Briefing Note on Recent Developments in Cyprus
Since the middle of March, there have been unprecedented developments in the Republic of Cyprus (“Cyprus”) following the application by the Cyprus government to the European Central Bank, the EU and the IMF (together, the “Troika”) for financial assistance.
A Memorandum of Understanding (the “MOU”) has been agreed between the Cyprus government and the Troika setting out the terms and conditions upon which the Troika will provide up to €10 billion of financial assistance to Cyprus for its budgetary requirements. The Eurogroup’s decision on 12 April 2013 agreeing to the terms of the MOU, puts an end to months of uncertainty regarding the framework within which Cyprus may continue to operate fully as an international corporate centre.
This note provides a brief update on these developments. The recent developments in Cyprus relate to two distinct sectors of its economy, namely (A) the banking sector and (B) the corporate sector.
(A) The Banking Sector
A critical situation arose as a result of the two largest banks in Cyprus, namely Cyprus Popular Bank Public Co Ltd (“Laiki Bank”) and the Bank of Cyprus plc, facing serious financial difficulties to the point of insolvency. Following lengthy negotiations, the Troika’s decision was that no financial assistance should be provided to Cyprus for the purpose of bailing out these two banks but that the banking system should, in fact, resolve the situation itself with no external aid. The Central Bank of Cyprus therefore devised a plan aimed at a “controlled” reorganisation of the two banks (the “Reorganisation”) to avoid the risk of a complete collapse of the banking system. This led to the depositors of the two banks suffering considerable losses as they contributed to the cost of the Reorganisation, in other words, “bailing-in” the banks. In enacting the Reorganisation, the Cyprus authorities acted within the applicable EU framework for bank recovery and resolution.
Although there has been criticism, to a large extent legitimate, of the specific measures that the Central Bank of Cyprus has taken, the Reorganisation was consistent with the approach that any bail-in should first be at the expense of the shareholders, then of the bond holders and, only as a last resort, which unfortunately was the case in the present instance, of the depositors. The end result of the Reorganisation is that (a) Laiki Bank (which, of the two banks, was in a worse state) is now in effect in dissolution with its depositors losing all of their deposits, other than deposits below the €100.000 threshold which are guaranteed by the government, and (b) the Bank of Cyprus plc continues as an ongoing concern on a healthier basis despite its depositors having suffered substantial losses as well, the precise extent of which is yet to crystallize. Shareholders and bond holders of both banks are, in effect, losing their whole investment.
For the purpose of implementing the above measures, temporary restrictions on bank transfers and withdrawals from and within all banking institutions in Cyprus have been put in place, which are gradually being lifted.
For the latest information on the temporary restrictions on capital controls, please visit the Ministry of Finance’s website by clicking the link below:
Ministry of Finance
(B) The Corporate Sector
There has been considerable uncertainty and speculation as to whether the terms of the MOU would adversely affect this sector. Additionally, concerns have been expressed that the losses that have been suffered by depositors may be replicated in the corporate sector with the perceived risk that either the shares in Cyprus companies or the assets of such companies may be expropriated by the Cyprus government.
We consider that such concerns are completely unfounded for two main reasons:
(a) Firstly, the losses in the banking sector are not the result of any expropriation or similar action by the Cyprus government but the result of the two specific banks being insolvent and of the Troika’s decision not to bail them out by providing funds but to instead impose the bail-in on depositors.
(b) Secondly, and as elaborated on below, the framework of the corporate sector remains substantially unaffected by the final agreement reached between Cyprus and the Troika.
The agreed MOU contains provisions that solidify the position of Cyprus as an attractive jurisdiction for establishing and maintaining holding companies for the purpose of investments outside Cyprus, including, but not limited to, the Russian Federation.
In this respect, the terms of the MOU which will affect the use of Cyprus companies as part of such corporate structures are the following:
(a) The corporate tax rate will increase from 10% to 12.5%. Please note that:
(i) This provision has minimal or no impact on holding companies the profits of which are derived either from the receipt of dividends or from the sale of shares which are exempt of taxation;
(ii) The provision may have an impact on the taxation of interest received by Cyprus companies in their ordinary course of business but, even in this case, since it is only the net interest received which is taxable, the effect is minimal; and
(iii) This is still one of the lowest corporate tax rates within the EU.
(b) The special defence tax on interest payments received by a Cyprus company, other than in the ordinary course of business, is increased from 15% to 30%, noting that this in practice affects only interest received from bank deposits.
Most importantly, the MOU makes no further changes to the corporate tax regime, and, in particular:
(a) Gains of Cyprus companies from the disposal of shares they own remain tax exempt;
(b) Dividends received by a Cyprus company from a company outside Cyprus remain tax exempt;
(c) Gains from the disposal of shares in the Cyprus company remain tax exempt;
(d) Dividends received by a non-tax resident of Cyprus from a Cyprus company remain tax exempt;
(e) No levy on financial transactions is imposed; and
(f) All double tax treaties remain intact.
In light of the above, it is clear that the Cyprus government, through its negotiation of the MOU, is fully committed to preserving Cyprus as a centre for establishing holding company structures. The benefits of such a regime such as the tax free flow of dividends through Cyprus, exit opportunities offered by favourable national tax legislation and the wide network of double tax treaties, remain unaffected and, in fact, are reconfirmed by the terms of the MOU.