The service sector, mainly tourism and financial services, dominates the economy; erratic growth rates over the past decade reflect the economy's reliance on tourism, which often fluctuates with political instability in the region and economic conditions in Western Europe. Offshore banking in the region however is secure and reliable.
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In 1975 the Cyprus Government began to create a welcoming regime for offshore companies. Due to Cyprus's particularly favourable tax treaties with Russia, the CIS and the countries of eastern Europe, the island is chosen by a high proportion of firms needing to set up an offshore base as a holding or investment company, or trading subsidiary, for those regions. Among emerging markets there are also favourable tax treaties with China, India, South Africa and a number of Middle Eastern countries.
In July, 2002, as part of the Income Tax Act No. 118(I) of 2002, Parliament approved a uniform 10% corporate tax rate, to apply to both onshore and offshore companies, plus a 2% levy on wage bills (meant to subsidise pensioners), and a 'Special Contribution' related to defence which in effect applies the 10% corporate tax rate to inter-company dividend and interest payments. However, the rules are complex.
The 10% corporate tax gives Cyprus one of the lowest rates in the EU, alongside Ireland (12.5%), with the exception of the Isle of Man, Jersery and Guernsey, which have all announced (but since decided to reverse) a nil rate - but these islands are not in the EU anyway for most purposes.
The new regime introduced a 'residence'-based system of taxation, and was in operation from 1st January 2003.
The remainder of this section describes the most important types of international business activity carried out from the island. As far as the taxation of offshore companies is concerned, it is now of mainly historical interest, although existing companies were allowed to opt to continue the 4.5% 'offshore' taxation level through 2006. In other respects the sectors described are ongoing.
For further information about the taxation of companies in Cyprus under the new regime.
Cyprus Trade Marketing & Distribution
Cyprus's taxation regime doesn't stand out particularly among its offshore competitors, but the island does have some considerable advantages, including its geographical location, its network of double tax treaties(especially those with the CIS and Eastern Europe), and its relatively sophisticated, European business environment.
Thus, a substantial number of companies involved in the trading or distribution of FMCG and other physical goods use Cyprus as a trading base for the Mediterranean, Middle East and North African region. Non-resident enterprises (ie those neither 'managed and controlled' nor with a local permanent establishment) are allowed to store, maintain, break bulk or re-package their own transit goods in bonded warehouses, providing the handling doesn't result in any change of customs' tariff classification. They are also permitted to conduct sales activities on the island, as long as no local deliveries result, and no permanent establishment is created.
Cyprus is not a particularly convenient base for supplying the CIS and Eastern Europe in physical terms, but that does not prevent companies with interests in those regions from establishing holding companies in Cyprus, and very many do so. Not only are the Cyprus treaty withholding tax rates normally lower than those in other countries' treaties, but there will be no local taxation as long as no permanent establishment is created, and even if it is, Cyprus's own 10% tax rate on company profits is itself low. The combination is quite hard to beat; see below, Financial Holding and Investment Activities.
Along with other low-tax jurisdictions, Cyprus is a suitable place in which to base e-commerce services for retail or wholesale distribution of material or non-material goods: see Offshore-e-com.com for extended descriptions of how such businesses can take advantage of the combination of offshore and e-commerce.
Cyprus Licensing, Royalties & Franchising
A frequent feature of international trade and investment, particularly as between advanced and less advanced countries, is the transfer of technology or 'brand' or intellectual property in return for license, franchise or royalty payments. Due to its network of double-tax treaties and favourable taxation regime, Cyprus is a suitable place in which to locate an intermediary company to handle payments streams which might otherwise be highly-taxed in the receiving country.
Such payments would normally be deductible expenses in the originating country, and under the tax treaties will be subject to low or zero withholding tax (Central and Eastern Europe, China, India, South Africa and a number of Middle Eastern countries). At worst, the income received in Cyprus will be taxed after deduction of expenses at 10%. See below under Financial Holding and Investment Activities for comments on the tax treatment of repatriated Cyprus profits in Western countries.
Cyprus Financial Holding & Investment Activities
Many international investors choose Cyprus as the location for financial holding and investment companies, due to the island's combination of tax treaties and low-tax regime.
Investment into Central and Eastern European countries and a number of Middle Eastern countries, as well as India, China and South Africa, benefits from low treaty withholding tax rates. Often it would be best for the investment to have a high debt component, since the interest is normally a charge against profit in the destination country, and there is a low or zero withholding tax on interest payments. There is no case in which the withholding rate on dividends is less than the rate on interest payments, and it is sometimes more. The old Russian treaty had zero withholding on both counts, but the new treaty has 5% withholding on dividends.
Whatever the mix of interest and dividends, the income once in Cyprus will in the worst case be taxed after deduction of expenses and attached tax credits at 10%.
Under the new regime, from 2003 dividend income from abroad is untaxed in most cases. While a few Western countries have lower withholding rates than Cyprus in their treaties with Central and Eastern European states, none competes on profits tax rates. Profits can then be retained or distributed without further taxation.
Distributions to some countries benefit from tax-sparing credits; US investors will be able to mix low-tax Cyprus income with high-tax income, avoiding wastage of tax credits; and even for countries like the UK which have rules on the attribution of profits from Controlled Foreign Corporations there are benefits to be got from careful planning of international financing structures.
As part of Cyprus's accession to the EU, companies and individuals giving investment advice now come under the supervision of the Securities and Exchange Commission (SEC). Local investment companies such as brokerages and banks are however able to compete in the financial services single European market. The new regulations cover a multitude of investment services including brokers acting on their clients' or their own behalf and portfolio investment managers among others, and identifies which companies are permitted to offer such services. In addition, it is compulsory for local finance service providers to contribute to a compensation fund for investors; foreign advisors on the Island can make voluntary contributions.
Cyprus Offshore Banking Unit
An Offshore Banking Unit (now known as an International Banking Unit - IBU) is a Cypriot limited liability company, or a branch of a foreign bank, which has obtained a banking license from the Central Bank. In Cyprus, non-Cypriot banks are offered the status of IBU, being restricted to banking operations with non-residents in foreign currencies, and with Cyprus-registered non-resident companies and their expatriate staff. The Central Bank issues IBU licenses and normally requires fully-staffed operation. If the IBU is controlled from abroad, and there is no local permanent establishment, there will be no profits tax.
The following forms are permitted:
Branches of foreign banks
The Central Bank favours this arrangement; there are no liquidity or risk ratio requirements, and there is no reserve requirement.
Subsidiaries of foreign banks
These are supervised more closely, and liquidity and risk ratios may be imposed.
Representative Offices
Representative Offices may be formed under the Companies Law, but may not conduct banking business except with clients of their parent bank.
Administrative Banking Units (ABUs)
These units carry out their banking business through local Cyprus banks but are otherwise similar to branches or subsidiaries.
Commercial banking arrangements and practices follow the British model.
Cyprus Offshore Financial Services Company
An Offshore Financial Services Company (OFC) used to be an offshore company which engaged in any of the following:
dealing, buying, selling, subscribing to or underwriting investments
managing investments belonging to other persons
giving investment advice to actual or potential investors
establishing collective investment schemes
The usual Central Bank vetting process for offshore companies also ensured that prospective OFCs were linked to existing investment or financial services companies in well-regulated (meaning in practice, high-tax) countries, although exceptions were made for the internal financial services of respectable companies. The Central Bank imposed additional conditions on OFCs, and usually requires a 'Letter of Comfort' from the foreign parent or associate.
In 2001, as part of preparations to join the EU, Cyprus began to construct a modernised regime for mutual fund operation. The Cyprus Mutual Fund Law came into force in March, 2003, allowing both native and foreign firms to offer mutual funds to Cypriot residents.
The new law, the International Collective Investment Schemes Law No. 47, offered many benefits to international mutual funds.
“Our objective is to upgrade the depth and breadth of the offshore financial sector,” Andreas Philippou, chief senior manager of the Central Bank’s Banking Supervision and Regulation Division, announced at the time.
“Previously, mutual funds took advantage of low taxes through the feeder funds,” he adds. “Now we want the funds themselves to be domiciled in Cyprus.”
It was decided by the SEC that prospectuses can be written in English, though the rules required that a potential purchaser of the fund has a sufficient enough grasp of the language to understand the implications of buying into the fund.
The major objective of the new law is to provide transparency in the market place. All funds have to publicise their bid/offer rates and make clear commissions and costs in their promotional literature.
The Central Bank of Cyprus (Bank) which is the regulatory and supervisory authority for Schemes, their managers and trustees, may upon a written application, recognise a company incorporated under the Cyprus Companies Law, a trust created under the International Trust Law or a partnership registered under the Partnership and Business Names Law, as an International Collective Investment Scheme.
Under the new legislation, therefore, a Scheme may take one of the following forms:
All four legal types of Schemes, can either be of limited or unlimited duration.
A Scheme, once recognised, may be designated by the Bank as:
A Scheme to be marketed to the general public;or
A Scheme to be marketed solely to experienced investors; or
A private international collective investment scheme.
A manager of a Scheme must be approved by the Bank. In this respect, a manager must on an ongoing basis, satisfy, among other, the Bank that, having regard to the investment policy and the particular investment objectives of the Scheme for which it acts as manager that it has sufficient financial and operational resources at its disposal to meet its liabilities, as well as sufficient investment expertise to conduct its business effectively.
Trustees of Schemes must also be approved by the Bank. Under the Law, only the following can act as trustees of Schemes:
A Cyprus local or international bank or an overseas bank established in a jurisdiction which in the opinion of the Bank exercises adequate banking supervision and which has such minimum paid-up share capital as the Bank may from time to time prescribe; or
A local or international or an overseas professional trustee company which is adequately supervised and which has such minimum paid up share capital as the Bank may from time to time prescribe; or
A company incorporated in the Republic, which is a subsidiary of a person referred to at (1) and (2) above, provided that its liabilities are fully guaranteed by that person.
Every Scheme, its manager and trustee are subject to on-site inspections by the Central Bank of Cyprus. In addition, the Bank may, under certain circumstances, apply to the Court in order to appoint an inspector to investigate the affairs of the Scheme, its manager or trustee, or any associated undertaking of any of the aforementioned.
Every Scheme, its manager and trustee are also subject to off-site monitoring and are, therefore, required to furnish the Bank with such information and returns concerning the business of the Scheme, its manager or trustee as the Bank may specify from time to time.
Cyprus Offshore Company