Amendments to Tax Treaty with Cyprus

Russian Government has submitted the Protocol amending the Russia-Cyprus Double Tax Treaty to the State Duma for ratification. It was signed on October 07, 2010 during the visit of President Dmitry Medvedev to Cyprus. The Protocol seeks to tighten rules on tax breaks and information exchange.

Thus, the Protocol introduces the article ‘Limitations of Benefits’ allowing the Cypriot authorities to refuse tax benefits where ‘it was established … that the main purpose (or one of the main purposes) of the creation or existence of such resident was to obtain benefits’.

Article 26 (‘Exchange of Information’) of the amended treaty will extend the exchange of information between the countries to tax violations, not just to information about taxes as it is currently the case. Banks and other financial institutions, nominee shareholders, agents and trustees will not be able to refuse giving information to the authorities.

The amendments will come into force on January 1 of the year following ratification

The upcoming changes will not come as a surprise to Russian beneficiaries using Cypriot companies for tax optimization. Cyprus has long ceased to be a ‘classic’ offshore, so that entrepreneurs had either stopped using Cypriot companies and moved to more convenient jurisdictions (like i.e. British Virgin Islands, Hong Kong, Bahamas) or optimized the ownership structure for Cypriot companies making themselves virtually invisible to Russian tax authorities. Today it is almost impossible to find a Cyprus company directly owned by Russian beneficiaries. As a rule, entities from the countries whose legislation does not provide information about ultimate beneficiaries act as nominal owners of Cypriot companies (for example, companies incorporated in BVI).

New article ‘Limitation of Benefits’ implies that Cyprus companies must give evidence of some activity on the territory of Cyprus. We can expect that in many cases such activity will be carried out only for show.

Changes related to the possibility of Russian and Cyprus authorities determining the place of effective management

of an entity, in our opinion, are more serious than others.

The amendments to the agreement do not define the list of documents / grounds that would unequivocally determine the place of effective management which creates a situation of uncertainty for Russian beneficiaries.

Additions to the article 26 (‘Exchange of Information’) in our opinion are of little practical significance for Russian beneficiaries who use a complicated corporate structure for their businesses comprised of not only Cyprus companies but entities in other offshore jurisdictions. Obviously, tax control and supervision will be limited to Cyprus and Russia.

This can only contribute to gradual move of assets to more ‘loyal’ jurisdictions. Moreover, the possibility of effective exchange of information between tax authorities is, in fact, limited to certain bureaucratic procedures. Cyprus has no obligation to assist in the following cases:

  • when Russian tax authorities failed to take all reasonable steps at their disposal in accordance with the law or administrative practice to ensure the recovery of tax;
  • when the administrative costs born by Cyprus are clearly disproportionate to the benefits that the Russian Federation can get as a result of such actions.

Thus, Cyprus has yet to be sure that the Russian tax authorities have taken all possible steps to recover taxes. We can expect that this new article will be followed by the establishment of certain procedures that would determine the execution of queries for exchange of information.

Muranov, Chernyakov & Partners