Impact of Russian de-offshorisation may be neutral for Cyprus (Updated)

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By Stelios Orphanides

A new law passed by the Russian Duma on November 18, and signed by President Vladimir Putin a week later, aiming at increasing Russia’s tax revenue from companies operating in Russia but domiciled outside the country, may change the pattern of Cyprus’s economy where a significant number of Russian-owned companies are registered, business service professionals said.

The de-offshorisation law which enters into force on January 1, 2015, is expected to lead smaller Russian owned companies to leave Cyprus and settle in Russia, and to encourage larger ones to relocate their actual headquarters to the island in order to continue benefiting from the Cypriot tax regime and legal framework, they said, adding that this would at the end of the day prove neutral for Cyprus’s economy.

The law which is officially named “concerning the introduction of amendments to parts one and two of the tax code of the Russian Federation (regarding the taxation of the profit of controlled foreign companies and the income of foreign organizations) law”, is a set of measures introduced by the Russian government with a view to modernising the country’s taxation system.

It aims at enhancing transparency and compliance on the basis of taxation standards which have been applied for many years in various European Union countries,” Kyriakos Iordanou, general manager at Institute of Certified Public Accounts said in an interview. “Any person who fails to comply with this legislation, will be subject to additional tax burden in Russia”.

The legislation framework is based on three pillars: rules for the controlled foreign companies rules, the determination of the tax residence and the concept of the beneficial owner, the ICPAC general manager said. “Any company that falls within these pillars is subject to additional taxation as per the provision of the new legislation,” he said and added that the law allows for some exclusions from the controlled foreign companies and tax residence definitions.

Companies domiciled outside Russia will be treated as controlled and will be subject to Russian corporate profit tax, if they are not Russian tax residents and are controlled by individuals or legal entities that are Russian tax residents, according to summary of the law prepared by Ernst and Young.

The criterion of recognition of Russian residents who own more than 50 per cent of a controlled foreign company as a controlling person will apply only next year while the law lowers the threshold to 25 per cent in 2016, the EY document said. In cases where at least a 50 per cent participation interest in aggregate is held by Russian residents, then a 10 per cent threshold will apply.

The criteria determining the tax residency of a foreign company include that a relative majority of board meetings take place in Russia, the company’s executive bodies regularly do their work in Russia or to a greater extent there than in any other country abroad, and that the company’s top managers perform their duties in the country, the EY document adds.

Iordanou added that the measures contained in new legislation, which also contains some exemptions from the controlled foreign company and tax residence definitions, are “applicable to all countries, irrespective of any double tax treaty in existence” and as a result, all jurisdictions, including Cyprus, “will inevitably feel the consequences of this new act”.

As this legislation is being studied in Russia as well as in Cyprus and other countries, Elias Neocleous, vice chairman of the Limassol-based Andreas Neocleous & Co LLC said. “There are still questions and ambiguities with respect to the implementation. It wouldn’t surprise me to see at some point Russian authorities issue some regulations or memoranda to provide additional information about how they will implement this legislation”.

The extent to which Russian owned offshore companies will be affected “will depend on how rigorously authorities will implement the provisions of the law,” he added and as a result some Russian business people who will not be able to afford maintaining companies abroad, “as the maintenance cost will disproportionally high compared to the benefit” may decide to bring their companies to Russia and save the taxes they would have to pay in Cyprus on top of those in Russia.

At the same time, Neocleous, whose law firm offers its services to Russian clients and also has offices in Moscow, said that “others may take the social and political situation into account and terminate their tax residence in Russia and relocate elsewhere and Cyprus could become one of the countries they would then turn to. This legislation may be considered as an incentive for Russian taxpayers to leave to find tax residence in another country”.

Corporate tax rate in Russia is 20 per cent while in Cyprus it is 12.5 per cent.

Russia’s economy is being hurt by sanctions imposed by the European Union and the United States in response to its role in the Ukraine crisis, which the Russian government denies. The sanctions include restrictions of access to financial markets. Critics of Putin say his rule is becoming increasingly authoritarian.

The arrest of billionaire Vladimir Yevtushenkov, the chairman of AFK Sistema, for money laundering raised fears of a repetition of the Yukos case. In 2003, oil company Yukos was broken up and was stripped of its assets by the state and its owner Mikhail Khodorkovsky was sentenced to imprisonment. Khodorkovsky said his case was politically motivated.

While the de-offshorisation legislation may lead to a decline in business from Russia, Neocleous said, as some companies may terminate their presence in Cyprus it “also presents an opportunity”.

“The biggest advantage Cyprus offers, beside its geographical position and tax system, is that it is cheaper when it comes to creating a company base and buying offices compared to other jurisdictions such as Luxembourg, Austria or Switzerland,” he said.

Some Russian-owned companies based in Cyprus may opt to continue their operations in Russia as they do today and accept the additional tax burden this will imply, “but remain Cypriot companies so that they can continue enjoying the protection offered by Cyprus’s legal framework”.

Similarly, Elena Constantinou, who supervises the asset management at the Nicosia-based financial services company UPM Ltd, said that a number of Russian companies will opt to demonstrate that they are present in Cyprus for tax purposes. “Because of the sanctions, and the drop in the oil price, many Russians are afraid of repatriating their capital”.

The price for the barrel of Brent oil fell to below $70 in December from above $110 in July. Energy exports make out the lion share of Russia’s foreign trade revenue.

On December 4, Vladimir Putin proposed full legal and tax amnesty to capital returning to Russia in an attempt to kick-start the economy.

Repatriating capital to Russia legally would mean “there will be no questions from the tax and law enforcement bodies,” Putin promised. “Everybody who wants to should have the right to come back to Russia. We have to turn this offshore page of our economy. I believe that after the Cyprus events our business will understand that its interests abroad are not valued and the best guarantee for them is national jurisdiction.”

Constantinou added that some business people may accept paying the extra tax in the form of a “security premium” and keep their companies registered abroad. “Larger companies can afford this and smaller ones won’t and will therefore leave Cyprus”.

In order to minimise the impact of the Russian de-offshorisation law, the finance ministry launched an initiative together with ICPAC, the Cyprus Investment Promotion Agency and the Bar Association, to examine the situation and update the tax system, ICPAC’s general manager Kyriakos Iordanou said. “Legislation and practices must be adapted to the new developments and the professionals of the field should be able to advise their clients accordingly”.

“What is important to promote is that all companies should be able to demonstrate that they have actual presence and substance in Cyprus, Iordanou said. “The administrative services sector has to adapt to the new environment which calls for enhanced transparency, disclosures and compliance. Some measures to this direction have already been taken by the adoption of the law regulating companies providing administrative services and related matters of 2012”.

Tax authorities are trying to be up to date with exchange of tax information requests from their peers in other countries, he added.

Already, some major Russian companies are looking in to reorganising their business and “Cyprus is in their plans,” lawyer Elias Neocleous said. “It will be entirely up to us whether we will be able to help them in the future”.

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Stelios Orphanides is a journalist at CyprusBusinessMail.com. To contact Stelios Orphanides: [email protected]

  • de-offshorisation doesn’t show up in any spellchecks.

    • Alexander Reuterswärd

      then its correctly spelled 😉

      • Perhaps I should clarify. It doesn’t show up in any spellchecks or dictionaries, but it seems business publications have just invented the word. I think I should switch to decaff.

    • thebluehornett

      South African.

    • Grungemonkey

      Doh you need to put Geo in front of it lol

  • Alexander Reuterswärd

    As always people here see everything as best case scenarios and dreams 🙂
    Russian companies will move home or face consequences
    Owners of Russians companies with assets in Russia will not be able to move outside and go tax free, then Putin will make sure their assets is taxed heavily in Russia. So no benefits of living in Cyprus, these people want France, UK etc.

    • Ronny Verhoeven

      There is another matter Alexander: a Russian owned company will pay 12,50% corporate tax in Cyprus. But if the shareholders will decide to come and live in Cyprus (to avoid Russian taxes) the company will also be liable to pay “Deemed Dividend Withholding Tax” which will make the total tax they pay here similar to what they would pay in Russia. I never understood this “Deemed Dividend Withholding Tax”; it is withholding tax on non-existing dividends. Only in Cyprus! If they want to keep the Russians here, they should start to look into this very strange phenomenon.

      • Себастьян Returns

        Doesn’t Cyprus have the same DDWT ?

        Pay out profits within 3 years (as dividends), or suffer the tax anyway.

        Either way the Government get the money, assuming the shareholder declares it of course !

        • Ronny Verhoeven

          It is about Cyprus I am talking Sebastian. I think there is no other country in the world that levies withholding tax on dividends that are not being given.

          • Себастьян Returns

            Apologies !

  • R Smyrna

    Putin thought he could get away with another Georgia, in Ukraine. Instead, he started an economic war with the west.. A war Russia cannot win.

    Putin must feel he can get away with it, just by seeking out allies like Turkey and China, and harassing Nordic countries territory with his military. Apparently, Putin is threatening a kinetic war as well.

    In the end… It’s the Russian people who will pay the price for Putin’s paranoia, and thirst for power.

    • Себастьян Returns

      “kinetic war”… sorry, I think that is being a little over-dramatic.