Cyprus tax. Drawing by Dan Pototsky

Drawing by Dan Pototsky. Click to enlarge the image.

Yawn! Cyprus is a tiny country, who cares what happens there? Well if you’re a Russian with a fair bit of cash squirreled away in the island’s banks, you most certainly do. In fact, even if you don’t have any deposits parked there, chances are the chain reaction from the European Union’s intended Great Bank Robbery could one day hit your finances too.

For years, Russians have treated Cyprus like their own private little Switzerland. They have collectively pumped in more than $31 billion into Cypriot banks, boosting the local economy and turning the idyllic island into an upscale playground. But now it has all come unstuck.

The EU’s cash grab

Cyprus is the latest addition in the long line of insolvent European countries – Portugal, Ireland, Greece and Spain – needing a bailout from the wealthy northern Europeans (for “northern,” read Germany). The Eurogroup’s intended solution was simple: it would provide nearly $13 billion in bailout money to help the Cypriot government pay its bills and avert a banking collapse.

But there was a hitch – in exchange, the EU’s bosses also wanted Cyprus to pick up part of the tab by levying a one-off tax on bank deposits of up to 9.9 percent. Basically, if you had a deposit of, say, $100,000, you would get a $10,000 haircut.

The plan is in limbo, however, as Cyprus’s parliament has refused to back the idea – voting it down on Tuesday by 36 votes to 0, with 19 abstentions. Instead, Cyprus’s finance minister travelled to Moscow, to assure the Kremlin about Russian depositors’ money – and presumably to explore the possibility of an alternative “bailout.”

Of all the nations that came knocking at Brussels’ door with a begging bowl, why did the EU single out Cyprus for such harsh treatment? The answer is simple: over 40 percent of the depositors in Cyprus banks are Russians and, therefore, easy targets.

The EU banking bureaucrats evidently believe most of these Russian account holders are illegitimate, so that relieving them of a tidy amount will not hurt the good gentry of Europe. But if you go back a little in history, you’ll find that the same set of people applied the same logic to sponge off Asia, Africa and the Americas.

Why are Russia’s leaders worked up?

The popular belief is that if Russian money travels outside Russia it must be tainted – by the mafia, graft, uranium smuggling or something like that. But in reality most of the money belongs to Russian companies. In fact, both private and state-run companies use Cyprus as a tax haven because the country has a corporate tax rate of 10 percent, which is 50 percent lower than Russia’s.

Here is how it works: Russian investors wire the money to shell companies in Cyprus. The money is then repatriated through investments in Russian ventures at home and abroad. According to data from Russia’s Central Bank, Cyprus is the leading source of foreign investments into Russia.

Believe it or not, this is standard global practice these days. The United States uses Puerto Rico in a similar way, and the role of Mauritius to pump investments into the Indian stock market and Indian Premier League cricket matches is well known.

A U.S. Senate investigation last year revealed how dozens of American tech companies move their profits offshore to evade the taxman. Microsoft has shaved nearly $7 billion off of its U.S. tax bill since 2009 by using such loopholes.

Similarly, Hewlett Packard avoided paying taxes through a series of loans that shifted billions of dollars between two offshore subsidiaries.

The $31 billion in Russian deposits belongs to corporates, banks and individuals. Cyprus offers them anonymity and ease of banking in their day-to-day business and personal lives. A 10 percent levy would amount to a $3 billion loss that could directly impact the Russian economy.

This is why Russia’s president, Vladimir Putin, this week slammed the move as “unfair, unprofessional and dangerous.” Indeed, if the Russians knew the money was tainted – and you can bet the FSB is keeping a watchful eye on the cash pipeline and every tax-dodging businessman taking his money out of the country – there’s no way Putin would have associated himself with it.

As for corrupt Russian individuals and the mafia parking their ill-gotten gains in Cyprus, there’s no evidence to prove they aren’t there. But wouldn’t the mafia find more secretive havens like Switzerland or Britain’s Isle of Man? In fact, last year over $200 billion was wired out of Russia, but only a fraction of that reached Cyprus.

A dangerous precedent

Mikhail Prokhorov, the metals magnate-turned-liberal politician, wrote in Kommersant that Europe “has opened a Pandora’s box, creating a dangerous precedent in deciding the problem of the capitalization of the banking system in problem countries.”

Prokhorov noted that he held no money in Cypriot banks. Nobody in his right mind would call him a crook.

Alexander Lebedev, who owns major newspapers in London, said Cyprus was also a transit point for criminal money leaving Russia so such a tax doesn’t really affect transit. But he added, “There are fears for the middle class, who also used Cyprus.”

The proposed tax needs to be approved by the Cypriot parliament. But with ordinary – and hurting – Cypriots hitting the streets in large numbers, a vote in favour of the EU deposit tax seems unlikely. But if the tax does go ahead, it would be akin to holding a banner warning “You Are Next” to the PIIGS countries. It could lead to an irresistible run on the banks. Note that banks in Cyprus were closed on Tuesday and Wednesday to prevent precisely that.

Trouble in Europe will also impact nations that export to the world’s biggest single market. India’s rupee dropped to 54.2725 per dollar on Monday, the most in two weeks. This is the kind of news that the global economy, which is limping back from the recession, can do without.

The amazing thing about this “bailout” is that ordinary people are being made to foot the bill for the negligence of bankers and European regulators who were clearly sleeping on the job. It makes you wonder how long such abuse can go on before people take matters into their own hands.

Europe’s leaders appear to be playing a dangerous game with the people they lord over. So far, Cypriot lawmakers are holding out against this blackmail. The denouement is not yet clear – but Russia may very well end up being part, not of the problem, but of the solution to the crisis.

Rakesh Krishnan Simha is a New Zealand-based columnist for Russia Beyond The Headlines.

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  1. EU's cash grab
  2. A dangerous precedent