Eurogroup’s decision overview

On the 25th of March Eurogroup has decided to provide financial assistance (low rated loan) to the Republic of Cyprus for its state budgetary needs (mainly for refinancing existing government bonds, which will expire in the next few years). Unlike prior decisions relating to other EU member states facing debt problems, Eurogroup deemed reasonable not to provide financial assistance for Cyprus’ two largest banking institutions, which faced liquidity and capitalization problems. Given the country’s oversized banking system (as a percentage of the country’s GDP) the Eurogroup deemed that any funding towards Cyprus for the needs of the two major banks would have made the island’s public debt not recoverable. Hence Cyprus has to adopt drastic restructuring and reorganization measures regarding its banking system.

Banking system measures
The main terms of Eurogroup’s decision in relation to Cyprus’ two major banks (Cyprus Popular Bank and Bank of Cyprus) are the following:

• Cyprus Popular Bank (Laiki) will be split up into a ‘good bank’ and a ‘bad bank’ based on the Resolution prepared by the Cyprus Central Bank.
• Deposits in Cyprus Popular Bank (Laiki) in excess of €100,000 will remain in Laiki (‘bad bank’) and will be fully subject to the winding-up of the bank.
• Deposits in Cyprus Popular Bank (Laiki) of less than €100,000 will be transferred to the ‘good bank’, which will in turn become part of Bank of Cyprus, which will continue operations as normal.
• Bank of Cyprus will be recapitalized solely by its depositors with funds exceeding €100,000. In exchange for their investment, depositors will receive premium class shares – Class A (first right on dividends and voting powers). The rate of contribution is set at 37.5% on deposited amounts over €100,000. An additional 22.5% of the deposits over €100,000 will be frozen for the next few months for any future needs of the recapitalization.
• Existing holders of Bank of Cyprus issued bonds will receive Class B and Class C shares (right to dividends after Class A shares and no voting powers). Existing shareholders will receive Class D shares (right to dividends after Class A, B and C shares and no voting powers).
• Deposits in Bank of Cyprus of less than €100,000 will not be affected by the restructuring.
• Deposits in any other banks operating in Cyprus are not affected.

Capital controls
Temporarily and in order to be able to monitor outward cash flows, which inevitably may have a negative impact on the banks’ liquidity and capital needs, the Central Bank of Cyprus and the Ministry of Finance imposed transfer/capital controls on March 28th. Gradually, these controls are being relaxed. It is worth noting that these controls only affect funds that existed in bank accounts held in Cyprus’ banking institutions as at March 28th and not any freshly received funds.

Measures regarding Cyprus tax regime
Cyprus will implement a number of measures in order to further improve its state finances and putting public finances on a sustainable path, including state employees’ salary reductions, reduced public expenditure in general and increase of retirement age. In relation to tax rates, corporate tax rate is expected to increase from 10% to 12.5% and withholding tax on interest from 15% to 30% (payable only by residents).

Comments
The Eurogroup’s decision was unprecedented and similar to no other prior Eurogroup decision for financial aid towards any Eurozone country. It is widely condemned that the decision in relation to the banks’ restructuring was unfair as the major cause of the liquidity problems and capitalization needs of the Cyprus banks was the haircut (prior Eurogoup’s decision) of Greek government bonds in early 2012 ( both banks were heavily invested in those bonds). However, it leaves Cyprus with a fully manageable public debt (maximum public debt of Euro10billion) and a sounder banking system.

While the corporation tax rate increases from 10% to 12.5%, it is still among the lowest in EU and provides the prospect of potential removal of Cyprus from many non-EU countries’ ‘tax heaven’ lists, thus opening a new window of opportunities for the international investors. We should highlight the fact that no further tax amendments affecting the use of Cyprus companies by international investors are introduced. Cyprus tax regime continues to provide for full exemption on dividends (incoming and outgoing), the new IP regime which provides for 80% exemption on profits from the exploitation of intellectual property rights is intact, the zero withholding taxes on payments to non-residents still apply, as well as the exemptions on capital gains on the disposal of shares, other securities and immovable property situated outside Cyprus. We should also note that Cyprus avoided the introduction of a financial transactions tax.

As a result, we strongly believe that Cyprus will continue to be an attractive jurisdiction for international tax planning.

We will be monitoring the developments on a continuous basis and provide our associates/clients with further updates.