As of October 2015, the island of Cyprus officially lost its status as a tax haven when the Organization for Economic Cooperation and Development (OECD) declared the country, along with Luxembourg and Seychelles, had been found to be largely compliant with standards set forth by the Global Forum on Transparency and Exchange of Information for Tax Purposes. The rating is the same as that given to the United States, Germany, and the United Kingdom.
Cyprus as a Tax Haven
Beginning shortly after the fall of the Berlin Wall, the government of Cyprus established its country as a tax haven, specifically targeting Russian oligarchs, as well as Eastern European civilians and companies. The country’s low flat corporate tax rate, strict privacy laws and geographic desirability due to its proximity to Europe and Russia helped to increase the popularity of the tax haven over the following three decades. As a result, the banking industry boomed in Cyprus, growing to become nine times larger than the country’s economy by 2009.
The Fall of the Cypriot Banking System
Prior to 2012, deposits in the country’s banking system had grown steadily, but capital began flowing out of the country during the financial crisis in 2008. Capital outflows reversed in the aftermath of the crisis but remained slow due to weak property prices and global real estate markets. By 2012, the banking system was reeling under the weight of Greece’s sovereign debt crisis as the number of nonperforming loans held by Cypriot banks rapidly escalated.
By March 2013, the country’s banks were in dire need of a bailout. To secure the financial assistance package necessary to keep the banking system afloat, the country agreed to unprecedented terms with the European Commission, the European Central Bank, and the International Monetary Fund. One of those conditions was the imposition of losses on depositors at two of the largest banks in the country. In effect, the country took depositors’ funds more than insured levels and used the equity to recapitalize the banking system’s balance sheets.
The End of a Tax Haven
Additional terms of the bailout included the country’s agreement to change its banking practices to end its status as an offshore tax haven. One of the primary conditions was the country’s hike in corporate tax rates to 12.5%, which is still among the lowest corporate rates for non-offshore entities in the world.
In addition to raising its corporate tax rate, Cyprus will initiate participation in the Automatic Exchange of Financial Information in Tax Matters program by 2017. Countries participating in the program automatically send tax-related banking information of noncitizen account holders to tax authorities in their countries of citizenship. With that information, local tax authorities can compare the information on tax returns to determine if offshore income has been reported. In the event of discrepancies, the tax authorities can then pursue their citizenry for taxes owed. The participation of Cyprus in this program marks the end of the country’s status as a tax haven.