Cyprus' special relationship with Russia has been rocked by its exposure to the eurozone crisis – and Luxembourg is perfectly positioned to step into the breach, says Simon Dinning
The financial crisis in Europe has been a constant in the news for longer than many of us would care to remember. The near financial collapse of Cyprus, developed primarily as a result of its exposure to Greece, is the latest highly publicised example of a wholly unstable economy and a country in political disarray.
Described by some members of the Cypriot parliament as the "enslavement deal", parliament in Cyprus has recently approved the country's international bailout after warnings that the alternative would indeed be financial collapse. MPs voted through the loan package by 29 votes to 27. The small eurozone state secured a loan package worth €10bn (£8.5bn) from its EU partners and the International Monetary Fund. In return it must raise €13bn (£11.1bn), largely through banking reform. This has created huge divisions in the country's representative house, where no one party has a majority.
The link between Russia and Cyprus has existed for many years and is one of convenience for the Russian market. While the double taxation arrangements between the countries are the main reason for Russian business flowing through Cyprus, there are many softer issues that have sustained the relationship. Proximity, "ease of doing business" and the ability of a number of service providers to speak the language has certainly assisted relations.
However, the depth of the crisis and the fact that it has shown not only extreme economic difficulties but also political division has left the financial services world concerned about whether the Cypriot offering is sustainable or secure. Certainly the idea of sending physical money through the Cypriot banking system seems unlikely in the medium (and perhaps longer) term but many are also questioning whether structuring through the jurisdiction is advisable. These factors, aligned with general concern over reputational issues in Cyprus have left them with a very challenging financial services model.
In the Russian market in particular, there are a range of views across the spectrum on this. Some believe that the double taxation agreement (DTA) will mean that Cypriot special purpose vehicles continue to be used. Some see Cypriot vehicles being used purely for tax structuring with no significant business or shareholder arrangements at the Cypriot level. Most suggest that they are actively looking for an alternative to Cyprus as a result of both political and economic instability and reputational risk.
So what are the alternatives? The answer depends to some extent on what role the vehicle needs to play in a structure. For pure holding companies or joint venture entities, both the British Virgin Islands (BVI) and Jersey are widely used in the Russian market already.
It is common to see a chain with Russian assets, moving up to a Cypriot company and then a BVI entity on top. For some of the larger transactions, particularly where European money is invested, Jersey may take the place of the BVI.
The BVI and Jersey are both termed tax neutral jurisdictions. Neither has a DTA with Russia but these jurisdictions can ensure that there is no additional tax leakage. The flexibility of the corporate legislation in both domiciles makes them exceptionally attractive structuring options.
In looking for a tax favourable alternative to Cyprus, Luxembourg emerges as a leading contender.
Why Luxembourg?
A founder member of the European Union benefiting fully from free movement of capital and freedom of establishment within the EU, Luxembourg is also one of the largest global financial centres, with flexible and attractive legal, regulatory and tax regimes and a significant concentration of professional service providers to the financial services industry.
Luxembourg's sophisticated financial services infrastructure, global brand recognition, full EU single market access and extensive double tax treaty network has also lead to its development as a core jurisdiction for investment structures.
This has resulted in the domiciling of several tens of thousands of holding companies, many of which form part of globally recognised corporate groups, or hold the portfolio investments of leading international investment funds. Luxembourg'ssecuritisation vehicle forms a third principal pillar of its financial services sector.
As a leading global jurisdiction for the establishment and management of investment vehicles, Luxembourg has demonstrated one of the most solid track records for stability in relation to the challenges arising in global markets since 2008 with a triple A credit rating, low levels of sovereign debt and one of the highest per capita GDP globally. This economic and political stability, allied to the legal, regulatory and fiscal attributes of its financial services industry has resulted in Luxembourg's position as a premier-ranking global fund domicile.
It was interesting to read in the Russian newspaper Pravda in May of this year that "Luxembourg is a state that ranks third on the total volume of investment in the Russian economy. Luxembourg has invested €28bn (£23.8bn) in Russian projects, while Russia's investment in the economy of the Duchy makes up only €4.4bn (£3.7bn). Luxembourg enjoys great popularity among wealthy Russian, Kazakh and Ukrainian businessmen." The links are clearly well established and there is a determination by Luxembourg to act as a platform for Russian capital.
On 21 November 2011, Russia and Luxembourg amended their double tax treaty of 28 June 1993 (the DTT) with the signature of a new protocol. The protocol was ratified by Russia on 2 January 2013. It will enter into force after Luxembourg has completed ratification procedures under its domestic law. This is anticipated to be in 2014.
The tax position, coupled with political stability, make Luxembourg a prime location for Russian companies to conduct international business across European markets. In particular, Russian entities seeking investment in the global marketplace will see investors easily able to get comfortable with the use of Luxembourg vehicles.
While Luxembourg cannot match Cyprus from a tax perspective at the current time, it is nevertheless more advantageous than a number of other jurisdictions and we are finding that many clients would prefer the certainty that comes with Luxembourg to the vagaries of Cyprus.
Recent Fitch analysis (May 2013) noted that while Luxembourg is a small European country with a large banking system, that is where its similarity to Cyprus ends. Fitch stated that not only has Luxembourg got healthier banks and a stronger sovereign than Cyprus, the structure of their financial sector means it is less vulnerable to a destabilising withdrawal of non-resident deposits and losses from foreign exposure.
In short, Luxembourg is not the next Cyprus – a key factor when considering other contending jurisdictions.
Simon Dinning is a partner at Ogier.
http://www.legalweek.com/legal-week/analysis/2275388/russias-new-ally-why-luxembourg-is-perfectly-positioned-to-form-a-special-relationship-with-russia
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