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. Last Updated: 07/27/2016

Cyprus Sees Onshore Solution

Russian companies using Cyprus as an offshore haven may soon have to move onshore to take advantage of the country's lower tax rates.

As part of efforts to join the European Union in 2004, the Cypriot parliament is expected to pass a series of tax bills Thursday that, among other things, require Cyprus-registered Russian companies to be managed and controlled from the island to take advantage of a double-tax treaty. The treaty, which was approved in 1998, allows Cyprus-registered businesses operating in Russia to pay Cypriot taxes, which are among the lowest in the world.

"In the past, tax residency was based merely upon incorporation in Cyprus, but this is no longer the case," said Bill Henry, a tax partner with Ernst & Young's Moscow office.

According to the draft law, all companies registered in Cyprus will be subject to a new tax rate of 10 percent starting Jan. 1, while before, offshores paid 4.25 percent compared with the rate of 29 percent applied to local companies.

Even after the increase, Cypus will have the lowest income tax in Europe, followed by Ireland's 12.5 percent, and much lower than the 24 percent that is currently applied to Russian citizens or legal entities owning offshore entities.

"The new rate of 10 percent was approved by the EU, and there is no fixed time period in the law, which means the rate can be applied in the foreseeable future," said Neophytos Neophytou, a Cyprus-based international tax partner with Ernst & Young.

The new laws would eliminate or change the ownership structure of thousands of so-called shell companies that are used by Russians to minimize corporate and personal taxes. An estimated 52,000 companies are registered in Cyprus, and about 40 percent of those are believed to be owned by Russians or by foreigners operating in Russia and the Commonwealth of Independent States.

A grandfather clause in the tax law stipulates that companies registered in Cyprus before Dec. 31, 2001, will be taxed at the current rate of 4.25 percent until 2006. Firms that were registered in Cyprus this year will pay 4.25 percent until Jan. 1 and 10 percent afterward.

The new Russian Tax Code will have an even stronger influence on Russian businesses in Cyprus than that country's new tax legislation, said Eduard Niygibaeir, deputy head of Prospekt brokerage. Under the code, only companies that are tax residents of foreign countries are exempt from Russian taxes.

Russian brokerages won't have to shift their operations to Cyprus, Niygibaeir said. "The directors of Cyprus-based offshore companies now have to be non-Russian residents. Only then will companies be exempt from paying income tax in Russia," he said.

Cypriot Ambassador to Russia, Caralambos Ioannides, said recently that entry into the EU would not have any negative effects on Russian business interests on the island.

None of Ernst & Young's clients in Russia has shown any interest in leaving the island, Henry said. "Cyprus is still a very attractive place for doing business with Russia, provided that certain steps are taken now to deal with the changes in the law," he said.

Niygibaeir said that 2006, when companies will be subject to the new tax rate, is very far off in Russian terms.