For many years, Cyprus has been a shelter for investors looking to take advantage of the sun, sea and favourable corporate tax regime. However, in light of the Cypriot banking crisis of March 2013, and the measures imposed by the Eurogroup, IMF, Cypriot Central Bank and Cypriot government, investors may be forced to look to fairer climes.
Roadmap to recovery
Since the measures were imposed by the Cypriot government and Eurogroup, IMF and Cypriot gentral bank to prevent economic turmoil in late March 2013, there have been gradual attempts to ease a number of these restrictions. In order to achieve this, Cyprus has been following a roadmap to recovery. It is widely reported that the Cypriot government aims to lift most of the capital controls by early 2014 – which would be some turn around considering the banking system was near collapse nine months earlier.
That is not to say that there will not be a few bumps along the way. With recession biting in Cyprus, we would expect to see outbreaks of so-called ‘zombie companies’ that plagued the UK press not so long ago. These companies have enough money to meet their immediate needs, such as paying their employees, monthly rent payments and interest on their loans, but they do not have enough money to clear their debt, invest or innovate. Clearly with capital controls and restrictions on what business can and cannot do this could lead to economic stagnation in Cyprus.
Moreover, while the Cypriot government intend to lift most of the currency controls by early 2014, this does not extend to the prohibition on certain payments and transfers to accounts outside of Cyprus. In our view, this restricts the ability of companies based in Cyprus to trade on an international platform. As a consequence, this may lead to high profile disputes with the Cypriot Government; or an outflow of large international companies from Cyprus to other tax friendly jurisdictions such as the British Virgin Islands, Luxembourg, or Switzerland.
So, what does this mean for Russian/CIS investors?
The long-standing double taxation treaty between Russia and Cyprus, alongside the 10 per cent corporate tax rate, has proved an attractive prospect for many large Russian/CIS companies who would otherwise be paying high corporate tax rates at home. Furthermore, with a legal system based on the English common law system, Cyprus offers a flexible alternative to more rigid Russian/CIS corporate legislation. As a result, many large Russian/CIS companies incorporated their holding companies in Cyprus to obtain the full benefit of the jurisdiction.
With strong ties between the Cypriot legal system and English legal system, Russian/CIS holding companies incorporated in Cyprus have commonly elected to have their agreements governed by English law with English dispute resolution clauses. English law does not apply as a matter of course. However, it will apply where the parties have agreed to submit to English law at the time of entering into the contract.
Not only does the English legal system offer flexibility but also confidence in the integrity of the judiciary, an on-going duty to disclose documents (which advances a fair playing ground for disputes), and a wealth of interim remedies such as injunctions, freezing orders and search orders.
As a result of the measures imposed by the Eurogroup, IMF, Cypriot Central Bank and Cypriot Government, it is inevitable that Russian/CIS companies consider their legal position in relation to these measures and consequently disputes will arise. In light of the ties with the English legal system, the English courts could see a number of claims against these institutions for breach of contractual duty, breach of free movement of capital and payment, negligence of the banks, their directors, auditors and advisors, and expropriation, among other things.
However, in our experience of international dispute resolution, whether or not Russian/CIS companies choose to litigate these grounds is a different question. With a long-standing Russo/CIS-Cypriot relationship at stake, and question marks over the correct forum for the dispute, and public policy, litigation is a very risky option. However, that is not to say that these points of action cannot be used as a commercial bargaining chip between Russia/CIS and Cyprus for commercial transactions in 2014 and beyond.
Time to pack your bags?
With the Cypriot economy proverbially on the rocks, Russian/CIS companies based in Cyprus may consider moving to alternative tax friendly jurisdictions. Traditionally, the stability of the British Virgin Islands, Luxembourg, or Switzerland have proved favourable, however the emergence of Bulgaria and Latvia may prove an option closer to home.
However, in our opinion, the Cypriot banking crisis will not leave the island deserted. While the 9.9 per cent levy on deposits over €100,000 will certainly have hit local business and investors hard, the creative and complex structuring of many international holding companies means that they would not have felt such an impact.
Furthermore, in light of the fact the corporate tax rate stands at 12.5 per cent (a 2.5 per cent increase but still considerably lower than the majority of jurisdictions) and the double taxation treaty with Russia is still in place, it seems clear that Cyprus still has a huge amount to offer investors.
The future of the Cypriot business environment depends on whether Cyprus can restore confidence in the banking system and stabilise the economy. If investors decide to pursue litigation in the English courts, they should consider the commercial reality of pursuing such an action, alongside the potential difficulty of enforcing any order or award granted, from the outset.
Meanwhile, in our experience, there is no place like home for many holding companies. Provided that Cyprus maintains its corporate friendly status it should remain a favoured destination for holding companies in years to come.