Private (Equity) Funds in Cyprus: Insight into the legal,
regulatory and recently updated tax frameworks
The intent of this article is to highlight certain selected elements of the legal,
regulatory and tax frameworks in Cyprus relevant for Private (Equity) Funds or Private
Collective Investment Schemes and to evaluate how the recent amendments to the
tax laws in Cyprus could be instrumental for Cyprus in attracting such funds and
schemes. For the purpose of this article a Private (Equity) Fund or Private
International Collective Scheme under the ICIS Law will be referred to as a (“Private
It is noted that this article emphasizes only on certain tax and legal issues we
consider to be relevant for investors and fund managers. It is noted that many other
important issues such as the robustness and reputation of the financial system, the
supervision of the regulatory authorities, timezones, the availability and quality of
professional service providers and financial institutions and the access to investors
and capital markets are other equally important issues to determine the
attractiveness of a jurisdiction to consider establishing funds.
Part A – Legal and regulatory framework
Cyprus made its first attempt to become an investment fund friendly jurisdiction back
in 1999, with the enactment of the International Collective Schemes Law 47 (I) 1999
(the “ICIS Law”).
It turned out this legislation did not quite meet the expectations of the government,
regulators and service providers in Cyprus in terms of attracting Private Funds
however. Something that was reflected in the small to moderate number of Funds
registered under the law. It can be argued that that one of the main reasons for this
was that Cyprus had not more to offer than certain traditional and already well
established Private Fund (offshore) jurisdictions both outside of Europe (such as
Bermuda, The Cayman Island, The British Virgin Islands, Singapore) as well as within
Europe (such as Luxembourg, Switzerland and the UK (London).
With a number of important changes in Cyprus such as the significant overhaul of its
tax system in 2002, the accession to the European Union in 2004 (“EU”) and the
introduction of the Undertakings for Collective Investment in Transferable Securities
and Related Issues Law in 2004 (the “UCITS Law”) in Cyprus was given a fresh basis
for the attraction of Private Funds.
However, this fresh basis still did not give Cyprus the necessary tools to compete
with certain other jurisdictions and become a jurisdiction of choice to establish
Private Funds. This is considered – amongst others – due to the fact that certain
provisions of the tax laws related to the treatment of income and gains derived by
Private Funds remained uncompetitive compared to other jurisdictions.
Recent changes in the primary and secondary tax laws of Cyprus now seek to remove
some of these uncompetitive provisions and are welcomed bythe professional
service providers and regulatory authorities in order to increase the competitiveness
of Cyprus and further attract the establishment of Private Funds.
Historically, the ICIS Law regulated both closed ended and open ended funds. The
relevant regulatory and supervisory body under the ICIS Law is the Central Bank of
Cyprus (the “Central Bank”). With the enactment of the UCITS Law the authority for
the set up and supervision of funds other than Private Funds, has passed to the
Cyprus Securities and Exchange Commission (“CySec”) and the set up of Funds other
than Private Funds falls under its jurisdiction.
It should also be noted that open-ended funds investing directly in real estate (not
through companies or funds) would not fall within the ambit of the UCITS law.
Private International Collective Schemes (Closed-ended funds)
The ICIS Law remains the most important piece of legislation for the reason that
Private Funds are set up and regulated in accordance with its provisions. As
mentioned above the regulatory and supervisory authority for Private Funds is the
Central Bank which may recognise a scheme (fund) as a private international
collective scheme pursuant to an application made to the Central Bank.
A fund is classified as “private”1 if its constitutional documentation includes all of the
(i) a restriction to the right of transfer of units2;
(ii) a limit on the number of investors3 to one hundred (employees who are also
investors are not included);
(iii) a prohibition on an invitation to the public4; and
(iv) a prohibition on the issue of bearer units.
An additional important and compulsory inclusion in the constitutional
documentation of a Private Fund (as well in the offering memorandum) is the
methods and frequency of calculation of the net asset value of its units (“NAV”) and
the manner in which units will be distributed to the unit holders.
1 Section 37 (1) of ICIS.
2 The term “unit” includes shares in case the form of the Private Fund is a company.
3 The word “investor” shall include a shareholder or unitholder as the case may be.
4 Under Section 37 (2) an invitation to experienced investors is not deemed to be an invitation to the
A Private Fund can have any of the following forms:
(i) an international fixed capital company (“Fixed Capital Company”);
(ii) an international variable capital company (“Variable Capital Company”);
(iii) an international unit trust scheme (“Unit Trust”); or
(iv) an international investment limited partnership (“Limited Partnership”).
ICIS law runs in parallel with the related laws such as the Companies Law Cap 113
(“Companies Law”), The International Trust Law 1992 (“ITC”) and the Partnership
and Business Names Law Cap 116 (“Partnership Law”) and only where expressly
provided in the ICIS Law certain provisions of the above mentioned laws will not
For instance the formation of an International Fixed Capital Company and Variable
Capital Company will be subject to the provisions of Companies Law but certain
provisions of that law shall not apply. To name a few: matters related to the issue of
prospectus, annual report, inspection of register of members and in case of Variable
Capital Companies the restrictions on the repurchase of own shares by the company,
are expressly waived the provisions related to reduction of capital,
A private company may have up to fifty members (shareholders), therefore in case of
Private Funds having the form of either a Fixed Capital Company or a Variable Capital
company and having more than fifty investors the company should take the form of a
public company (“PLC”) Even in the case of a PLC the requirement to issue a
prospectus will not apply since the offering memorandum will not be offered to the
public and the relevant provisions of Companies Law would not apply.
In case of a Private Fund taking the form of a Unit Trust, the provisions of ITC law
would apply. An important provision is that the Settlor and Beneficiaries of the Unit
Trust must be non residents of Cyprus for tax purposes (see tax part for relevant
definitions) whilst at least one of the trustees must be a resident of Cyprus for tax
purposes, Another important provision is that in case of conflict of laws related to
succession issues the provisions of ITC will prevail. ITC law runs in parallel with Trust
Law Cap 193. regulating trusts in Cyprus however in the absence of any special
provisions that could adversely affect the set up of a Private Fund in the form of a
Unit Trust we shall not elaborate further on the matter.
ICIS law expressly waives certain section of Partnership Law. Therefore in instances
where a Private Fund will be formed as a Limited Partnership, the provisions limiting
the number of partners to twenty as well as other provisions relating to dissolution of
the partnership by court order, profits distribution on dissolution, registration of
names of persons acting as trustees (which is important for feeder funds) and
provisions restricting the withdrawal and or injection of capital in the partnership
during the lifetime of the partnership shall not apply.
The non application of certain important provisions of each of the Companies Law
ITC Law and Partnership Law shows the intention of the legislator in creating a
modern and Private Funds friendly law with the ultimate intention to grow the Private
Funds practice in Cyprus. Following, the most important provisions of the ICIS
applying to any form the Private Fund will take shall be examined.
A Private Fund must appoint an auditor (licensed to carry out audit in Cyprus) who
must be approved by the Central Bank and audited half year and yearly reports
prepared under the international financial reporting standards must be sent to the
investors and the Central Bank. The reports must be sent within two months from
the end of the six months period and within three months from the end of the year
A Private Fund can be capitalised either by cash or by other kind of property
(contribution in kind), provided that in the case of a contribution in kind the valuation
of such contribution has been made at fair market value. Where the contribution in
kind exceeds 10% of the NAV, a report must be prepared by the auditor or a person
approved by the auditor (other than the manager or officer of the Private Fund) and
the report should include the opinion of the auditor on the valuation made, that no
material change has been made in the value of the property since the valuation and
that the number of units to be issued is or is not reasonable. The report must be
given to the Private Fund, the manager and trustee (if they have been appointed) and
must be made available to the investors free of charge.
Whilst a Private Fund has the power to appoint an (investment) manager or trustee, it
may (if it choose to), avoid the appointment of a manager or trustee 5 as that is not
compulsory under the law. An offshore special purpose vehicle providing advisory
and/or management services could act as what would traditionally be seen as a
manager without falling in the ambit of the ICIS Law.
If, however, the Private Fund has elected to appoint a Manager and or Trustee, the
Central Bank must be satisfied that the manager has sufficient financial and
operational resources, it has investment experience, there are no directors of the
company acting as manager on the board of the Trustee (though associate
undertakings may with the prior consent of the Central Bank act as manager and
trustee), it can perform the compliance work adequately and in general the officers
are person of high integrity.
A Trustee can be a bank licensed to carry on business (outside Cyprus provided the
Central Bank consents to it) or a company licensed to provide such activities to the
public (again potentially outside of Cyprus provided the Central Bank consents to it).
The law is exhaustive on the obligations of the Trustee, however, having in mind that
the vast majority of Private Funds are likely to prefer not to appoint a Trustee the
obligations will not be covered in detail. It suffices to say that the Trustee must follow
the instructions of the manager and comply at all times with the constitutional
documents, ensure that the value of the units of a Private Fund are calculated in
accordance with the law and that transactions are carried out in time acceptable to
The books and records of Private Funds must be kept at an address (within Cyprus)
which has been notified to the Central Bank. Inspection is carried out by Central
Bank’s officers and an inspection fee is yearly paid to the Central Bank.
5 Section 38 of ICIS.
Part B - Tax framework
Private Funds which are established as either Fixed or Variable Capital Companies
are legal entities which are opaque (non transparent) from a Cypriot tax perspective
whereas Funds which are established as either Trusts or Partnerships are considered
to be transparent (looked through) from a Cypriot tax perspective. This usually means
that the choice of the form of a Private Fund usually depends on investor’
preferences and tax efficiency of the chosen form. The most common form of Private
Funds registered in Cyprus take the form of companies although – in our experience
- such Funds are also being set up as Partnerships being the Master Fund vehicle
investing all of the investors contribution into Feeder Fund vehicle which is
structured as a company.
Following the accession of Cyprus as a full Member State of the EU as per May 1,
2004, many international investors have considered to include and have included
Cyprus in their international investment planning strategy. One of the key reasons for
considering this is because the Cypriot (corporate) tax system is considered to be
one of the most investor friendly tax systems available within the EU and provides -
coupled with Cyprus’ membership of the EU and the availability to access numerous
Double Tax Treaties Cyprus has concluded with other countries - a tax efficient
investment platforms to Investors.
One of the key advantages of the Cypriot (corporate) tax system is that the flat 10%
headline (corporate) income tax rate for corporate taxpayers is currently the lowest
tax rate on corporate income of all 27 EU Member States. Currently there is not a
single EU Member State which is to be considered a jurisdiction of choice to
establish Private Funds within the EU that offer a better proposition as regarded
headline taxation of corporate profits. It should be noted however that having a low
headline corporate tax rate alone does not make a jurisdiction the efficient from a
tax perspective. Determining the taxable basis in terms of providing for objective tax
exemptions income and gains and also being able to reduce the taxable basis
through base erosion techniques is equally important in this respect. For income
from (investment) holding activities the preferred method of taxing profits resulting
from such activities is providing a full (participation) exemption on dividends received
from and capital gains realized from the sale of equity investments qualifying for
such exemption. The Cypriot corporate taxation system contains (participation)
exemption rules under which profits realized from the sale of securities are fully
exempt from tax (irrespective of the trading nature of the gain, percentage of
investments held or holding period) and dividends received from non tax resident
(subsidiary) companies are also exempt from tax provided some requirements
regarding dividends originating from investment activities combined with a low tax
burden are met.
Compared to other EU Member States the Cypriot (participation) exemption is
regarded to be as one of the best exemption systems available within the EU
framework of yax systems. Notwithstanding this observation so called portfolio
dividends (dividends received from investments in companies in which aCypriot
corporate investor has less than 1% of the share capital) were still subject to Special
Contribution for the Defence of the Republic in Cyprus at a rate of 15% whereas the
exemption applying to profits from the sale of securities were restricted to certain
selected number of securities which could be considered securities for the purpose
of foreign tax and/or regulatory purposes (meaning profits from the sale of various
sorts of financial instruments were subject to (corporate) income tax at a rate of
Another (perceived) disadvantage of the Cypriot corporate tax system was considered
top the uncertainty as to the taxation of interest income in Cyprus. This as interest
income which is considered to arise in the ordinary carrying on of a business or is
considered to be closely connected thereto was subject to (corporate) income tax at
a rate of 10% whereas any other type of interest income was subject to an effective
tax rate of 15%. This as 50% of the interest income was subject to (corporate)
income tax at a rate of 10% and such interest income was also subject to Special
Contribution for the Defence of the Republic at a rate of 10%. These taxation rules
were considered to be difficult to interpret and explain and therefore considered to
be prohibitive to (foreign) investors.
In order to remove some of the above explained disadvantages the following
changes in secondary and primary tax legislation have been introduced in the last
Circulars No. 2008/13 and 2009/06 (secondary tax legislation)
The Cypriot tax authorities have issued Circular No. 2008/13 in December 2008 and
Circular 2009/06 in January 2009 through which they have clarified and have
broadened the scope of the definition of “securities” or “titles”. The issuance of this
circular was aimed at providing clarity as to which instruments fall within the
definition of "titles" and are aimed to eliminate, to a certain degree, the uncertainty
that existed as regards the tax treatment of profits realized on the sale of certain
derivative investment products and instruments.
The law defines securities as:
shares, bonds, debentures, founders’ shares and other securities of companies or
other legal persons, incorporated under a law in the Republic or abroad and options
Gains arising on the sale of securities are also not subject to capital gains tax in
Cyprus (levied at a rate of 20%) unless the asset disposition relates to shares in a
private (and public) limited liability company the assets of which consist of real
estate situated in Cyprus (unless the shares of a company are listed on a recognized
The circulars include a (non exhaustive) list and additional explanations
clarifyingwhich securities would fall within the definition of securities for the purpose
of applying the exemption from the profit from sale of securities.
The list includes the following instruments:
1 Ordinary shares
2 Founder’s shares
3 Preference shares
4 Options on securities
7 Short positions on securities
8 Futures/forwards on securities
9 Swaps on securities
10 Depositary receipts on securities, such as ADRs and GDRs
11 Rights on claim on bonds and debentures (but not including rights on the
interest of these financial products)
12 Index-linked securities
13 Repurchase agreements or Repos on securities
14 Participations in companies, such as the Russian OOO and ZAO, the US LLC,
(provided that these companies are subject to taxation on their profits), the
Romanian SA and SRL and the Bulgarian AD and OOD
15 Units in open-end or closed-end collective investment schemes which are
incorporated, registered and operating in accordance with the provisions of a
specific and relevant legislation of the country in which they were founded.
The circulars also provide some examples of such collective investment schemes:
Investment trusts, investment funds, mutual funds, unit trusts, real estate
International collective investment schemes (ICIS)
It has also been clarified that in case a repo agreement provides that the two parties
have agreed to sell and repurchase the securities at two different prices, then the
resulting profit /loss will not be taxable or tax deductible for (corporate) income tax
purposes. In the event that the repo agreement provides that the sale and
repurchase price are identical and also provides for a repo interest or any other form
of compensation, then such kind of income would be subject to income (corporate)
income tax at the standard rate of 10%. Any income arising or accruing on securities
and paid by the issuer of the securities during the term to maturity, such as interest
and dividends, is not part of the profit/ loss from the sale and repurchase
agreement. Consequently, such interest income shall be subject to income tax or
defence tax (unless an exemption applies) and dividends shall be subject to defence
tax (unless an exemption applies).
The Circulars further clarify that any profits or losses arising on index participations
should be exempt from (corporate) income tax provided that the underlying asset is a
security (i.e. bonds or equities). This means there is no requirement for an actual
delivery of the basket of underlying securities representing the index-linked
participation. Although not explicitly mentioned in the circulars, the same conclusion
could be drawn in our view for equity/ bond futures and options on such futures (i.e.
there is no need to actually buy or sell the underlying securities).
Strangely though the tax authorities have also clarified in the circulars that in order
for shares in a US limited liability company to qualify as securities (and hence profit
on the sale of such shares to be exempt from (corporate) income tax), such company
should not be a tax transparent entity for the purpose of taxation on its income. In
our view this non transparency condition does not find any support in the tax laws.
This as the exemption is to be applicable when the (equity) investment can be
considered a legal person incorporated under a law abroad irrespective of its
(foreign) tax treatment.
Lastly the Cypriot tax authorities have clarified that they consider promissory notes
and bills of exchange as not meeting the definition of a security for the purpose of
applying the exemption.
The list is not exhaustive and due to the complexity and many variations in financial
derivate instruments, it may be recommended for taxpayers to seek an Advance Tax
Ruling from the Cypriot tax authorities to clarify the taxation of certain derivative
instruments not explicitly mentioned in the circulars. This moreover as Circulars
issued by the tax authorities do not have a legislative basis and are not binding on
either the courts or the tax authorities. Nevertheless, the tax authorities apply and
respect circulars unless a circular is officially withdrawn or there is a change in law
which renders an existing circular inapplicable.
Recent (primary) changes to the Cypriot tax legislation which will further enhance
Cyprus position as an international business centre
On 22 October 2009 the Cyprus Parliament enacted legislation which removes
certain tax disadvantages to companies involved in investment activities. The
legislative changes have retroactive effect as of 1 January 2009.
The main changes in the law can be summarized as follows:
Dividends received from investments in foreign companies
Dividends received by a Cyprus tax resident company from investments in non
resident companies were exempt from Cypriot (corporate) income tax and special
defence contribution/defence tax, provided the participation in the share capital of
the non resident company was at least 1%, otherwise dividends received were
subject to 15% special defence contribution (unless an exemption applies subject to
certain conditions). Under the recent amendment this percentage threshold has
been removed and - as from 2009 - the exemption will apply to all dividends received
from non resident companies.
It should be noted that dividends received from a non resident company, the income
of which is directly or indirectly derived for more than 50% from activities leading to
(passive) investment income will still be subject to 15% special defence contribution
unless the profits have been taxed at an effective tax rate of at least 5% on the level
of the dividend distributing company.
Interest income received by tax resident companies
Interest income earned (on an accrual basis) by Cyprus tax resident companies,
which is not considered to be derived in the ordinary course of business or closely
connected to the ordinary course of business was subject to 10% special defence
contribution and 50% of the interest income was subject to Cypriot (corporate)
income tax at 10%, i.e. such income was effectively taxed at 15%. With the recent
changes, such interest income would be either included in the taxable income of the
company and be subject to 10% (corporate) incometax (if considered to be derived in
the ordinary course of business or closely connected to the ordinary course of
business) or be subject only to 10% special defence contribution in all other cases.
Taxation of Collective Investment Funds
With the recent changes in the tax legislation, it has been codified that interest
earned by a collective investment schemes (registered in Cyprus) is subject only to
(corporate) income tax at 10% and at the same time it has been codified that the
redemption of participations/shares in such funds is considered a disposal of
securities/titles which means that the redemption proceeds exceeding the capital
contributed by the investor shall be exempt from (corporate) income tax in Cyprus.
Furthermore dividends deemed to be distributed by collective investment funds
established in Cyprus to a Cypriot tax resident individual are - as a result of the
changes - subject only to 3% special defence contribution instead of 15% which
applies for all other dividends received by such persons.
Whilst Cyprus has never been a traditional jurisdiction of choice for setting up,
managing and administration of investment funds the legal and tax framework as
described above could prove the ideal stepping stone in placing Cyprus on the
shortlist of jurisdictions worth considering for setting up Private Funds.
The foregoing discussion and analysis is for general information purposes only and
not intended to be relied upon for legal advice in any specific or individual situation.
ABOUT THE AUTHORS
Pavlos Aristodemou has an LLM from Oxford Brookes University and an LLM from
Boston University. He is the managing partner of Harneys Aristodemou Loizides
Yiolitis. He practices in banking and finance, private equity and capital markets and
corporate tax law. His client base includes financial institutions and corporates
throughout the world. Pavlos is recommended by several leading international legal
directories such as Legal 500, Chambers & Partners, Who’s Who Legal, Best
Lawyers, IFLR and others.
Pavlos can be contacted at:
Tel: + 357 25820020
Maarten Koper has a Masters Degree in Tax Economics from the University of
Amsterdam, the Netherlands and a Bachelors Degree in Tax Economics from the
Amsterdam Business School and he is an International Tax Services partner of Ernst
in Young located in Cyprus with over 15 years of experience in advising on
international tax matters. Maarten specializes in the area of taxation of mergers and
acquisitions, spin offs and joint ventures, public offerings, reorganisations, financial
instruments, investment funds and structured finance transactions. His area of
expertise also includes advising on EU tax matters and he is a member of the
European Tax Competency Group of Ernst & Young.
Maarten can be contacted at:
Tel: +357 25 209 722