Permanent Establishment – Are new rules on the cards?

Permanent Establishment is a concept anchoring much current tax legislation. Any activity which is carried out by a business in a country that results in the generation of revenue in that country is likely to be regarded as a Permanent Establishment (PE); on that basis, local authorities will assess corporation tax on deemed in-country revenue. To be formally recognised as a PE, the revenue-generating PE will normally need to be registered as some form of corporate entity in the host country – either as a branch, a subsidiary, or representative office.

There is no universal definition of PE – it is usually determined on a country by country basis, by reference to local law and applicable double tax treaties. However, there are a number of commonly used indicators to determine whether the activities of a foreign organisation give rise to a PE in a particular country. These include:

  • If an organisation operates out of a fixed place of business in the host country (this can either be a fixed office or even an office in an employee’s house);
  • If an organisation’s employees in the host country receive some form of sales-based compensation, such as commission or bonuses;
  • If the job-title of an employee includes some reference to sales or revenue generation, and that employee has been contracted in the host country for a prolonged period of time; and
  • Sales made to customers in the host country which have been negotiated by locally-based staff or agents.

When an activity is deemed, however, to be preparatory or auxillary in nature – in other words it is not an essential part of business as a whole – then PE is generally not regarding as existing; although, in practice, it may be the responsibility of the tax payer to demonstrate that it does not exist, rather than that of tax authorities to prove that it does.

Essentially, this tax residency approach has been the fundamental behind the concept of PE for more than a century, which makes a recent proposal, leaked and published by Reuters, all the more radical. At a meeting held in Tallinn last weekend with EU Finance Ministers, a proposal was put forward by Estonia, which currently holds the presidency of the European Union, to amend and change the definition of PE.

Under their proposal,rather than using tax residency as the basis for determining Permanent Establishment, value creation should be used instead. In other words, a multi-national would be taxed according to the value it created in a host country; that virtual PE would be considered enough to substantiate a taxable presence in a country and, therefore, make it liable to corporate income tax.

This would have potentially large-scale implications for international taxation and the application of double-tax treaties, and comes hard on the heel of news that the OECD, in the light of the BEPS initiative and consideration of the tax treatment of technology groups, has indicated that the definition of PE is up for wider debate.

It is acknowledged that theseproposals are radical, and that a consensus needs to be built before there is wider acceptance of the need to change the definition of Permanent Establishment. Nevertheless, this could mean yet another shake-up to the taxation of foreign subsidiaries, and another level of complexity added for accountants, tax experts and managers of multi-national organisations.

Thin Capitalisation

Thin capitalisation refers to a condition in which a company is financed with a high level of debt compared to its equity. This means it is highly leveraged. This method of financing is often used by multinational companies as a way of reducing tax; a lender in a low-tax country lends to a borrower in a country in which the borrowing cost can be deducted from profits for corporate tax purposes. As a consequence, profit can be shifted to a lower tax jurisdiction.

However, in the wake of wider initiatives such as BEPS and CRS, a number of national governments have been looking at the practice of thin capitalisation, and sought to impose limits on how much interest expense can be deducted for tax purposes.

Typically a thin capitalisation rule will prevent the complete deduction of interest if the ratio between debt and equity exceeds a certain level. There are two main categories of such rules – either the amount of interest which is deductible is restricted if the total debt-equity ratio exceeds a certain numerical value, or the internal debt-to-equity ratio is limited.

Recently, regimes from Australia and New Zealand, from Canada to Russia, and Indonesia to South Korea have all, in various ways, sought to introduce measures to counteract the use of thin capitalisation as a tax avoidance strategy.

In terms of Cyprus, current tax legislation does not provide for any rules when it comes to thin capitalisation, which makes it an ideal location in which to situate a holding company. However, caution needs to be exercised when it comes to interest deductions for loans which are not of a trading nature. Such interest payments are deemed non-deductible, whereas interest on a loan of a trading nature is treated as qualifying, and, therefore, eligible for deduction.

The battle against thin capitalisation is part of the wider picture in which national and international authorities are cutting-down on aggressive tax planning strategies and moves to shift profits from higher to lower tax jurisdictions. International companies which find themselves affected by the tightening regulations may want to consider using Cyprus as a base for their holding companies as there are no thin capitalisation rules currently in place, and because of its attractive low corporate tax rate.

The new rules on transfer pricing

One of the key action areas from the OECD BEPS (Base Erosion and Profit Shifting) initiative is the introduction of new rules on transfer pricing. Put simply, transfer pricing relates to how companies, which form part of the same group, pay each other for goods, services, intangible assets and similar transactions.

Traditionally, companies have used transfer pricing as a means of reducing their overall tax burden, and look to move profits from higher to lower tax jurisdictions, structuring their operations to ensure that the tax they pay is minimised. There has been nothing inherently illegal in this – it was part of business strategy to take advantage of differing corporate tax rates and treaty provisions to reduce the overall tax paid by a group.

However, all that is now changing, and the practice of multinationals allocating income to lower tax countries and expenses to higher tax jurisdictions is now coming under increased international scrutiny and censure.

The OECD, through BEPS, which has not only been approved and endorsed by the G20 Group of Finance Ministers, but also been supported by laws and recommendations adopted by many developed countries and the EU, wants companies to align where they pay taxes with where they have economic substance i.e. where they have operations and employees.

This means an end to the practice of allocating too much value to low-tax countries, where a group has few (or even no employees), and too little to those higher tax regimes where they many employ most of their people and sell the bulk of their products and services.

For multi-nationals, this marks a substantial change.

There will be much greater transparency required regarding the transfer pricing practices of a business, and a correspondingly greater risk of challenge from local tax authorities where the profitability of a jurisdiction is not sufficiently aligned with its economic substance. Greater focus will be placed on the attribution of capital and intangibles, and the alignment of profit with the location of key decision-makers and company management.

Under the new framework, a heavy emphasis will be placed on documentation, with a requirement for companies to provide a detailed country-by-country overview, and specific transfer pricing information for each country in which they operate.

This documentation will need to provide as much transparency as possible to tax authorities regarding a company’s activities, and how profits are aligned with tangible economic substance, with a much greater emphasis placed on tangible physical assets and employees.

The additional reporting and compliance burden for companies is going to be significant, and there are also concerns that what has, hitherto, been confidential commercially sensitive information will now be disclosed in a wider public domain. Nevertheless, these changes are coming and companies need to prepare for them.

BEPS is also going to force a radical change as to how IP (intellectual Property) is treated. Currently, a company may choose to have its IP located in a low (or favourable) tax jurisdiction with few employees, such as Switzerland, Luxembourg, or the Caribbean. However, such “brass-plate” operations will no longer be allowed under the new rules. Companies will need to have employees, and key decision-makers, in jurisdictions where IP is based.

This is a significant departure for companies who may need to consider where their IP is located.

One option would be to spread it around places where they already have senior people based, but this could include high tax countries.

Another alternative is to move people to low tax jurisdictions – such as Cyprus – where there IP may be already based, or to structure operations so that staff and IP are shifted to such a jurisdiction.

The new transfer pricing rules will dictate a major shift in the way that multinationals structure their operations, and will place a much greater emphasis on the alignment of economic activity and value creation with the payment of tax. Not only will the involve a reorganisation of operations in some cases but a considerable increase in reporting and the cost of compliance.

The corporate tax landscape is changing, and with the increased requirements for transparency and the need to justify economic decisions, groups have to accept that what, why, and how they do things will become a matter of public scrutiny and debate.


BEPS explained

The BEPS (Base Erosion and Profit Shifting) programme is an OECD initiative, endorsed and approved by the G20 group of leading nations, designed to identify ways of providing more standardised global tax rules.

BEPS is an umbrella term used describe tax planning strategies which exploit mismatches and discrepancies between the tax rules of different jurisdictions, allowing companies to minimise their overall corporation tax payable, either by making tax profits disappear, or by shifting them to low tax jurisdictions where there is little or no genuine activity. In general, BEPS strategies are not illegal; they just take advantage of the different tax rules which apply in different tax jurisdictions.

Examples of the practices that the BEPS initiative is attempting to eliminate include the practice of reducing the taxable base (base erosion) and the practice of shifting taxable profits from high to low tax countries (profit shifting). An example of the former is using large interest payments to reduce taxable profits, whilst the latter is exemplified by the transfer of IP (Intellectual Property) and income derived from it from the US (high tax) to Bermuda (low tax). It also covers the highly-publicised cases of multi-nationals like Starbucks, Google, Yahoo and Amazon who operate extensively in countries like the UK whilst paying little corporate tax there, and Apple and its tax arrangements.

BEPs is really an attempt to address one of the challenges of the current global and digital business environent – how to make sure that all companies, including large corporations, pay their fair share of tax.

Following the initial report on BEPS by the OECD in 2013, an action plan was drawn up to tackle “weaknesses” in existing taxation principles, which was endorsed by the G20 Finance Ministers and which spawned further  initiatives at the UN and EU level. These initiatives have resulted in a number of new policies which have been created at both the national and international level to prevent Base Erosion and Profit Shifting.

The extensive Action Plan on BEPS published by the OECD identified 15 separate action points which needed addressing. These included:

  • Addressing the tax challenges of the digital economy;
  • Neutralising the impact of hybrid mismatched tax agreements;
  • Strengthening CFC (Controlled Foreign Company) rules;
  • Limiting the extent to which interest deductions and other financial payments can reduce base taxation;
  • Countering harmful tax practices more effectively, and preventing treaty abuses;
  • Changes to transfer pricing arrangements; and
  • Requiring taxpayers to disclose aggressive tax planning arrangements.

In terms of Cyprus, the Minister of Finance issued a Decree on 30 December 2016, introducing mandatory country by country reporting requirements for multinational groups with a consolidated annual turnover in excess of €750 million (so-called “MNEs”). This Decree is in line with EU Directives as regards the mandatory automatic exchange of information as regards taxation and the OECD BEPS initiatives.

As a result, MNE Groups which have an ultimate parent that is tax resident in Cyprus are required to file annually a report which includes specific financial data such as income, taxes, and other measures of economic activity on a country by country basis. There can also be a reporting requirement, under certain circumstances, for a Cypriot tax resident entity which is part of an MNE Group.

BEPS can be regarded as one more element in the sea of global tax changes which are being brought to bear to prevent not only tax evasion but aggressive tax evasion as well, with the stated aim of promoting transparency, compliance and coherence. It, therefore, takes its place alongside such initiatives as FATCA, the Common Reporting Standard (CRS), AML, and changes to the EU Parent-Subsidiary Directive.

Such initiatives, will, inevitably, lead to a huge increase in the compliance cost for business, because the extent of information that requires reporting for an international group is so much greater than it used to be. BEPS will have a major change on the international business landscape. Policies adopted and practices followed will need to change and improve, and there needs to be a corresponding alteration, for some, in the corporate mentality. The need for compliance and transparency will now trump the use of planning strategies aimed at exploiting loopholes and treaty provisions so as to reduce the tax burden.

For Cyprus, it will have an impact on the corporate sector because certain existing tax arrangements will no longer be attractive or even valid. There will, as a consequence, be a reduction in the number of legal entities registered in the country, whilst, at the other end of the spectrum, increased compliance costs for international businesses headquartered her.

The BEPS programme will be rolled-out in a number of phases, and there will be transitional arrangements in place to cover a number of the “action points”, before finally becoming enshrined in national and international law. However, it is clear that businesses must now expect a degree of scrutiny, and reporting of their tax position and arrangements which goes way beyond what they have been used to in the past, and they need to adapt accordingly.

Internal Benchmarking

Companies looking to carry out benchmarking studies will often turn internally and compare the performance and processes of business units from within their own organisation. There are a number of reasons why they might take this approach, including the ease of access to data and information, the availability of standardised data, and cost -it is usually less expensive and time consuming than benchmarking a competitor or firm from another industry.

There is, of course, one principal drawback. Operations from within the same organisation tend to be more heterogenous in terms of functionality, performance and corporate framework than those of an industry peer or rival. Potential insights are curtailed by breadth of the organisation itself.

However, provided these limitations are understood and acknowledged, then internal benchmarking can still yield some valuable results.

Through internal benchmarking, a company attempts to learn from their own structure. Similar operations within an organisation that can be defined and measured are compared. This is especially true for medium or large companies with multiple divisions, production facilities or business units. Examples of this in practice might mean, for example, comparing the warehousing and shipping of products at one site with those at another, or assessing the relative performance and processes of an accounting and finance team in Country A with those in Country B.

The idea behind internal benchmarking is not only to promote efficiency but to foster a culture of continuous organisational improvement. That is why it is important that senior management both endorse the process and underline the importance of the exercise as a learning opportunity. Failure to do so risks a “silo” mentality taking hold, whereby different parts of an organisation can, either directly or covertly, refuse to cooperate with the benchmarking exercise, or ignore the teachings from another department, team or business unit whose performance or methods has been judged superior to theirs.

Communication is obviously a key element. The reason for the benchmarking exercise needs to be communicated to all those impacted – and potentially wider within a company – and the perceived advantages clearly spelled-out. The message also needs to be sent that this is a positive, sharing experience, and not a stick which will be used to beat a particular part of an organisation over the head.

One other benefit to internal benchmarking that should be highlighted is that it provides the opportunity to stand back and examine some of the reasons why an operation, business unit or department handles a particular process in the way it does. Often internal ways of doing things evolve over time, until they become accepted practice. There is no recognised methodology, as such, it is just the way “we do things round here”. Benchmarking gives you the opportunity to stand back, look at a process objectively and critically, and ask whether it is the most effective way of delivering the desired outcome or performance.

An effective benchmarking exercise comprises the following main steps:

  • Firstly, identify which processes to benchmark. It is recommended that a company starts with only one, or perhaps, two processes to examine at the same time – perhaps order fulfilment or customer service. To do otherwise, risks focus being lost, internal competition for scarce resources, and, possibly, contradictory results.
  • Then organise the benchmarking efforts, Identify who will take part in the effort, try and ensure, as much as possible, that team members are dedicated to the task, and are not trying to benchmark “around the day job”. Also decide how the benchmarking will take place – for example, organising a small team to visit the company’s major warehouses to learn effective tactics and strategies in place at each.
  • Organise and prioritise the ideas that the team has found, and turn them into a discrete project, which can then implement the best processes and practices on a wider basis. This is a more structured approach to achieve lasting performance gains than adopting a scattergun approach.
  • Finally implement and begin to achieve results.

Once this methodology has been adopted with one key process, the same approach can be used for the next and subsequent processes, until all the major parts of an organisation have been benchmarked. This creates a cycle of continuous improvement, so that a company is always looking to learn and improve its internal processes, with the same exercise repeated every few years or so.

The advantage of internal benchmarking is that it is much easier to get data and information from within one’s own organisation than from a key competitor or industry peer. It is also easier to understand that information because much internal reporting will be standardised, even if the processes or operations which provides that data is different. There are also cost advantages. However, if senior management are not seen to support such initiatives, or fail to communicate the positive benefits of carrying out such exercises, internal politics and resistance can undermine improvement efforts.

Despite this, many organisations would benefit from some form of benchmarking of their internal processes and methodologies, just to give them an objective view of what has often evolved by practice and the passage of time rather than with any applied forethought. Even small changes can lead to increased efficiency, greater employee satisfaction and improvements to the bottom-line.




Sales, Revenue, Gross and Net Profit explained

The terms sales, revenues and profit are often used by the uninitiated as if they were synonymous, whereas there are important differences between them, particularly when it comes to profit and the other two terms. Some basic understanding of financial terms and concepts can be very useful for the small business owner, because a company’s success or failure is often dependent on them, even if they don’t realise it. Knowing and understanding what are the important signs when it comes to the financial health of your business can be critical.

The easiest term to define is sales which, put simply, is the income you get from selling your products and services. This figure is usually calculated net – that is to say, taking account of any customer returns or discounts that may be offered.

Sales and revenue can be the same thing if all the income generated by a company comes from what it sells. However, many companies have many other sources of income – interest, royalties, fees and dividends – which do not fall under the definition of sales, but which can still represent important sources of cash flow for a business. Although sales are sometimes referred to operating revenue and revenue as total revenue, the same differentiation applies.

Profit, on the other hand, reflects the money left over from your revenue after you have deducted the costs of running your business. Again, there is an important distinction to be made – between gross and net profit.

Gross profit is the revenue that you earn from selling a product or service, less the direct costs of producing it. These include, for example, materials consumed, advertising and marketing costs, staff involved in the production or selling activity, and other expenses involved in getting the goods or services to market. Net profit, on the other hand, takes account of all the costs associated with a company doing business, including overheads such as administrative costs, depreciation, bank and loan interest.

Not only are the differences between these terms not always understood, but their relative significance can be missed as well. High sales may be a good thing, for example, but if the cost of producing your goods or services is such that your gross profit is negative, or too low to cover your overheads, then your business is in trouble. Conversely, you may have modest sales, but if your production costs and overheads are also low, you may have a successful operation.

Once you have identified these key metrics, it is important to apply them to your own business. For example, if you forecast, based on current and forecast sales, your gross profit for the month, you should be able to estimate if you are going to generate enough money to cover your operating expenses. If you project your gross profit is not going to be enough, then you either need to promote your product or services more heavily, or offer some form of promotion to build sales.

Of course, at least in the short-term, it is often easier to cut costs than increase sales. But it is important to know which costs can be easily reduced. Accountants will often talk about variable and fixed costs, for example. A variable cost is one that changes with the level of production or sales, whilst a fixed cost is relatively constant, staying the same if one unit is sold in a month or a thousand. Whilst somewhat of a simplification, a variable costs can be reduced quickly if there is a need to cut expenses, whilst it is difficult to reduce fixed costs. For example, land and buildings usually represent long-term investments which it is hard to sell, or otherwise get off the books (via a sale and leaseback transaction, for example). On the other hand, variable costs such a advertising, promotion and travel costs can be easily cut or adjusted as demand and performance dictates.

Sales, Revenue, Gross and Net Profit are terms that entrepreneurs and small businesses should understand, as well as appreciate the difference between them. They are all related, so know what they are for your business, understand how the change in one can impact the others, and always keep these in mind before embarking on any new project or investment.

CRS – What is it?

Many people in Cyprus who hold a bank account in the UK may have received, or will soon get, a letter from their bank asking them to self-certify their tax status. This may come as a surprise to some, whilst others will regard such a request with suspicion. However, this is now a necessary compliance procedure for the citizen of any country which has signed up to CRS – the Common Reporting Standard.

CRS is a standard for the automatic exchange, on a global level, of information about tax and financial holdings, developed in 2014 by the OECD (Organisation for Economic Cooperation and Development). Modelled on the US FATCA (Foreign Account Tax Compliance Act) legislation, the main purpose of CRS is to combat tax evasion.

As of August 2017, 102 countries have signed up to the standard, with 49 jurisdictions undertaking the first exchange in 2017, and the remaining 43 committing to 2018. In addition, the USA is undertaking automatic information exchange under the FATCA legislation.

While CRS has been criticised in some quarters for leaving open too many loopholes, the exclusion of a number of developing countries from its provisions, and for promoting, rather than preventing the use of tax havens, its introduction can be seen as a major step forward in the global fight against tax evasion.

The information to be exchanged is governed by a very detailed standard but, in essence, the following will be shared with respect to accounts held in Jurisdiction A by a tax payer resident in Jurisdiction B, and vice versa.

  • The name, address, Tax Identification Number (T.I.C. in the case of Cyprus), place and date of birth of each Reportable Person;
  • Account Number;
  • Name and identifying number of the reporting financial institution; and
  • Account balance or value as at the end of the relevant calendar period, or at the date of closure (in the event the account was closed).

The OECD has left it up to each jurisdiction to determine what accounts are reportable under the standard. However, to all intents and purposes, you can assume that if you hold an account in a bank or financial institution in another participating country within CRS, then its existence and value will be reported and shared with the relevant authorities in the country in which you are tax resident.

It also means that if you open a new bank account, invest in new financial products or change your personal circumstances in some way, then you will need to report certain details about yourself under the self-certification process.

Financial institutions are legally required to determine the tax residency status of all their customers, even if they are tax resident in the same country in which they hold their account (although typically in such cases details do not have to be reported to tax authorities for CRS purposes). The legislation applies to both personal and business customers, with sole traders treated as individuals for reporting ease.

Of course. individuals may be concerned about data privacy and security, given major cyber attacks and information leaks in recent years. Banks and other financial institutions will, naturally, assure their customers about their codes of secrecy and data protection protocols, but, cynics will point out, too often these have been breached in the past to offer complete peace of mind. Nevertheless, CRS reporting is here to stay.

Even if you choose to ignore the request for self-certification, the bank or financial institution concerned will use the information they already hold about you to try and establish your tax resident status. As this could have unfortunate consequences of the wrong information being shared with the wrong authorities, it is better to confront the situation upfront and self-certify yourself.

For many, even those not involved in tax evasion, CRS can be regarded as an unwelcome intrusion into areas they regard as private, namely details concerning their bank accounts and financial holdings. Nevertheless, CRS can be regarded as the next step on the road to global transparency with regard to tax and financial affairs. As such, if not welcomed, it needs to be at least accepted.

AML – The ever-growing monster

Last week I received an email from my Institute which contained, among other things, an anti-money laundering (AML) update, described as the “essentials” needed to inform one’s AML risk assessment, policies and procedures.

Looking for a quick update on the subject, I drilled down to the guidance notes issued only to find that these ran to a staggering 73 pages! Perhaps in another life I might have the time to read such a tome but I suspect, like most other accountants, we have too much else to do with our days (and nights), and cannot afford the luxury of ploughing through such texts.

It also occurred to me that AML has become a monster that keeps growing, showing no signs of stopping, This begs a few supplementary questions. Are we placing too much of a burden on sole practitioners and small accounting firms to stop money laundering? And should governing bodies start tailoring their advice to individual constituents, and stop assuming everybody works for a big firm which can afford compliance officers and extensive risk assessment procedures?

Back when I trained and first qualified as an accountant, money laundering was rarely discussed, if ever, more the stuff of movie scripts than an everyday concern. Perhaps it can be argued that controls back then were too lax and needed to be tightened-up, but, at the same time, is the world really more corrupt and dangerous than it was 30 years ago?

Seen from the prism of today possibly, but, if the lens is slightly adjusted, it can be argued not. The threat of terrorism obviously dominates many political and news agendas now, but the 7os and 80s had their own share of terrorist activity, both in the Middle East and elsewhere – Northern Ireland, Spain and South America to name but a few.

Then there is the so-called war on drugs which is often cited as the starting point for money laundering regulation, as lawmakers attempted to seize the proceeds of crime. But illegal smuggling of contraband or banned substances has been going on from time immemorial, be it tobacco, alcohol, tea or even salt. There is nothing new under the sun.

What has changed is the attitude of governments and legislators to such matters. Gone is the presumption of innocence which used to form the basis of the legal systems of most developed countries. Now accountants, lawyers and other professionals are required to assume clients are guilty unless proved otherwise. In other words, until proper due diligence is carried out, a new – or even existing client – should be regarded with suspicion.

Furthermore, professionals are now required to report any suspicious activity or face criminal and regulatory sanctions. In  the UK, for example, the Proceeds of Crime Act (POCA) legally obliges accountants, and other professionals, to know their clients and submit a suspicious activity report (SAR) to the National Crime Agency if they have any reason to suspect that money laundering or terrorist activity is taking place.

Gone are the days when the relationship between accountant and client was almost as sacrosanct as the confessional or as guarded as that between doctor and patient. Now the accountant has been press-ganged into the role of informant, with the threat of criminal penalties if they fail to comply. And much AML legislation rides roughshod over personal privacy rights and data protection laws, in the same way that the requirement by banks to report on their own customers has been described by the American Civil Liberties Union as the coercion of private businesses “into agents of the surveillance state”.

This is not to abdicate the responsibility of the accountant or any  other professional to prevent money laundering or other criminal activity taking place. Rather it is a plea to regulators to trust more in the integrity and personal ethics of the professionals in the front-line. Old-fashioned as such notions might be, many people practicing a profession have worked long and hard to get to where they are now, and are proud to be able to add their qualifications after their name. They do not want to risk their reputations by working with a dodgy client, or one whose business practices they dislike. Simply put, they have too much to lose.

Equally, this is a plea to the accounting bodies and other regulators to issue guidance that is sensible and appropriate to its audience. Sending out 73 pages of guidance is too much because people just do not have the time to read and absorb this volume of material. Practical advice could be condensed to twenty pages or less, which means that practitioners would be able to digest it easily, Brevity is not only the soul of wit, it is also the key to effective communication.

Unfortunately, I suspect that my objections may fall on deaf ears, and that I may be like King Canute fighting against the tide. Nevertheless it is worth asserting that the world is not inherently a more dangerous or corrupt place than it used to be, that most clients are honest, hardworking people just trying to make a living, and that they do not deserve to be treated with suspicion from the get-go. And it should also be said that most accountants and other professionals do have their own moral code, and do not want, or need, to be involved with criminals, and their activity.


How not to win friends and influence people

Prior to 2013, Cyprus had a reputation as an investment-friendly country, with the lowest corporate tax rate in Europe, a light regulatory environment, and a thriving banking, accounting and legal infrastructure to support business activity.

Of course, the events of March 2013 when Cyprus had to appeal to the international community for a bail-out, the 10% haircut applied to all bank deposits in excess of €100,000, and the near-collapse of the banking system undermined that reputation very swiftly. However, ignoring media hysteria about the country as a centre for money laundering and other corrupt practices, Cyprus has tried very hard in the past 4 years to get its house in order.

The bail-out was exited early and all loans repaid (compare and contrast with Greece, for example!); the banking sector has been reformed and strengthened – even if the issue of NPL (Non-Performing Loans) remains the elephant in the room; tax laws have been tightened and reporting requirements made more stringent, so much so that Cyprus has been an early adopter of legislation such as CRS (the OECD Common Reporting System), which seeks to develop a single global standard for the automatic exchange of information between tax authorities.

Cyprus remains, in theory, an attractive place in which, and from which, to do business. At 12.5% its corporate tax rate rivals Ireland as the lowest in Europe (and without the Irish barriers to entry for small businesses). It has a highly educated work force (Cyprus has the highest number of graduates per capita in Europe), whilst salary levels are 30% lower than Western European equivalents.

However, there are a number of ways that Cyprus continues to let itself down, not least in terms of its bloated government sector, archaic civil service, and working practices that belong more to the 19th than the 21st century.

To cite a few examples.

In 2011, as a short-term measure to boost dwindling state coffers, an annual levy of €350 on all Cyprus companies was introduced. Six years later, what was intended to be a temporary tax remains in place, with no sign of being repealed. This is very short-sighted and it discourages investment; the money it raises would be dwarfed by the wealth which would be created, direct and indirect, by would-be investors.

Whilst the official language of the country is Greek, most business is conducted in English. Contracts are written in English, invoices drafted in it, emails and other communications are usually in  English, and most business discussions take place in it. Most professionals have a high degree of spoken and written English, whilst it is the lingua franca of the international business world. Despite this, many official forms are only written in Greek, government websites offer only partial or incomplete transactions, whilst many civil servants will stubbornly refuse to speak English, even if they can probably speak it very well.

This is just perverse and counter-productive. If you want business to invest in your country, make it easy for them to communicate with you.

Government departments and their practices are hopelessly outdated; thousands of words could be devoted to the subject of the vast over-manning (or “over-womanning” as many of these employees seem to be female) of these departments, and their continued reliance and addiction to paper records in the digital age. However, this is beyond the scope of this current post.

Illustrative perhaps of these practices is the use – or misuse – of email. If you have a problem with the Social Security department or they need additional information, you can either fax them (an outdated technology in itself), send it by snail mail, or deliver it to them in person. Forget email or scans – they are not allowed individual email accounts, and do not have access to a printer anyway. And, if they do have an email account, chances it won’t work properly.

During a recent encounter with the VAT department, I was asked to supply details of my company bank account when applying for a VAT refund. Three different email addresses were supplied to me in the course of my interaction with the VAT department, and three different email addresses failed to connect, despite a flurry of follow-up calls to verify spellings, hyphenation etc.

Then there is the culture of the front-line staff who deal with the public. Rather than a “can-do” attitude, many adopt a “won’t do” or “can’t be bothered” stance. This includes the staff at Companies House who would not accept a change in company directorship because one document was in English; a Nicosia municipality who insisted on imposing a punitive event tax on a non-profit organisation; or the tax authorities who have designed an annual tax declaration so complicated that the average PhD student would struggle to complete it.

Any Cypriot could give you myriad examples from their daily lives of the incompetency, intransigence and unhelpfulness of their civil servants. This is not to condemn the people themselves, many of whom are good, friendly folk outside work. Rather it is the culture and mindset of the government apparatus which is to blame. Civil servants are not empowered, they do not have the tools to do the job, and are not incentivised for the right behaviours. This needs to change if Cyprus is truly to succeed.

There is a popular image of a Palestinian carrying an image of Jerusalem on his back, like a turtle with a shell. This is akin to the private sector in Cyprus which is encumbered by the government and civil service, weighing it down and hampering its movement. If Cyprus truly wants to become a hub for investment, then it needs to take steps to modernise the civil service, adopt 21st century practices, and foster an attitude of cooperation and willingness to help.

Then we can really say that Cyprus is open for business.


Cryptocurrency Valuation

For a commodity that is less than ten years old – the first bitcoin was mined as recently as 2009 – the market for cryptocurrencies has been volatile, with wild periods of growth followed by sudden slumps. Nevertheless, the underlying trends are upwards. In April this year, the total market capitalisation for all cryptocurrencies was US $25 billion; two months later that figure had grown to over US $100 billion. There are now over 900 cryptocurrencies available on the internet.

It looks like then that cryptocurrencies are here to stay, but will continue to suffer peaks and troughs in value before markets mature in understanding and transparency. Bitcoin, for example, hit an all-time high over the weekend of US $5,000 a coin, but has since fallen back quite sharply after the Chinese Central Bank announced a ban on organisations raising funds using initial coin offerings (ICOs), which they deem as illegal fundraising. Although this announcement does not affect bitcoin directly, it did inspire negative market sentiment against the virtual currency sector, causing traded prices to drop.

Many experts expect, however, that this is a short-term issue, and the underlying trend for bitcoin is up. In part this is because of its very nature. One of the features of bitcoin is that there is a finite number of them – 21 million – a figure derived from the assumption that people would “mine” (discover) a set number of transaction blocks daily. Every four years, a new cycle of bitcoin is released, which is half that issued during the previous cycle, as does the reward which miners get for discovering new blocks.

This means bitcoin is never subject to inflation – you cannot dilute its buying power by creating more because there is no more available once the 21 million have been released. It is estimated that 94% of all bitcoin will be released by 2024, and that the total supply of 21 million will have been mined by 2140.

One of the areas which is struggling to catch-up with cryptocurrencies is accounting, where governing bodies have yet to provide any definitive guidance on how to account for holdings of bitcoins, or other cryptocurrencies, or transactions denominated in them. In part, this may be due to confusion as to what they are in nature.

Although they are talked about as currencies, some leading economists claim it should not be regarded as cash or an equivalent, because of its inherent price instability, and limitation on the number of transactions that can be traded each day, due to the process of protecting the security of its blockchain. Moves to change the way that transactions are processed have met resistance from those in the bitcoin community who wish to preserve its anonymity and traceability.

And, at a more atavistic level, cryptocurrencies are digital, virtual in nature. You cannot handle a digital coin like you can with one in your pocket or purse.

If treating them as cash or cash equivalents is not suitable, then the alternative is probably to treat holdings as some form of asset. Again there is some resistance from investors and economists to treat a cryptocurrency as a financial asset – one that is held for long-term growth in value – because of its extreme volatility to date. Perhaps the closest approximation then is to treat bitcoin or another virtual currency in the same way that gold or any other commodity is currently classified in financial statements. This would mean that holdings of bitcoin, or the equivalent, would be classified as either inventory or intangible assets.

For businesses that happened to hold a virtual currency or to trade in them as part of its business, this means that the holding would need to be measured at either purchase price or fair value of the goods or services provided at the time of transaction. However, for a virtual currency trader, it would make more sense to measure its digital holdings at fair value through the profit and loss account.

The fact that there is no official accounting guidance yet on how to value cryptocurrencies and transactions denominated in them suggests that regulators and governing bodies are still coming to grips with the issue. However, despite the volatility and negative connotations which are sometimes attached to them, bitcoin and the many other digital currencies now available show no sign of going away, and the recent news that major banks are collaborating in creating their own virtual coinage, shows they are now becoming mainstream. The accounting profession will need to catch up.