Greece risks losing tax revenues from relocations

The European Union’s enlargement to the east more than two years ago has not really been felt as much as the Greek pessimists feared, or the optimists hoped. Yet, the Greek government may stand to lose large sums in tax revenues if local companies start relocating to Cyprus as some analysts and businessmen think will inevitably happen, assuming the current tax gap between the two countries is not bridged sufficiently. Greece was among the strongest proponents of the EU’s enlargement to Eastern Europe a few years ago for various reasons. The accession of Cyprus, one of the 10 new entrants, into the powerful economic group was one of them and what is perhaps most important for political reasons is finding a fair solution to the thorny Cyprus problem which has hurt Greek-Turkish relations for decades. At the time, May 1, 2004, Cyprus commanded the highest per capita income, the highest labor costs and the second-lowest corporate tax rate among the new entrants, according to comparative statistics. Apart from Cyprus, the EU’s enlargement was hailed by some in Greece as a great step in the right direction. It opened up new markets and led to a more efficient allocation of resources, as labor intensive production was going to move eastward, freeing up labor resources in the «old» EU-15 to be employed in more productive activities. The enlargement was not supposed to cause havoc in the «old» block because the combined GDP of the new entrants was very low compared to the economic pie of the EU-15. The increase in the EU’s population was much bigger but studies showed the immigration impact would be relatively small since many of the new entrants had assigned agreements with the EU in the last decade to facilitate the transfer of goods and services and remove many trade barriers. At the time, Greek skeptics of the enlargement pointed out these studies on immigration trends were based on the EU’s earlier expansion toward the Iberian peninsula. Therefore, they argued, the studies were not relevant for countries like Greece, which experienced a mass influx of illegal immigrants after the collapse of the Soviet Union. In general, their concerns were not vindicated in the two years that have passed. Even the final outcome from the allocation of EU structural funds, known as the Fourth Community Support Framework (CSFIV) – to span the period 2007-2013 – turned out to be much better for Greece than anticipated by critics of the enlargement. The country secured some 20 billion euros in the relevant negotiations and a two-year extension for the delays that had plagued CSFIII. It definitely got a smaller amount than it otherwise would have received had the new members not entered the EU but was still satisfactory given the new reality. What the critics and proponents of the EU’s expansion had likely underestimated then was that a growing number of local companies thought of moving to take advantage of the much lower corporate and personal tax rates found in Cyprus by seeking to establish subsidiaries there and even relocate their headquarters. Cyprus may not be the only tax paradise near Greece. Neighboring countries aspiring to soon enter the EU have also cut their corporate tax rates aggressively in the last few years to become more competitive in attracting foreign direct investment (FDI). However, Cyprus is already an EU member, it offers favorable tax treatment to companies and individuals relocating there and Greek is spoken, making some feel more comfortable. Of course, 40 percent or so of the island is under Turkish occupation but the political risk factor has been less important since Cyprus entered the EU, giving hope to a permanent settlement to unite the two sides, Greek and Turkish, on the island. The famous offshore companies may be a thing of the past but the 10 percent corporate tax rate levied in Cyprus is something Greek companies cannot ignore, even after the Greek corporate tax rate falls to 25 percent, following a three-year plan of gradual reductions instituted in 2004 by the conservative government. To be fair, a number of Greek companies, including state-controlled organizations, had set up offshore companies in Cyprus over the last decade to take advantage of the island’s lower taxation. Some businessmen admit in private they did so to avoid bringing the dividends paid by their subsidiaries abroad to Greece where dividends are still taxed at a rate of 35 percent. In so doing, they managed to lower their tax bill, causing the Greek state to lose hundreds of millions in tax revenues in the process. Others say they chose this to be able to pay bonuses to third parties they did not want the Greek authorities to know about. Even though more and more local companies follow the same route by setting up subsidiaries in Cyprus, the Greek government may be forced to take a harder look at this trend in the months or years ahead since a number of high-profile companies have reportedly looked into the possibility of being incorporated in Cyprus while keeping their productive activities in Greece. There have been reports in the local press lately that Marfin Financial Group, which controls a major Cypriot bank and a few smaller companies in Greece, may be among the first to make such a move. The much lower corporate tax rate may not be the only reason for a company to relocate to Cyprus. The amount of personal income that is not taxed exceeds 17,500 euros when the corresponding amount in Greece is 11,000 euros. Moreover, the highest personal tax rate on the island is 30 percent instead of 40 percent in Greece and applies to incomes above 35,000 euros, compared to 23,000 euros here. In addition, the personal income tax scale is much more progressive in Greece, that is, the higher the income, the more taxes are taken out, than in Cyprus. In addition, VAT (valued-added tax) is 15 percent on Cyprus, compared to 19 percent here for most goods and services. It is an irony that the Greek government may lose more and more in tax revenues by local companies setting up subsidiaries in or relocating their headquarters to Cyprus, the country it supported the most in getting into the EU. The only viable solution to this problem is to offer them the same carrot as the Cypriots: more competitive tax rates. To engage in other tactics, such as harsher treatment of the companies in their dealings with the Greek state, as some officials point out, would be quite counterproductive.