Geographical location has rarely been more critical in ensuring an economy’s development than it is in the case of Cyprus. The island in the eastern Mediterranean has burgeoned in direct proportion to the problems of its less stable neighbours. Whether it is Middle Eastern war, Russian instability or central European strife, Cyprus has welcomed those in need of a safe resort, as well as a place to do business with security.

Many of the 50,000 refugees that made the hazardous sea journey from Lebanon to Cyprus during the recent outbreak of violence in the Middle East may have since returned home, but the crisis alerted the world to the island’s hospitality and role of safe haven. Cyprus dug deep to give the refugees shelter: the daily bill for hosting them was reputedly some C£100,000 ($220,000), and the island won plaudits for its humanitarian stance.

Mardig Haladjian, Cyprus-based general manager for rating agency Moody’s, says: “Cyprus has benefited a lot from the troubles in the region and worldwide. The Lebanese civil war in the late 1970s, the break-up of Yugoslavia and the collapse of the Soviet Union were all good for Cyprus. The island has been able to attract international customers who wanted to be close to their home base, but away from disturbance.”

Russians move in

Russian and central European companies have moved there in droves to take advantage of favourable tax and investment incentives. Cyprus now ranks as one of the major sources of foreign investment from Russia. Mr Haladjian says: “Russian companies dealing in oil and gas have parked some of their revenues in Cyprus companies and banks. Russian banks have set up in Cyprus and they are booking transactions in Cyprus. They are attracted by the EU environment.”

Cyprus has also been a convenient base for many private transactions between Israeli and Arab businessmen, at times when political tension would have made publicity about such trade both unthinkable and unwise.

It has responded to the growing demand for a safe haven by liberalising rules of investment for both EU and non-EU nationals. Foreign companies can now invest freely in most areas of the economy (with the exception of the ever-sensitive media) without restriction. The next important step for Cyprus will be to join the eurozone, which is scheduled for January 2008. The country is already a member of the Exchange Rate Mechanism.

The EU had earlier imposed an excessive-deficit procedure against Cyprus. This has now been removed as a result of a tough spending clampdown. Its budget deficit has dropped from 6.25% in 2003 to 2.4% in 2005, well below the permitted EU limit of 3%.

Tax appeal

An attractive tax regime is critical to the island’s appeal to foreign investment. Cyprus has a uniform corporate tax rate and double taxation treaties with more than 40 countries. This brings it in line with EU taxation rules. In 2003, the foreign corporate tax rate was raised from 4.25% to 10%, with the exception of the shipping industry, for which the tax rate has remained at 4.25%.

Harris Kleanthous, manager of the tax department at Ernst & Young in Cyprus, says: “Cyprus has more than 30 treaties in force, which apply to more than 40 countries. These offer reduced rates of withholding tax on dividends, interests and royalties paid from states into Cyprus.

“Together with low tax rates in Cyprus itself and the absence of withholding taxes on dividends and interest payments from Cypriot tax resident companies to non-residents, this makes Cyprus a very attractive jurisdiction from which to hold foreign investments.”

Investor taxes

Further tax factors enhance the island’s attractions to investors. For example, dividend income derived by a Cypriot tax resident company from shareholdings in foreign companies is exempt from income tax. A special defence contribution (SDC) of 15% is levied on dividend income if the shareholding in the foreign company is less than 1%. Mr Kleanthous says that if the shareholding is more than 1%, dividend income is exempt from the SDC impost.

Institutional and private investors have been attracted to the island as a result of its tax structures, says Mr Haladjian. “They view Cyprus as a base from which to invest in Russia, eastern Europe and in the Middle East. The number of international companies based in Cyprus continues to grow. EU membership has enabled Cyprus to establish itself as a reputable base.”

The country is also seeking to develop its mutual fund sector to enable it to compete with Dublin and Luxembourg. One competitive tool will be a series of preferential taxes that are now in the process of passing through the legislature, which will benefit fund managers setting up on the island.

Foreign investors are being encouraged to participate in the island’s burgeoning high-tech and biotechnology sectors. Full ownership of Cypriot companies makes this attractive. The island has forged three important schemes to develop its high-tech sector. They include an agreement with the Harvard School of Public Health to assist in the development of a local public health institute, the establishment of four business incubators and a link-up with the French Riviera Chamber of Commerce and Industry to establish a technology park in Cyprus.

Foreign investment in Cyprus, which currently exceeds $1bn a year, is facilitated by the Foreign Investors Services Centre (FISC), an arm of the Ministry of Commerce, Industry and Tourism. This serves as a one-stop shop for investors.

George Tsiamettis, commercial and industrial officer at the FISC, says: “The centre focuses on the development of high technology products, the enhancement of research and development, and technology transfer.”

Recent investors in Cyprus include UK software company GFI, Lebanese telecoms company Scancom and German retailer Lidl.

Shipping boom

Two other sectors have furnished Cyprus with much-needed foreign currency: shipping and foreign exchange. The shipping registry ranks ninth in the world, with almost 2000 vessels. European owned and managed ships provide the majority of clients. Improvement in the quality of the registry will raise income from this sector.

The island is also a transit base with a throughput of 333,000 boxes. It is investing heavily in ports infrastructure, although the sector’s expansion is inhibited by a Turkish embargo. The Cypriot government is seeking to counter this by expanding the Limassol port, and a new passenger terminal is due for completion in 2008.

In terms of tourism, the Cyprus government has offered incentives to firms building golf courses in a bid to create the infrastructure for a high-quality tourism sector. France, Germany and Italy provide most tourists to Cyprus, although the number of Russians has grown since the island joined the EU and visa restrictions were lifted.

Foreign direct investment into Cyprus originates primarily from EU countries (41%). Other European countries account for 21%, and 8% of FDI comes from the Middle East.

Educated workforce

A highly educated population has made Cyprus particularly attractive to companies involved in the service sector, says John Shekeris, commercial counsellor at the Cyprus High Commission Trade Centre. “Cyprus has a very high proportion of young people with university degrees,” he says. “Many have qualifications that are suitable for work in commerce, like law and accounting degrees.”

This may explain why Cyprus has a large number of legal and accounting and audit firms. The country started audit monitoring for audit firms in January 2005, ahead of the EU schedule, which allows each EU country two years to introduce its own legislation complying with the Audit Directive.

Financial services now account for 76% of the island’s GDP, says former minister of finance Makis Keravnos. “Cyprus has been gradually transformed from a country dependent on the primary sectors to a fully fledged export-oriented service economy.’