Cyprus Based Company - Andreas Neocleous & Co

global legal update
Cyprus Based
Company
by Yuriy Y. BLAZHEVYCH
as an Ideal Tool for
Tax Optimization
and Financial Planning
by Dmytro T. KORBUT
1. Introduction
Cyprus has always been
an excellent location for
holding companies for a
host of reasons that include
its transparent legal
system, excellent communications and
world-class professional and banking
services. It has a market economy and
no restrictions on capital movements.
The simple and modern tax system in
Cyprus, with a corporate tax rate of
only 10% and an extensive network of
double tax treaties, further enhance its
attractiveness as a regional business and
financial centre. Cyprus’s tax system is
in full compliance with the EU Code
of Conduct for Business Taxation and
the OECD’s rules for the elimination of
harmful tax practices.
Cyprus has always ranked among
the main sources of investment into
Ukraine and investment from Cyprus
to Ukraine during the period 1991-2005
Yuriy Y. Blazhevych, Ph.D is a legal
advisor with Andreas Neocleous & Co
Dmytro T. Korbut is a Head of Kyiv Office
with Andreas Neocleous & Co
38 • The Ukrainian Journal of Business Law | September 2006 •

cyprus | global legal update
amounted to more
than USD 1.6 billion.
The reasons for this
are clear and include
the traditionally close
political, economic, financial
and historical
connections between
Cyprus and Ukraine,
the numerous advantages
of the Cyprus
tax and legislative
system (particularly
the network of double
tax treaties), official
encouragement of
investment activity
abroad and free
movement of capital.
Furthermore, there is
no doubt that in many
cases investments
from Cyprus were repatriation
of Ukrainian
capital previously
exported due to perceived
deficiencies
including excessive
regulation, unstable
tax and judicial systems,
unsatisfactory
corporate laws and an
unbalanced property
structure. Under such
conditions domestic
businessmen and
companies sought to
minimize their tax
and regulatory burden
and protect their
assets by unofficial
means.
However, it is now
possible to take steps
to minimise the tax
burden and to protect
assets entirely within
the law and in accordance
with all appropriate
official rules and
restrictions. Cyprus is
a full member of the
EU and a responsible
and respected corporate
and financial
center and the use of
a Cypriot holding or
finance company is
highly beneficial for
tax optimization and financial planning
for Ukrainian businesses. Furthermore,
use of a Cypriot company may bring additional
advantages over and above tax
mitigation, including:
• Asset protection
• Attracting investments
• Financial optimization
• Tax planning and tax free gains on
disposal
2. The advantages of Cyprus
In the following paragraphs we outline
the benefits of using a Cypriot corporate
structure to deal with the issues
described above.
2.1. Asset protection.
Cyprus offers a number of benefits in
terms of asset protection, including:
• An extensive network of bilateral
and multilateral investment protection
treaties which can give increased confidence
to investors repatriating capital to
Ukraine.
• The confidentiality of ultimate
beneficial owner can be protected by the
appointment of nominee shareholders
and directors in Cyprus. The registration
of the company will be achieved
through the appointment of nominees to
hold shares on behalf of the true owners,
whose identity therefore remains known
only to the nominees and the fiduciary or
registrar company only. After registration
the nominees may delegate their
rights to the beneficial owner, for example,
by signing blank undated transfer
documents or powers of attorney in relation
to the investment. In this case there is
no need for the Ukrainian beneficiary to
obtain a special licence from the National
Bank of Ukraine entitling him to make
investments and establishing a company
abroad unless he decides to disclose his
identity as registered owner.
• The corporate law and culture on
Cyprus are long-established and based
on English law in full compliance with
EU requirements.
• Cyprus is known for its fair and
transparent judicial system, which effectively
safeguards the rights of Ukrainian
or foreign investors. Furthermore, while
the quality and reputation of the legal
system in Cyprus are on a par with the
United Kingdom, costs are much lower
in Cyprus.
• Since September 2004 an agreement
for mutual recognition court decisions in
civil cases has existed between Ukraine
and Cyp rus under which each country
recogni zes and enforces decisions of the
other country’s courts. Consequently,
decisions of a Cypriot Court protecting
the interests of a fo reign investor may be
enforced in Ukraine.
2.2. Tax optimization.
The use of a Cyprus resident company
for tax optimization has numerous potential
benefits. First, a Cypriot company has
a considerable advantage in joint venture
activities in Ukraine, primarily because of
the reduction in the impact of withholding
taxes on the distribution of the joint
venture’s profit under the Cyprus-USSR
double taxation treaty of 26 August 1983
which applies to Ukraine in accordance
with the rules of legal succession. Within
Ukraine withholding tax is charged at
15% on the income of non-residents derived
from Ukraine unless international
treaties provide otherwise. Thus, the following
payments received from sources
in Ukraine by a resident of Cyprus will be
exempted from payment of withholding
tax in Ukraine and vice versa:
(1) Royalties of all kinds
(2) Profits derived from international
traffic operations (including profits derived
from the participation in a pool,
a joint venture or in an international
organization en gaged in the operation of
international traffic);
(3) Dividends (income from shares,
founders’ shares and other similar
rights);
(4) Interest (income from loans, bank
deposits, public loans, debt obligations);
(5) Income derived from the sale,
exchange, lease or any other form of use
of movable property, excluding motor
vehicles, situated in Ukraine;
The following income will be free of
tax in Cyprus and will be subject only to
taxation in Ukraine and vice versa:
(1) Profits derived in Ukraine by a
resident of Cyprus if they are derived
through a permanent establishment (an
agency, an office or any other fixed place
of business) located therein and only to
the extent which is attributable to the
activity of such permanent establishment
(the fact that a resident of Cyprus
controls or is controlled by a resident of
Ukraine shall not of itself be considered
• The Ukrainian Journal of Business Law | September 2006 •
39

global legal update | cyprus
to be a reason for treating one of them as
a permanent establishment of the other);
(2) Immovable property belonging
to a resident of Cyprus and situated in
Ukraine;
(3) Income derived by a resident of
Cyprus from the sale, exchange, lease or
any other form of use of the immovable
property situat ed in Ukraine.
Negotiations are in progress between
Ukraine and Cyprus to conclude a new
double taxation agreement to replace
Cyprus offers a
number of benefits
in terms of establishing
business
the old USSR-Cyprus agreement. The
second round of negotiations was concluded
in May 2006 and a third round
is expected to take place soon. A number
of issues remain to be resolved and it is
likely to be some time before the new
agreement is finalized and effective. In
the meantime the existing agreement
remains in place.
Secondly, all expenses of Ukrainian
companies incurred for purchasing goods
and services from Cyprus companies are
fully deductible in arriving at taxable
income, because under Ukrainian legislation
Cyprus is no longer an offshore
zone for Ukraine. A Ukrainian company
purchasing any goods and services from
a company incorporated in a country
appearing on the list of offshore zones
is allowed to deduct only 85% of any expense
incurred. Consequently, Cypriot
companies now have a great advantage
compared with companies incorporated
in offshore zones.
Thirdly, Cyprus has a modern, business-friendly
tax system, including the
following benefits:
• Residential principle under which
there is no tax discrimination between
resident or non-resident companies in
Cyprus.
• A corporation tax rate of only 10%,
the lowest in the EU.
• A VAT rate of only 15%, again the
lowest in the EU. For some categories of
output, VAT is charged at 5% or zero.
• Dividends received by one Cyprus
resident company from another are exempt
from all forms of tax.
• If a Cyprus resident company
owns 1% or more of the share capital of
a foreign corporation any dividends it receives
are also exempt from tax, except in
the event that: directly or indirectly more
than 50% of the activities of the paying
company result in investment
income and the paying company
is subject to tax at a rate
substantially lower than the
Cyprus rate.
• Tax credits are available
for taxes paid out of Cyprus.
• Under Cypriot law all
expenses incurred for the
production of the associated
income are deducted before
arriving at taxable income.
• The profits of a Cypriot
company’s permanent
establishment in another jurisdiction
are similarly exempt, subject to the same
conditions as for dividends.
• Interest income that is the result of
the main activities of the company or that
is closely connected to those activities is
subject only to corporation tax at a rate
of 10% like any other “active” trading
income. Group finance income is treated
as active trading income.
• Group relief is available, allowing
a loss-making company to surrender its
losses to be set off against profits of a fellow
group company.
Finally, an extensive network of
double tax treaties between Cyprus and
many other countries makes the Cypriot
company an ideal corporate wrapper as
an intermediary between a Ukrainian
company and a foreign investor from
a third country that has no double tax
treaty with Ukraine.
Moreover, even for those who are
deterred by Cyprus’s corporation tax
rate of 10% it is always possible to deduct
from taxable income certain payments to
companies established in offshore zones,
taking into account that the only withholding
tax levied by Cyprus is a 10%
(subject to treaty provisions) withholding
tax on royalties derived from the use of
a right or asset within Cyprus. All other
dividend, interest and royalty payments
made to non-Cyprus resident recipients
may be made without deduction of tax.
2.3. Attracting investments.
Any Ukrainian company wishing to
attract foreign investment must not only
provide an attractive return, but also certainty
of capital. In the current political
and legal climate it is difficult for Ukrainian
companies to give such guarantees
on account of deficiencies in corporate
law and reporting requirements in
Ukraine. Using a Cypriot intermediary
company could remove those problems
and it easier for Ukrainian business to
attracting foreign portfolio investments.
Using a Cypriot intermediary company
could also facilitate a future Initial Public
Offering (IPO) to provide an exit for
investors.
2.4. Financial optimization.
Since Ukrainian interest rates are
higher than in any EU country, ranging
from approximately 10% to 20%, Ukrainian
companies would prefer to obtain
credits or loans from foreign banks at
European rates. However, European
banks or other financial institutions do
not generally consider Ukrainian companies
as good credit risks, partly because
of concerns about enforcing the debt
should this prove necessary. The use
of a Cyprus-based entity may remove
these concerns. Moreover, Cypriot tax
legislation does not contain any specific
provisions relating to thin capitalization
of companies, i.e. a debt: equity ratio
requirement. A Cypriot company may
therefore be capitalized with loans in
order to finance a Ukrainian subsidiary
company. Interest income that is the result
of the main activities of the company
or that is closely connected to those activities
is subject only to corporation tax
at a rate of 10% like any other “active”
trading income. Group finance income is
treated as active trading income. Interest
paid from Ukraine to Cyprus will be exempted
from VAT and withholding tax
in Ukraine under the provisions of the
double tax treaty as described above.
2.5. Tax free purchase/sale of shares
and assets.
Mergers, acquisitions and other reorganizations
in Cyprus may be carried out
without tax cost. Thus, any asset (including,
in certain circumstances, non-Cyp-
40 • The Ukrainian Journal of Business Law | September 2006 •

iot real estate) that has scope for significant
capital appreciation may be placed
in a Cypriot corporate wrapper and sold
without any liability to tax on the gain.
Crucially, capital gains deriving from the
disposal of shares and other securities
(shares, bonds, debentures, founders’
shares etc.) are exempt from all forms of
taxation providing the company whose
shares are being sold does not hold Cypriot
real estate.
3. The verdict
All the foregoing factors make Cyprus
a highly attractive intermediate
company jurisdiction as they offer the
following benefits:
• optimization of income streams,
which will generally be tax exempt in
Cyprus and not attract withholding tax
as they leave;
• subsidiaries that have scope for significant
capital appreciation may be held
in Cyprus and sold without any liability
to tax on the gain;
• Cyprus’s double tax treaty network
and the EU Parent-subsidiary directive
offer a number of other tax planning opportunities;
• Cyprus offers a favourable exit
strategy which allows payment of dividend,
interest and royalties without payment
of withholding tax.
Cyprus can also be used as the location
for the ultimate holding company,
for instance in a group that is relocating
to a new jurisdiction or on formation of
a new publicly traded corporation with
international operations. It is particularly
suitable for any fund or investment vehicle
since there is no tax on transactions
in securities as defined, even if this is
the entity’s main trading activity. Since
there is no withholding tax on dividends
there is no uncertainty over recovery of
tax paid.
Some caveats should be made. First,
the holding company/IBC must genuinely
be resident in Cyprus. Mere incorporation
in Cyprus is not sufficient: the locus
of real management and control must be
in Cyprus. Second, this company must
have a genuine reason for being; if it is
no more than a tax-driven device the authorities
may invoke the wide anti-abuse
provisions of the law and withdraw the
benefits. All this is in line with current
EU tax principles, which basically affirm
that any holding or subsidiary company
within a group structure must have an
economic or business function.
The first step to find a right business
solution concerning financial planning or
tax optimization is to understand which
legal entity type satisfies your business
requirements in the best way. There is a
range of business entities used by foreign
investors to conduct business in Cyprus
such as: holding company, foreign company,
international business company,
Cypriot international trust or investment
company. The total cost of incorporating
a Cypriot registered company with
an authorized share capital of up to
CYP 5,000 (about USD 12,000) amounts
to CYP 1,250 (about USD 2,500).
The final choice of a company’s location
(or any other form of fiscally beneficial
entity) is a question of balancing tax
and non-tax considerations. While no
single location can claim first place on
every test, Cyprus should always be on
the shortlist.
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• The Ukrainian Journal of Business Law | September 2006 •
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