In an ever changing political, economic and regulatory environment we have seen a growing number of asset managers looking to establish asset management and fund structures beyond traditional markets such as the UK, Luxembourg and Ireland (for asset/fund managers) and the Cayman Islands and Delaware (for funds). Cyprus is well placed to play a role of significance in this shift, bearing in mind its EU membership, legal/regulatory regime, strategic location and attractive personal and corporate tax environment.
In light of a shifting international tax landscape, though, through the Base Erosion and Profit Shifting (“BEPS”) action plan, which is adopted by the OECD and G20 countries and has introduced tighter regulation on the international tax system as a whole, as well as unilateral measures adopted by developed and usually high tax jurisdictions, the requirement for ‘substance’ is becoming more and more a matter of relevance and importance. ‘Substance’ is a widely known tax concept, often used in cross-border tax situations. Even though there is no definition as to what ‘substance’ actually stands for, it is a key theme in international structures and tax planning. The matter of ‘substance’ has also been touched upon in courts; the European Court of Justice in its ruling on the Cadbury Schweppes Plc and Cadbury Schweppes Overseas Ltd v Commissioners of Inland Revenue Case decided that the application of the UK’s Controlled Foreign Companies (CFC) legislation, which required the inclusion of profits of Irish subsidiaries of Cadbury Schweppes Plc to its taxable base in the UK, constituted a restriction on the freedom of establishment and ruled that a restriction would only be justified in relation to ‘wholly artificial arrangements which do not reflect economic reality’; in defining such ‘artificial arrangements’, the Court pointed to a ‘letterbox’ or ‘front’ company. It is also relevant to note that the EU Anti-Tax Avoidance Directive (in force as of 1 January 2019) obliges member states to disregard any non-genuine arrangements which can be viewed as arrangements involving companies that lack ‘substance’.
Even though it has been commonly accepted in corporate structures that the exercise of management and control in Cyprus, in addition to the use of office space and the hiring of employees locally, do indicate the establishment of ‘substance’ on the island, in the funds sector it has been recently claimed that the utilisation of Alternative Investment Funds (the “AIFs”), as these are authorised by the Cyprus Securities and Exchange Commission to engage in investment activities, inherently “guarantees” the existence of ‘substance’ for such entities in Cyprus. This is one of the main reasons for which we are experiencing a high volume of conversions of what would traditionally be a corporate holding structure into self-managed AIFs, which in most occasions take the form of an alternative investment fund with limited number of persons.
In turn, this has led to the paradox that even though there are hundreds of funds being set up in Cyprus the total assets under management remain surprisingly low, while most of the funds established in Cyprus have not opted to obtain passporting license(s) to market their units in other EU member states – which is one of the most important elements for the establishment of such investment vehicles in EU countries -. We are, in a way, experiencing the formation of funds by non-asset managers, which has a negative impact on the island’s reputation as a funds jurisdiction, since sophisticated asset managers identify these irregularities.
It is therefore crucial that we promote Cyprus not only as a funds jurisdiction, but mostly as an asset management jurisdiction. Attracting asset managers that utilise AIFMs for their operation(s), will effectively:
a) increase the assets under management in Cyprus;
b) contribute in the enhancement of the local knowledge, through their sophistication and expertise, in a very crucial timing – where all service providers are going through a learning curve;
c) result in the positive reputation of the island; and
d) assist in making the island an attractive jurisdiction for global custodians/depositaries;
The introduction of the Registered Alternative Investment Funds (the “RAIFs”) by the modernised AIF Law of 2018, which requires a mere registration instead of a long and timely authorisation process, assists tremendously towards this direction. The formation and management of funds in Cyprus by AIFMs in now very competitive and has proven to be very efficient, without unnecessary delays.
In turn, the aforementioned-indicative benefits will be reflected in the local economy and Cyprus’ funds service offering in both the short and long run; attracting AIFMs is an investment towards the formation of a sustainable funds ecosystem.
[As was published in the January 2019 CIFA newsletter]