The Cyprus bailout: will Ukraine find itself a new haven for direct foreign investments?


Financier Worldwide Magazine

May 2013 Issue

May 2013 Issue

Recently, many in Europe closely monitored events in Cyprus, the latest struggling eurozone country to be bailed out. But perhaps – other than the Cypriots themselves – none were as nervous as Russian and Ukrainian businesses. Estimates placed Russian deposits in Cypriot banks at over $30bn, with estimates of Ukrainian deposits varying from as low as $1bn to as high as $25bn. The announcement of the deal may mean that those businesses, not prescient enough to join the other holders of just over $900m in deposits withdrawn from the Cypriot banking system in the days leading up to the announcement, may ultimately face significant losses. But will this be enough to end this island’s appeal as an offshore financial centre for Ukrainian businesses? Or will Ukrainian businesses as well as other international investors continue to utilise Cyprus as a base from which to invest into, and take profits out of, Ukraine? 

Why Cyprus?

Cyprus has long been a destination favoured by businesses investing into Ukraine due primarily to the favourable double tax treaty in place between Cyprus and the USSR since 1983. Although a number of former republics, such as Russia, have since entered into new, less favourable treaties (and Ukraine has signed one that awaits ratification), the benefits provided by the USSR-Cyprus treaty for investors into Ukraine remain unmatched, with no withholding tax charged on dividends, interest or royalty payments from Ukraine to Cyprus, and capital gains not taxed in Ukraine. 

Ukrainian businesses turned to tax havens such as Cyprus out of fear over the impact that the lack of a stable rule of law, instability of the Ukrainian banking system, high taxes, lack of convertibility of the Ukrainian hryvnia and selective government support of business might have on their businesses. Cyprus, with its favourable tax regime, common-law based traditions and offshore services (such as trusts to preserve anonymity of beneficial owners) became viewed as a close and attractive jurisdiction to funnel profits from Ukrainian businesses and to eventually reinvest into Ukraine. As levels of foreign investment into Ukraine grew, Ukrainian businessmen were joined by legitimate foreign investors lured by the beneficial tax rules, with the result that Cyprus became the largest source of foreign investment into the Ukrainian economy, representing nearly 30 percent of all FDI to date. Statistics indicate that in 2012, nearly $4bn dollars were invested into Ukraine through Cyprus, accounting for nearly 65 percent of total FDI in Ukraine that year. Cyprus, coincidentally, is also one of the largest destinations for Ukrainian investment abroad. 

Trouble in tax paradise…

The troubles in Cyprus can be traced back to March 2012, when two of the largest Cypriot banks – Bank of Cyprus (BoC) and Cyprus Popular Bank (Laiki) – suffered significant losses from the haircut they took on their holdings of Greek bonds as part of that country’s bailout. These losses greatly contributed to the current financial problems of Cyprus and eventually forced it into bailout negotiations. 

On 25 March 2013, agreement was reached on key elements of a €10bn bailout package under the condition that the depositors of BoC and Laiki share a portion of each bank’s losses. Laiki will be resolved, and will transfer deposits below €100,000 to BoC. The rest of its deposits will remain with Laiki and can only be recovered (if at all) once the bank is liquidated. Deposits in BoC which exceed €100,000 will, after being set off against any loans of that depositor, be subject to a 37.5 percent haircut on the positive residual amount in exchange for shares of this bank, with certain other measures applying to the remainder of the deposits. Other than BoC and Laiki, no other Cypriot banks, or Cypriot branches of foreign banks, will be affected. 

Relatively strict capital controls have also now been put into place with virtually all money transfers out of Cyprus and within Cyprus subject to various temporary restrictions. Initially planned for one week, it is not yet clear when the restrictions – which continue to be revised – will be removed. In general, companies are now (as of 5 April 2013) allowed to carry out transactions within Cyprus of up to €25,000 daily without restriction, with payments abroad limited to €5000 per day. Payments above these caps will generally require approval from a special committee, which will take into account a number of factors. 

Cyprus is expected to implement further fiscal measures, including an increase in the statutory corporate income tax rate from 10 to 12.5 percent. Cypriot holding companies should not be affected by this measure because their dividend income and capital gains from sales of securities are exempt from this tax. In addition, Cyprus will increase its ‘special defence contribution’ on interest income from 15 percent up to 28 percent. This measure should not have any impact on Cypriot finance companies because their interest income is generally exempt from this tax.Finally, a number of measures in the areas of anti-money laundering, fiscal consolidation, structural reforms, and privatisation are being developed and are expected to be announced soon. 

Time to find a new tax haven?

The measures introduced by the bailout are unprecedented and have already sent shockwaves throughout the eurozone. Ukrainian businesses and investors into Ukraine from Cyprus may suffer from losses on deposits, shortages of available cash and/or the capital controls, each of which may impact the continuity of business transactions and may, potentially, impact upon an already weakened Ukrainian economy.

Many businesses with holdings in Cyprus now consider whether to continue working through Cyprus or to relocate to another jurisdiction. Despite what some may consider draconian measures of the bailout, Cyprus continues to be one of the most attractive low-tax jurisdictions for legitimate tax planning in respect of Ukraine. It offers attractive conditions for the placement of holding, finance and IP structures. In particular, dividends received by a Cypriot company and capital gains on the disposal of shares are not taxed in Cyprus provided minimal conditions are met. The recently introduced IP regime provides for an 80 percent exemption on profits from the exploitation of intellectual property rights. Interest and royalty profits are taxed in Cyprus at a relatively low corporate tax rate of 10 percent. Even with the anticipated increase of withholding tax rates on income paid from Ukraine to Cyprus when the new Ukraine-Cyprus double tax treaty takes effect, such rates will be low and competitive with the rates under other double tax treaties. Also, no withholding tax is paid on dividends, interest and royalties paid from Cyprus to beneficial owners that are not Cypriot residents.  

Nevertheless, the bailout measures may ultimately lead to cash outflows from the Cypriot banking system. Because Cyprus will need to find money to repay the Eurogroup in the near future, it may once again face financial difficulties. This may push Cyprus to increase its tax rates even further, which may cause even more investors to relocate to other jurisdictions. 

Whether or not companies will relocate from Cyprus may ultimately depend upon their appetite for risk. Many companies have mitigated the effects of the bailout by opening bank accounts in other jurisdictions (Switzerland, Latvia, Malta, etc.). Businesses are also considering relocating to other jurisdictions often used for tax-efficient structuring of Ukrainian investments, such as the Netherlands, Switzerland, Austria, Sweden, and the UK. 

But the viability of Cyprus as Ukraine’s largest source of FDI and as a premier offshore financial centre may be weakened by other concerns. Both the United States and the EU have begun to considerably clamp down on low-tax or tax-free zones, requiring that countries not only more tightly control their banking sectors, making them more transparent and less susceptible to money laundering, but also reduce the size of those sectors relative to their economies (the Cypriot banking sector represents roughly 700 percent of its total economic output, compared to the United States at 91 percent of GDP). Even countries in the former Soviet Union are beginning to – at least publicly – shun offshore havens, with Russia recently launching a highly publicised ‘de-offshorisation’ campaign. 

In addition, substance over form, general anti-abuse and anti-avoidance rules are becoming more important in the world economy as countries face more fiscal pressures at home. Ukrainian tax authorities now pay more attention to beneficial ownership requirements, Ukrainian courts apply the business purpose doctrine to transactions, and the Ukrainian government is preparing new transfer pricing legislation in line with recent world practice. Given this, low-tax or tax-free zones such as Cyprus may be losing their appeal for Ukrainian investors. 

Ultimately, perhaps, Ukraine itself will benefit from more money being forced back into Ukraine. But in order to truly take advantage of this unique position caused by the misfortunes of its largest investor, the Ukrainian government may need to remedy those concerns that initially forced its business community to seek havens elsewhere and undertake the various reforms that the EU and others have long been advocating.


Adam Mycyk is an international partner and Anna Iakubenko is a senior associate at Chadbourne & Parke LLP. Mr Mycyk can be contacted on +380 (44) 461 7566 or by email: Ms Iakubenko can be contacted on +380 (44) 461 7561 or by email:

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Adam Mycyk and Anna Iakubenko

Chadbourne & Parke LLP

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