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. Last Updated: 07/27/2016

Cyprus Tax Treaty Targets Developers

A new double-taxation treaty between Russia and Cyprus includes a section that will make it more difficult for developers to use offshore firms to minimize their tax payments, according to a copy of the document.

Earlier this month, finance ministers from both countries agreed on a protocol that will alter the current bilateral agreement on double taxation. The main changes involve better information sharing between the countries' finance ministries and help in collecting taxes, but several of the alterations will have a direct effect on the real estate market.

Developers typically register their projects as part of a separate firm so that it is easier to sell, said Alexander Zakharov, a partner at legal firm Center YuSB. As a rule, he said, those firms are registered offshore, frequently in Cyprus.

For example, 85 percent of Mosinzhstroi, which counts Okhotny Ryad among its projects, is controlled by the Cypriot-registered MIS Holding Limited, in which investment company A1 tried to purchase a controlling stake last year. When developers sell a property, they usually sell the shares in the company that controls the project as well, said Dmitry Shmelev, commercial director of Snegiri Development. If the share sale takes place in Cyprus, Zakharov said, it is a tax-free transaction, whereas in Russia a 20 percent profit tax would need to be paid after deducting the construction expenses.

Changes to Article 13 of the agreement with Cyprus allow Russia to collect a profit tax on the sale of companies registered there if more than half of the firm's assets are in Russian real estate. The main problem is being notified of such deals, a tax official said, adding that they had to hope that the Cypriots would start informing the Finance Ministry under the rules spelled out in the protocol.

The result could be hundreds of millions of dollars in new tax revenue. According to Colliers International, the 10 largest commercial real estate projects in Moscow last year alone were worth $2.72 billion.

Knight Frank vice president Andre Zakrevsky said developers would face some difficulties, but by 2014, when the changes take effect, they will close their offshores in Cyprus and remove their assets -- most likely into other offshores.

The Cypriots, however, likely demanded that Russia make similar changes in its agreements with the more than 60 other countries it has such treaties with, which is probably why the changes start from 2014, said Vladimir Gidirim, a partner at Deloitte.

A Finance Ministry spokesman said the ministry was already working on additional protocols for its agreements with other countries to gain access to tax information. "With help from the Interior Ministry, we are working with Switzerland, Luxembourg, Austria and Malta," he said. Lawmakers in both countries must still ratify the new Cyprus treaty.

The new agreement also strengthens oversight of revenue from property management, which will take effect sooner but no earlier than Jan. 1, 2010. Many properties are managed through closed investment funds whose shareholders are Cypriot-registered firms, Gidirim said, adding that such funds do not pay tax in Russia.

Profit from such investment funds can be listed as "other income" of a Cypriot company, he said, meaning that under the current agreement, it is not taxed. After changes to Article 6 of the agreement, these payments will be subject to Russia's 20 percent profit tax.