Cyprus: Protocol to The Treaty Between Cyprus and Russia Signed

On the 16th of April 2009, the governments of Cyprus and Russia initialed a Protocol to amend the Double Taxation Treaty (DTT) of 1998 between Cyprus and Russia. The Final version of the protocol has been signed on the 7th of October 2010. The new Protocol has received much publicity in recent months and this is not surprising since it promises to bring about changes in the current taxation regime between the two countries. Although the 1998 DTT created a reciprocal trading and investment relationship between the two Countries, Cyprus was included in 2008 in the Russian Tax Authorities "List of Offshore States" amongst 53 countries. The Russian black list essentially barred Cypriot subsidiaries of Russian Companies to obtain a tax exemption on their dividends.

The Protocol will create a better climate in the Tax authorities of both States and Russian Businesses incorporated in Cyprus will not be seen with a suspicious eye. Indeed it has been agreed by the two states that as soon as their Parliaments ratify and bring into effect the Protocol, Cyprus will be removed from the blacklist. The ratification of the Protocol will probably occur within the next few months.

Article III (Immovable Property)

Income from mutual equity funds investing only in immoveable property will now be subject to taxation as income from immovable property and not as dividends or any other income under the DTT.

Article IV (Income from International Traffic)

The Protocol has now limited the application for tax exemption to International Traffic to the Contracting State in which the place of effective management of the person deriving such income is situated. This Article applies to the international traffic of ships, aircrafts, road vehicles, charterers etc.

Article V (Dividends)

The term "Dividends" has been extended in the new Protocol to include payments on shares of mutual investment funds or similar collective investment vehicles.

Article 26 (Exchange of Information)

The Protocol has also introduced changes to the 1998 DTT in the area of exchange of information. It is noteworthy to state that the new Article 26 utilizes an identical wording with the Organisation for Economic Cooperation and Development's (OECD) Model Tax Convention on Income and Capital.

The new Article 26 will allow the Competent Authorities of the Contracting States to exchange information which is deemed relevant for the administration or enforcement of domestic laws concerning all types of Taxes, insofar as these taxation laws are not contrary to the DTT. Any information received by a Contracting State shall be treated as confidential and may be disclosed by the Competent Authorities in court proceedings. The latter change has led to widespread criticism since it is feared that it might be used by Russian Tax Authorities to obtain unscrupulous information about the Russian beneficial owners of many Cypriot Companies.

Nevertheless the new Article 26 provides certain safeguards to the application of the general rule of exchange of information. The Contracting States shall need to follow procedures of collecting and supplying information which are in accordance with their domestic laws (or the laws of the other contracting state). In the case of Cyprus Authorities, Cypriot Law 72(I)/2008 on the Collection of Taxes, provides that the Director of the Inland Revenue shall only supply foreign tax authorities (signatories of a DTT) with information if he has received substantial details about the concerned person and the reason for the requesting of information. This provision seems to have been put in place to ensure that the foreign Tax authorities do not engage in "fishing expeditions" without having any real evidence against the person under investigation. As a further control mechanism the Cypriot Law, provides that the Director of the Inland Revenue shall only supply information if he has obtained the written consent of the Attorney General of Cyprus.

The Protocol makes further provision that a contracting state authority cannot refuse to supply information merely on the grounds that it has no domestic interest in that information. A further ground of non-refusal is for information held by a bank, nominee, agency or fiduciary capacity. In addition, according to the Protocol information which could qualify as trade, business or industrial secrets will not be caught with the ambit of the Protocol. That is, this information will not be exchanged.

The general public has been fearing that there will be an abuse of power by the Tax Authorities, in the sense that they will proceed to obtain more information than authorized by the Article. Therefore it is expected that the A.G. of Cyprus will exercise his powers with great care before giving his consent.

It can therefore be argued that Article 26 on the exchange of Information will not in the end be such a powerful weapon in the hands of Tax Authorities to obtain unscrupulous information as it is often thought. The Cypriot control mechanisms we have just seen are there to ensure that no such exchange of information takes place. In the end any request of information will be a balancing of whether the requesting authorities have already sufficient information in their hands to make it reasonable for the authority supplying the information to disclose it.

Article 27 (Assistance in Collection)

A further amendment initiated by the Protocol is Article 27 which provides that Contracting States shall lend assistance to each other in the collection of revenue claims. The protocol goes on to define what can amount to a revenue claim and provides that it "an amount owed in respect of taxes of every kind" but also any "penalties and costs of collection" related to such amount.

The new Article 27 allows Contracting States to collect any owed taxes of the other Contracting state in its territory. Nevertheless the Protocol does not allow a Contracting state to initiate Court proceedings in its territory for the collection of Taxes from another state.

Article 29 (Limitation of Benefits)

Article 29 is addressed for Companies which have been incorporated in a Country other than the Contracting States. The core issue is whether this Company attempts to take advantage of the preferential tax regime of the DTT. If the latter is concluded by the Tax Authorities of both Contracting States then the DTT advantage will not be granted.

Art.VII (Gains from alienation of property)

The new provision grants the right to a contracting state to tax gains from the alienation of shares of companies the value of which is deriving by more than 50% from property situated in the other Contracting State. Alienation of shares in the context of reorganisation as well as shares in companies listed in a recognized stock exchange are excluded from this provision.

Art VII comes into effect at the time of expiration of a four-year period from the date the Protocol comes into force.


After examining the main changes brought upon by the new Protocol, the issue which needs to be addressed is the issue of substance. Substance refers essentially to how legitimate looking is a company (either holding or trading) in Cyprus. In order to add substance to such an offshore holding, providing a registered address and a local director will not suffice anymore. What needs to be demonstrated is that the Company in Cyprus has employees, busy offices, assets, real job execution, decision making and even an economic value for its Cyprus operations. Once it can be proved that the business is solid it will be difficult for the structure to be interpreted as designed solely for the avoidance of taxation.

We do not know the extent, level and timing of substance needed in current or future structures. Will it be enough to add substance to a structure just today although it existed for 10+ years in Cyprus? These are crucial issues that will be of course somehow clarified with practice down the road. However they need to be looked at now, not in 3 or 5 years. For sure, all current Russian Structures will need to be revised and possibly restructured. This needs to be done immediately and the substance requirement assessed on a case by case basis. Only on a case by case basis a tax advisor can perhaps draw some conclusions or recommendations on the extent and level of the needed substance.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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