CYPRUS-ISRAEL: a one way road to success

The Republic of Cyprus is considered a new arrival in the sector of Oil and Gas exploration and exploitation. The latest studies demonstrate a noteworthy quantity of geophysical data which in combination with the enduring trade environment, the beneficial tax regime, and its geographical position, render the small island of Cyprus a first class destination for hydrocarbon exploration. And even though Cyprus is a newcomer in the Oil and Gas sector, many international Oil and Gas companies have already employed Cyprus to construct tax efficient structures and take advantage of the exceptional geographical position of the island as well as the expert professional services provided in all areas.

The exploration for gas will take part at the offshore blocks provided by the Republic of Cyprus once the successful bidder obtains the necessary license. The Government of Cyprus has presented detailed guidelines as to the procedures to be followed regarding licensing rounds and biddings. Up to date, Cyprus has sanctioned only one Production Sharing Contract which permits Noble Energy International Ltd to explore Block No. 12. The Cyprus Energy Office declared a second licensing round anticipated in 2011 for another 12 offshore blocks.

As regards the downstream sector, the Oil Industry is regulated by the Cyprus Energy Office which manages and preserves oil products stocks and is as well responsible for quality inspections. Since Cyprus is a member of the EU, it is required to preserve oil product stocks in accordance with EU standards and COSMOS (Cyprus Organization for Storage and Management of Oil Stocks) is responsible for making sure that these standards are met. The Gas Industry has moved into a more mature stage as the Republic of Cyprus has been examining the benefits of launching the production and use of Natural Gas. The Energy Centre was created for this reason which among its many tasks will be the import, storage and distribution of oil products as well as providing the facilities for degasification of Liquefied Natural Gas. In addition, the Public Gas Corporation (a private legal vehicle) was founded to perform any other tasks in consistence with the above.

An Oil and Gas company in Cyprus will benefit from the corporate taxation at 10%, the lowest in the European Union and if the Oil and Gas exploration site is considered a permanent establishment (PE), 0% withholding taxes can be levied on exploration and extraction depending on the relevant Double Tax Treaty. In addition, Cyprus applies the International Financial Reporting Standards (IFRS) so as to apply a universal reporting language which allows Oil and Gas companies to have analogous information. The IFRS permits users to have a common ground and more than one hundred countries apply the IFRS, amongst them Cyprus. Reports have been issued by the International Accounting Standards Board and the Financial Accounting Standards Board to address the Oil and Gas Industry. Topics stated include exploration and evaluation, depletion, depreciation and amortization, impairment testing and reversal of impairment. IFRS 6 regulates exploration and evaluation expenditure by adopting a more relaxed approach which permits capitalization of exploration and evaluation costs prior to discovery of commercial reserves.

IFRS do not state a specific method of depreciation and as a result Oil and Gas companies may choose between: (a) the straight-line method (b) the reducing balance method and (c) the Unit-of-production method.

Depreciation begins once an asset is open for use.

What is more, IFRS 6 adopts a more relaxed approach towards impairment testing of non-financial assets and states particular situations and conditions that denote that an impairment test is needed. Examples include: termination of the entitlement to explore, further exploration needed, failure to discover commercial reserves, cessation of activities in the area.

Oil and gas transactions have to follow the laws and regulations of the Republic of Cyprus in all aspects, including meeting the requested security, health and safeguard standards. The sector is basically regulated by the Hydrocarbon (Prospecting, Exploration and Exploitation) Law of 2007 and the Hydrocarbon (Prospecting, Exploration and Exploitation) Regulations of 2007-2009. The Cypriot laws and regulations have sovereignty over the recognized water territory, the continental territory and the Exclusive Economic Zone of the Republic of Cyprus.

The Declaration of the EEZ Law in 2004 defined the exclusive economic zone of the Republic of Cyprus, the outer limit of which shall not extend beyond 200 nautical miles from the baselines from which the breadth of the territorial waters is measured. When an overlap occurs between two neighboring territories, the issue will be resolved by an agreement signed by the Republic of Cyprus and the other State. Cyprus has signed a number of agreements with nearby countries: Cyprus –Egypt (2003), Cyprus- Lebanon (2007), and Cyprus- Israel (2010).

The Government of Cyprus is of the opinion that the EEZ agreement with Israel is one of the most important recently signed agreements on an economical as well as on a political level. Israel has also embraced the agreement with much enthusiasm, emphasizing on how it reveals the tight links and connections between the two neighbors.

In 2009, as a natural gas reserve was discovered in Israeli territories, Israel turned into a natural gas titan and Cyprus expects to follow the same route. Since Block No. 12 and the Leviathan natural gas field are extremely close to each other, the Israeli and Cyprus Governments are examining the idea of a joint venture for gas exploration in the area, a strategy that could maximize the chances for success.

It is also worth mentioning, that investments by Israeli businessmen in Cyprus have multiplied over the past few years. Cyprus is considered to be one of the most promising business forums of the European Union and this is mainly because of its astonishingly beneficial tax regime. Cyprus is regarded as premium finance and trading jurisdiction and this fact seems to have been acknowledged by Israeli investors and businessmen.

• Cyprus has a standard corporate tax rate of 10%, the lowest in the European Union.
• No Capital Gains Tax with the exception of real estate located in Cyprus.
• Tax losses can be carried forward indefinitely and can also be surrendered as group relief. Mergers, takeovers and other re-organizations can take place within groups with no tax consequences.
• Added commercial value and monetary benefits due to the ability to register for EU VAT in Cyprus.
• Unilateral tax-relief for foreign tax suffered is given to all Cypriot companies.
• Interest deduction is provided for borrowing costs.
• A wide Double Tax Treaty Network as well as the EU Directives for advantageous tax planning.
• No withholding taxes, in most cases.
• No thin capitalization rules.
• Absence of strict Controlled Foreign Company Legislation.
• Limited anti-avoidance provisions.
• Friendly Tax Authorities.
• Foreign dividends are tax exempt.

Taking everything into consideration, it is highly probable that the two jurisdictions will embark on joint venture so as to draw valuable investors for their growing gas industry. As in all victorious agreements, each party offers benefits that supplement each other. Israel is able to shelter the reserves and offshore establishments and offers a capital market for Gas corporations. Cyprus on the other hand, has strong international links, EU support, and an advantageous, flexible tax regime. All lead to one conclusion: this is the beginning of a long- lasting political and economical friendship.