Olivier Sciales, founding partner, Chevalier & Sciales

Luxembourg offers east Europeans and Russians additional structuring options

Prospects are clouded for Cyprus as a domicile for investment and transaction structures set up by entrepreneurs and investors from Russia and other eastern European countries such as Ukraine following a levy on bank deposits and capital controls imposed by the government as part of a package of measures to stabilise the country’s banking sector, says Olivier Sciales, founding partner, Chevalier & Sciales…

However, east European investors unsure about the long-term future of Cyprus as a financial centre have a choice of other jurisdictions within the European Union through which to channel investments either into EU countries or back into Russia.

One of them is Luxembourg, which has extensive financial services experience, expertise and infrastructure, in addition to political, economic and financial stability, a broad range of structuring vehicles and an extensive network of double taxation treaties.

In the face of questions about other EU member states where financial services represents a large proportion of economic activity and is dominated by international rather than domestic business, Luxembourg has emphasised the multi-dimensional nature of the financial services it offers.

Far from being dominated by private deposits, the balance sheets of its banks reflect the largely institutional nature of Luxembourg’s financial industry, including the provision of services such as custody to an investment fund sector with _2.4 trillion in assets under management.

The country has one of the lowest ratios of sovereign debt to GDP in Europe at just over 20%, and its AAA sovereign debt rating was recently reaffirmed by Standard & Poor’s. Its GDP per capita was the highest in Europe in 2012 and second highest in the world. It also enjoys the benefits of a diversified economy including manufacturing industry, steel production and telecommunications and broadcasting services.

The issue of legal and financial stability has become a more important criterion for investors from eastern Europe as they ponder how to manage existing investments and consider the structure for future ones.

Cyprus has long been popular with business people from the region; an estimated 40,000 Russians have residency on the island, and Russian-owned businesses include law and accountancy firms. Underpinning the ties between the two countries is their double taxation agreement, which has helped to make the Mediterranean island the largest source of direct foreign investment in Russia.

However, Russians that have used Cyprus as a business base have said their confidence in the country’s financial and legal systems has been undermined by the crisis. And its political fallout could even affect the double tax treaty, which Russian Dmitri Medvedev has threatened to terminate in retaliation for a planned levy on bank deposits. At least 20% of the funds in the Cypriot banking system are estimated to be of Russian origin.

Under the bailout deal agreed on March 25 by the Cyprus government with the European Commission, the European Central Bank and the International Monetary Fund, uninsured deposits (greater than _100,000) with Popular Bank of Cyprus (Laiki) and Bank of Cyprus will be subject to the compulsory levy.

Bank of Cyprus depositors could lose up to 60% of their savings in excess of _100,000 under the restructuring plan, which is part of the island’s contribution to the cost of rescuing its banking system.

According to the country’s central bank, 37.5% of deposits over 100,000 euros will be converted into Bank of Cyprus shares, while up to 22.5% will go into a fund paying no interest and may be subject to further write-offs. The other 40% will earn interest, but it will only be paid if the bank performs well. Losses could be up to 80% for depositors with Laiki.

Foreign investors that conduct business through Cyprus may also be affected by some of the temporary measures put in place by the government to prevent a bank run and capital flight when the country’s banks reopened for business on March 28 after a two-week shutdown.

Payments outside the country have been limited, with a _1,000 cap initially set on cash that can be taken abroad for each journey, a limit of _5,000 plus tuition fees per quarter on transfers to Cypriots studying abroad, and a _5,000 per person monthly maximum for credit and debit card transactions in other countries.

The capital export controls and limits on domestic cash withdrawals and other transactions were initially announced as lasting a week, but analysts believe some measures could be in force for at least a month and possibly longer.

While the measures are designed to restore stability and confidence to the Cyprus financial system, investors from eastern Europe are likely to be looking at a full range of options structures for conducting cross-border investments. This may be particularly the case for investors that are establishing international structuring arrangements for the first time.

Because of the stability of its finances and tax system, and the legal certainty it offers, Luxembourg is already a jurisdiction favoured by non-EU entrepreneurs and investors to make investments either within the union or in other non-European countries, using financial participation companies (soparfis) as holding and financing vehicles.

Soparfis may benefit from the participation exemption, which exempts dividends and liquidation proceeds received by a Luxembourg company from fully taxable subsidiaries, as long as these are EU-domiciled companies that benefit from the parent-subsidiary directive, or non-EU companies subject to a minimum statutory income tax rate of around 10.5 per cent.

The exemption is subject to conditions including a minimum participation size in terms of percentage stake in the subsidiary or acquisition price in cash terms, and a minimum holding period of 12 months for dividends, liquidation proceeds and capital gains to benefit.

Luxembourg does not impose a withholding tax on dividends paid by a Luxembourg holding company to a parent in another country, such as Russia or Ukraine, that is subject to income tax comparable to the grand duchy’s corporate tax. The tax authorities generally accept as comparable a statutory minimum tax rate of 10.5 per cent in the jurisdiction where the dividend is paid.

Other benefits of structuring international investments through Luxembourg include its broad tax treaty network, which comprised active treaties with 64 countries and 32 awaiting full ratification as of March 21, as well as highly flexible thin capitalisation rules.

Another attraction of Luxembourg for investors from eastern Europe is its intellectual property regime, under which 80 per cent of income derived from IP rights acquired or created by a Luxembourg company and gains from their disposal is exempt from income tax. The regime, which covers net income derived directly or indirectly from software copyright, domain names, patents, trademarks, designs and models, reduces the effective tax rate to less than 6 per cent.

These advantages ensure that even amid a lack of financial stability and legal certainty in Cyprus, investors from Russia, Ukraine and other countries still have a range of options for structuring assets and transactions in the EU in an advantageous manner.

 

For any query, please contact:

Olivier Sciales
Chevalier & Sciales
Partner
Route de Thionville 512611 Luxembourg

Office: + 352 26 25 90 30
Fax: +352 26 25 83 88

 

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