The island nation of Cyprus is enduring a financial crisis, and international tax professionals are wondering about the impact it may have on their companies and related planning efforts.
Cyprus has been a member of the European Union since 2004. The country has long been known for its low corporate income tax rate (10 percent) 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 recently placed significant withdrawal restrictions on depositors. Other tough requirements are expected.
Although it is a surprising development for any member of the EU to restrict the movement of capital, this freeze will likely not necessarily extend to funds of multinational affiliates on Cyprus. Rather, only those funds that are deposited in financial institutions in Cyprus, including Laiki Bank and Bank of Cyprus, are subject to the restrictions. 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 restrictions on withdrawals will be lifted in a relatively short period. Already each Central Bank Order has been relaxing the current restrictions by degrees every few days, so it is anticipated that normal business may resume soon.
The assistance provided to Cyprus by the Eurogroup contemplates that there may be future changes to the Cyprus tax regime, but these are not expected to affect current structuring, particularly as far as holdings are concerned. The contemplated increase in corporate tax from 10 percent to 12.5 percent is not significant enough to disturb existing trading structures and does not affect holding structures at all, because dividends, subject to the generous participation exemption criteria, will remain tax free.
For now, the low corporate tax rate, 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.