The ‘golden island’

Cyprus’s status as a ‘golden island’ for foreign direct investment has been built on the foundations of a competitive tax regime and liberal investment policies. Economic growth may be forecast to slow slightly until 2009, but the fundamentals remain strong


The only cloud on the horizon is the question of whether or not the new government can find a solution to the island’s unification problem. Yet even here there is optimism, with islanders hopeful that new president Demetris Christofias will make a fresh effort to unify the Greek- and Turkish-Cypriot parts of the island, split since 1974.

Against this background of long-running political uncertainty, Cyprus has excelled economically. There is no reason to suggest this is about to change. Mr Christofias may be a socialist, but he is a modern socialist with an appreciation of the free market. He has already declared that his policies will be liberal towards international investments and that he will continue the “mixed economy” system without making any changes to the island’s tax or social system. Such liberal policies have been supported by all major parties in the last 30 years.

According to Deloitte Cyprus, which has one of the largest teams of taxation experts on the island providing a full range of business and personal taxation services, tax incentives are the most obvious attraction. But there is more to Cyprus as a destination for FDI than its high-profile fiscal perks.

After all, Cyprus isn’t the only country in the European Union that has an attractive tax regime. Why should investors choose it over, say, Jersey or the Isle of Man?

Different philosophies
Pieris Markou, the head of tax services at Deloitte Cyprus, points out that the Channel Islands and Isle of Man have a completely different philosophy to their tax systems. They offer complete tax exemption but no double tax treaties or any other international investment agreements. Cyprus, on the other hand, offers not only the lowest corporate tax rate in Europe –along with Bulgaria – of 10 percent, but a low tax system that can be combined with double taxation agreements, other international investment agreements and, since accession to the EU, with various EU directives.

These unique combinations offer tax advisors the opportunity to use Cyprus in many international tax structures to effectively reduce a multinational’s tax burden. They also mean Cyprus has become an efficient jurisdiction for routing investments in the EU by third country multinationals, or for investing outside the EU by member state multinationals.

Hardly surprising then that since its accession to the EU Cyprus has been characterised by many as “the gateway to Europe”.

Foremost amongst the island’s tax breaks is that low tax rate, which applies to all companies irrespective of their ownership or business activity. Other tax advantages include:

Holding companies
As long as a number of straightforward conditions are met, dividends received by a Cyprus holding company from overseas participations are exempt from tax.

Financing operations
A Cyprus company acting as an intermediary between a holding and an operating foreign company can finance the foreign company through interest bearing loans using the Cyprus treaty network or EU directives. This results in a “double dip” effect with interest being deductible in the operating while also escaping taxation in the ultimate recipient’s jurisdiction. A small margin is taxable in Cyprus at the rate of 10 percent.

Royalty income
A Cyprus company acting as an intermediary between an overseas licensor and a foreign company in a treaty location or in the EU can reduce taxable profits in the operating location.  A small margin will be taxable in Cyprus at the rate of 10 percent.

Exemption from capital gains tax
No tax is imposed on any profit from the disposal of securities, irrespective of the length of ownership or percentage participation.

Treaty network
What distinguishes Cyprus from most other international business centres is its extensive network of double taxation treaties. The island has these treaties with 43 countries. Most treaties provide for reduced rates of withholding tax on dividends, interest and royalties paid out of the treaty country, or the avoidance of double taxation if a resident in one of the treaty countries derives income from another treaty country.

Withholding taxes
There are no withholding taxes on payments of dividends, interest and royalties to non-residents, irrespective of whether the recipient is a corporation or an individual.

Another new measure that has been introduced is a residency based taxation system which states that a company is considered a tax resident in Cyprus if it is managed and controlled in the island. In practical terms, management and control is usually interpreted to mean management of the company at its highest level, which is the board of directors. International investors who want to ensure compliance with this requirement can either appoint local directors or set up a fully fledged office in Cyprus, also relocating key personnel to the island.

This attractive tax regime is backed up by liberal policies on FDI that are designed to promote the island’s growing services sector. After tourism, the financial and professional services sector is the next most important source of revenue for the Cypriot economy.  According to Deloitte, having a liberal FDI policy promotes the services sector, which increases demand for services and in turn increases local employment and wealth.

The ‘spin-off’ benefits are significant, Mr Markou says. “This increased demand for services has encouraged the service providers in general to improve their product in terms of quality and efficiency. This can only be for the good of the Island as a whole.”

Because it has been able to demonstrate a stable financial and business-friendly environment since the 1970s, Cyprus has attracted significant foreign investment and capital flows for decades. But the island’s policy-makers have not sat back and happily watched FDI inflows grow. Reforms have been carried out, most notably as part of the island’s preparation for EU accession in 2004. Cyprus harmonised its financial and regulatory environment with that of the EU. A general tax reform came into effect on January 1, 2003 to align the Cypriot tax system with European principles of equality and to demonstrate a commitment to the Organisation for Economic Cooperation and Development (OECD) against harmful tax practices.

Equity participation
FDI policy has been liberalised for both EU and non-EU nationals in another significant way, says Mr Markou. Foreign investors can participate in most sectors of the economy with equity participation of up to 100 percent, without a minimum level of capital investment. This means foreign companies can invest and establish a business in Cyprus on equal terms with local investor.

The government also says administrative procedures have been simplified and measures have been taken to streamline the infrastructure regarding foreign investment, reducing the level of bureaucracy.

EU membership has given impetus to the island’s many reforms. As an EU member, Cyprus has entered what Mr Markou calls “a new era” as an economy offering a great number of advantages within a common European market. The euro was adopted by Cyprus as its unit of currency on 1 January 2008, further confirming the country’s macro-economic stability and its commitment to low inflation, low interest rates and high growth.

“I am confident that the impact of the euro can only be viewed positively by the foreign investor,” says Mr Markou. “It means an investor can put more trust in the socio-economic environment with minimum surprises as regards the kind of economic policies that can influence market conditions existing at the time the decision is taken to invest.”

“With globalisation, every piece of certainty that can be achieved is a plus for the international investor. Being part of the European economic family takes away a certain element of uncertainty in the macro-economic policies of the country and this can only be to the benefit of the international investor.”

If evidence of the success of Cyprus’s fiscal policies were needed, it comes in the form of new company registrations. More than 20,200 new companies set up shop on the island in 2006, rising to 29,016 in 2007. This is a trebling in the number of new company registrations in the last three years and the trend is continuing.

Mr Markou says there is a notable increased confidence in the use of Cyprus in international tax planning, especially from the European and US investors who are finding that using a company registered in the EU carries advantages that cannot be found in jurisdictions with similar tax benefits, but lack the EU identity.

And it’s not just corporations that benefit from moving their operations to the island. The benefits of an individual becoming a resident in Cyprus, either for employment or retirement purposes, are numerous. New residents are attracted by the Mediterranean lifestyle combined with a high standard of European infrastructure. There are also social benefits for residents, including low housing and education costs, and low crime rates.

Insurance contributors
From an economic viewpoint, the top marginal tax rate for employees is 30 percent and social insurance contributions are 6.3 percent. Both rates are highly competitive compared to other European countries.

For retirement purposes, Cyprus residents enjoy a low rate pension tax of 5 percent, whereas any interest or dividend income received would be subject to 10 percent and 15 percent tax respectively. Cyprus has no inheritance taxes, capital gains taxes (on property situated abroad), or transfer and exit taxes.

Yet it’s tourism that remains the primary source of revenue for the Cypriot economy, and the tourism sector has proved vulnerable during recent years. However, FDI acts as a cushion against swings in tourist arrivals, and revenue generated through the financial and professional services sector acts as “a stabiliser” on the economy.

“The government, together with the private sector, is making every effort to improve the service industry in Cyprus,” says Mr Markou. “The government recognises that this is the future of the Cyprus economy.”

Indicative of this is the recent setting up of the Cyprus Investment Promotion Agency, which combines the efforts of the private and public sector in promoting Cyprus as an international service centre. It is important to note, says Mr Markou, that all professional service providers in Cyprus employ qualified personnel educated mainly in the UK, the US and Greece. Accountants and lawyers employ qualified personnel from the UK and US professional bodies, while the professional services industry is self regulated and offers close quality control monitoring to ensure the standard of quality of services offered.

The only unanswered question about Cyprus is whether or not a solution can be found to the unification question. For the international investor community, is a solution even necessary?

“Political stability within a chosen jurisdiction is important to the international investor,” says Mr Markou. “Cyprus joined the EU without being subject to any restrictions about resolving the Cyprus problem. That said, a solution would remove any remaining uncertainties international investors may have and would act as a springboard to new challenges.”

Pieris Markou is the head of tax services at Deloitte in Cyprus. He is a fellow member of the Institute of Chartered Accountants in England and Wales, a member of the Chartered Institute of Taxation, IFA and STEP.  He is also an active member of the Institute of Certified Public Accountants of Cyprus, currently serving as Chairman of the Tax Committee, participating in a number of meetings with the Minister of Finance, the House of Representatives and the Tax Commissioners for the formulation of the Government’s policies on taxation. Pieris specialises in local and international taxation.

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