sustainability, reliability, cost effectiveness, ease of doing business rather than hard core increase of profit by avoiding to pay taxes.

How will Russia scrapping the Cyprus Double Tax Treaty affect Holding and Financing Structures?

In a recent article Rustam Vakhitov (available in Russian Language) confirmed that, due to the various repatriating actions of the Russian government, holding entities (which did not have a qualifying beneficial owner) did not apply the reduced 5% rate on dividend distribution. Those holding companies that did have a qualifying beneficial owner did. Furthermore Rustam notes that the losses generated from Covid-19 would undoubtedly create an opportunity to carry forward the credits into future years. Based on the forgoing if many entities did not apply the reduced rate of 5% since they did not qualify then what is the reason of even having the double tax treaty?

Rustam’s publication goes on to clarify that Financing Structures are divided into two categories. The first being those issuing loans from their own funds to the market and the second back to back loans. The back to back loan practice is risky anyway since the Cypriot Financing entity could not utilize the reduced rate of taxation. For financing companies issuing loans to the market the 15% withholding applied in Russia will be an eligible tax credit for the 12.5% paid in Cyprus.

How will Russia scrapping the Cyprus Double Tax treaty affect IT Companies and Trading Entities

Cyprus has been heavily used by Russian entrepreneurs and start-ups as a destination to set-up shop, develop and operate IT companies. Although the interests might have originated from Russia, these types of business operate, exist and function in many ways like any other Cypriot entity, with its employees, monthly payroll etc. These type of entities should not be affected by the absence of a double tax treaty between Russia and Cyprus.

Trading companies should not be affected by a change in the double tax treaty, since the payment of the purchase price to a resident in Cyprus bears no withholding tax in Russia.

Why is Russia scrapping the Cyprus Double Tax Treaty?

The below are some of my theories underlying the political decision of scrapping the Cyprus Double Tax Treay

Russia attempting to repatriate Russian business

It is very well known that in the last 3-5 years the Russian government has been attempting to repatriate and “on-shore” business with international structures. This can be seen by adding countries to a dedicated black list, the creation of its own offshore regimes, officially refereed to as “Special Administrative Regions“, the introduction of CFC rules and Beneficial ownership test.

All these measures aimed to close the leak taxes which the Russia government out to have gained but due to the treaty end up going to Russian nationals either residing in Russia or who decide to move out of Russia into Switzerland, United Kingdom, Cyprus or otherwise.

These type of structures can be seen as a loop, whereby, the national creates a foreign structure especially for the avoidance of paying national taxes and are, nowadays, frown upon.

In a recent article by Rustam Vakhitov (available in Russian Language) a search in the Russian commercial database SPARK-Interfax as of August 2, 2020, gave more than 8100 active Russian companies with Cypriot shareholders,  with a total share capital of more than 23 billion euros, total revenues of more than 185 billion € in 2019 and a total dividend distribution of approximately € 8.2 billion for 2018 and € 3.5 billion for 2019.

The Netherlands, often viewed as an alternative to Cyprus, lags significantly behind in all respects – the number of Russian companies with Dutch shareholders is approximately 1,600, the total share capital is about 10 billion euros, total revenues of 62 billion euros in 2019, and the dividends distributed amounted to 1.8 billion euros in 2018 and 0.9 billion in 2019.

Luxembourg closes the Troika with about 400 Russian companies with Luxembourgish shareholders, combined equity capital of EUR 1.4 billion, cumulative revenues of EUR 18.5 billion in 2019 and distributed dividends of about EUR 0.9 billion in 2018 and 2019.

How much cash flow is channeled out of Russia?

In a recent article by Rustam Vakhitov (available in Russian Language) a search in the Russian commercial database SPARK-Interfax as of August 2, 2020, gave more than 8100 active Russian companies with Cypriot shareholders,  with a total share capital of more than 23 billion euros, total revenues of more than 185 billion € in 2019 and a total dividend distribution of approximately € 8.2 billion for 2018 and € 3.5 billion for 2019.

The Netherlands, often viewed as an alternative to Cyprus, lags significantly behind in all respects – the number of Russian companies with Dutch shareholders is approximately 1,600, the total share capital is about 10 billion euros, total revenues of 62 billion euros in 2019, and the dividends distributed amounted to 1.8 billion euros in 2018 and 0.9 billion in 2019.

Luxembourg closes the Troika with about 400 Russian companies with Luxembourgish shareholders, combined equity capital of EUR 1.4 billion, cumulative revenues of EUR 18.5 billion in 2019 and distributed dividends of about EUR 0.9 billion in 2018 and 2019.

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Cyprus Oil and Gas

The delicate geopolitical balances swiftly developing around the Cypriot exclusive economic zone (the “EEZ”) have severely affected the political relationships between Cyprus and Russia. Since Noble initiate the first exploratory drilling in 2011, Cyprus turned to the west for political support because the internationally unrecognized Turkish Republic of Northern Cyprus (TRNC) and Turkey claiming rights over the EEZ.

The EEZ has been limited to 12 nautical miles since 2004 and the same was delimited by bilateral agreements with Israel, Lebanon and Egypt. Since Noble’s exploration in 2011 global energy giants such as Italian ENI, South Korean Kogas, French Total, American ExxonMobil, Qatar Petroleum, American Noble Energy, Israeli Delek Group, Royal Dutch and others have a vested interest in the EEZ.

In an interesting twist of events, the identification of quantifiable and commercially viable natural resources the European Commission, Regulation 347/2013, designated the Eastern Mediterranean pipeline (EastMed) as a project of common interest.

A project of common interest  is a project that the European Union has identified as a key priority for interconnecting Europe’s energy system infrastructure. The EastMed pipeline is a planned offshore/onshore natural gas pipeline, directly connecting East Mediterranean energy resources to mainland Greece via Cyprus and Crete.

The project, currently in design, will transport natural gas from the off-shore gas reserves in the Levantine Basin into Greece, and in conjunction with the Poseidon and IGB pipelines into Italy and other European regions.

Effectively when the EastMed pipeline is in use it will compete with one of the main export interest of Russia, crude oil and natural gas exportation to Europe. On the other side of the spectrum, American interests in the Levantine Basis are increasing in support of the EU/US interests.

Restrictions to banking

On the 2nd of November 2018, the Central Bank of Cyprus issued a Circular Letter to its members with reference number BS 6020 addressed to the Money Laundering Compliance Officers of all Credit, Payment and E-Money Institutions (the “Circular”). The Circular related to the classification of shell companies in Cyprus and prohibiting the provision of any banking services.

After the Circular it was estimated that over 100.000 bank accounts where closed in Cyprus. The circular especially affected business that utilized the Cypriot banking system but were deemed as Shell Companies per the central Bank of Cyprus. Additionally new business that intended to, or that were familiar with using the Cypriot banking system for international trade no longer found a safe heaven.

And although almost all companies registered in Cyprus would not qualify as a shell company ; it was commonplace for Cypriot service providers to set-up and administrate offshore entities with local bank accounts in parallel to local entities. These offshore entities were set-up for specific transactions or otherwise, but in any case controlled by the same clients as are frequently found in Cyprus.

The restrictions to banking might not be linked directly to the Russian Government however indirectly it placed pressure on various Russian connected business, entrepreneurs and private wealth structures.

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Harris Sharpe

Harris Sharpe

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For many years he has worked and devoted his skills and efforts towards building a successful career as a leading executive. From humble beginnings, his aim has always been to yield results; with a keen focus to attention to detail and client satisfaction. His experience has always been varied and not specific, at times he preferred it. With that in mind, he has dealt with CySEC on licensing and ongoing regulation, international private equity and credit fund managers, NASDAQ and NYSE listed companies occasional millionaires as well as self-made millionaires. His passion though is difficult transaction work organizing and deploying people for a common goal. Harris enjoys reading and studying the Cyprus law and sharing that information on this website.

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