Definition of Institutions and Acquisition of Legal Personality

The term institution is defined by The Societies and Institutions and other related Matters Law of 2017 (104(I)/2017), as amended (the “Law”), as the aggregate of property that is intended to serve a certain non-profit object and for its establishment, the worth of the dedicated property cannot be less than One Thousand Euro (€1,000) (section 2 of the Law).

Institutions acquire legal personality as of the date of their registration in the Register of Institutions (the “Register”) by the competent District Officer of the relevant district who is responsible in relation to any matters in connection with the registration and operation of Societies, Clubs and Institutions, and the issuance of the relevant registration certificate (the “Registrar”) (sections 2, 5 and 26(1) of the Law).

Registration of Institutions

For the purposes of establishment and registration of an Institution, a written application by the founders or the trustees of a trust or the executors of a will, must be filed with the Registrar in the prescribed form and shall be accompanied by the constituent deed, as well as by the articles of association of the Institution.

The constituent deed and articles of association must stipulate and/or include at least the following:

• The Institution’s name, object(s) and registered office;
• The emblem of the Institution (if any);
• Detailed reference to the mode of operation and/or administration of the Institution;
• The aggregate of the Institution’s property;
• The names and addresses of the members of the Institution;
• The names and addresses of the members of the Board of Directors of the Institution;
• The manner of succession of the members of the Board of Directors of the Institution;
• A provision according to which no remuneration of any kind whatsoever shall be paid to any founding member or officer or member of the Board of Directors of the Institution with regards to any services provided by them (sections 26(2) and 27(2) of the Law).

The Registrar shall proceed with the examination of the relevant application for the institution’s registration, without any delay, and in any event within three (3) months as of the date of submission of the relevant application and all the necessary, duly filled in forms and documentation (section 26(2) and 26(4) of the Law).

Provided that the requirements under the applicable Law are met, the Registrar will proceed with the registration of the institution in the Register of Institutions and the issuance of the relevant registration certificate in the prescribed form. The registration certificate shall be published in the Official Gazette of the Republic and will constitute conclusive evidence of the date of registration of the institution and of compliance with all legal requirements (section 26(5) of the Law).

Objects of Institutions

An institution may be established and registered by the Registrar, provided that the main objective thereof is to achieve one or more of the following objects (section 26(3) of the Law):

• The combat and/or alleviation of poverty;
• The promotion of education;
• The promotion of health and/or saving lives;
• The promotion of the community’s and citizens’ development;
• The promotion and/or flourishing of arts, culture, cultural heritage or science;
• The promotion of amateur sports;
• The safeguard and protection of human rights, the promotion of dispute resolution or reconciliation, as well as the promotion of religious and/or ethnic harmony, equality and diversity;
• The protection and/or safeguard of the environment;
• The relief of needs arising out of young or advanced age, health problems, disability, financial hardship or other disadvantage;
• The promotion of animal welfare and protection;
• For the achievement of any other object that benefits the public in general, or for the achievement of any purpose which is considered to be relevant to any of the aforementioned objectives.

Administration of Institutions

Institutions must be administered by a board of directors consisting of at least three (3) members. Unless otherwise provided in the articles of association of the Institution, their decisions are taken by a simple majority of the members of the board of directors present at the meeting and, in the event of tied vote, the president of board of directors’ meeting shall have a casting vote (section 32(1) of the Law).

In case an institution is administered by three (3) persons, the presence of all three (3) persons is required for quorum purposes (section 32(1) of the Law).

Obligations of Institutions

The members of the board of directors of any institution are bound to keep accurate and detailed books of account where all accounts of money received and paid on behalf of such institution shall be recorded and shall also, at the end of each financial year, prepare the following accounts:

• an account of the gross income of the institution during the financial year;
• an account of any surplus in hand at the commencement of the financial year and of all moneys received during the same year on behalf of the institution;
•  an account of all money owing to or from the institution and an account regarding all payments made during the same financial year (section 49(1) of the Law).

The members of the of the board of directors of an institution are obliged to submit to the Registrar, at the latest within seven (7) months from the end of each financial year, the accounts and relevant report prepared by a certified auditor.

Definition of Societies and Acquisition of Legal Personality

Society is defined by The Societies and Institutions and other related Matters Law of 2017 (104(I)/2017), as amended (the “Law”), as an organised association of at least twenty (20) persons that is established for the accomplishment of a common objective (section 2 of the Law).

Societies acquire legal personality as of the date of their registration in the Register of Societies, Clubs and Institutions (the “Register”) by the competent District Officer of the relevant district who is responsible in relation to any matters in connection with the registration and operation of Societies, Clubs and Institutions, and the issuance of the relevant registration certificate (the “Registrar”) (sections 2 and 5 of the Law).

Registration of Societies

For the purposes of registration of a Society, a written application must be filed with the Registrar by the board of directors of the society or the founding members thereof. The aforesaid application shall be accompanied by the Articles of Association of the society which must be executed by its founding members and bear an execution date, and the relevant forms including information as the names, addresses and contact details of the founding members and the members of the society’s board of directors, copy of the emblem of the society (if any) and a description of the immovable and movable property belonging and/or possessed by the society at the time of registration thereof and/or any immovable and movable property that is to be transferred to the Society after its registration in the Register (section 7(2) of the Law).

The Registrar shall proceed with the examination of the relevant application for the society’s registration, without any delay, and in any event within three (3) months as of the date of submission of the relevant application and all the necessary, duly filled in forms and documentation (section 7(4) of the Law). Provided that the requirements under the applicable Law and regulations are met, the Registrar will proceed with the registration of the society in the Register and the issuance of the relevant registration certificate upon payment of the prescribed fee (section 7(4) of the Law). The registration certificate shall be published in the Official Gazette of the Republic and will constitute conclusive evidence of the date of registration of the society and of compliance with all legal requirements.

Articles of Association of Societies

The Articles of Association of a society shall be deemed as acceptable for registration purposes, provided that this includes and/or addresses the following matters:

• The Society’s name, object(s) and registered office, which shall be located in the areas controlled by the Republic of Cyprus;
• The society’s resources;
• The terms of admission, resignation, expulsion of members, and the rights and duties of the society’s members; 
• The manner and the body of representation of the society in Court and out-of-Court cases;
• The terms of alteration and/or modification of the Articles of Association of the society;
• The manner of auditing of the society’s accounts, in accordance with the principle of transparency;
• The terms relating to the convocation and holding of the meetings of the society’s members, the manner the decisions are taken, as well as the term that a members’ meeting is held at least once, on an annual basis;
• The administrative body of the society, the process of election of its board members, the term for which the members of the board will remain in office, the terms of formation and operation of the administrative body, the dismissal of its members and the frequency of their meetings;
• The terms relating to the society’s dissolution and/or merger with another society, as well as terms in relation to the utilisation and/or exploitation of the society’s property in case of dissolution thereof, as such property cannot be distributed to the society’s members.

Administration of Societies

Societies must be administered by a board of directors consisting of at least five (5) members, who, unless otherwise provided in the Articles of Association of the society, shall also be members of the society. Decisions are taken by absolute majority of the members that are present in the meetings, unless otherwise provided in the society’s Articles of Association (section 16(1) of the Law).

Provision of services without the payment of remuneration

No remuneration shall be payable to the members and/or administration members of the society in relation to any services they may provide to the society, unless otherwise provided in the society’s Articles of Association (section 18A of the Law).

Membership is non-assignable

Membership in societies is not eligible of representation, and cannot be assigned and/or inherited (section 15 of the Law).

On April 24, 2013, the Council of Ministers approved the policy for the issue and renewal of Temporary Residence and Employment Permits for third country nationals employed by International Business Companies / Companies of Foreign Interests operating in the Republic of Cyprus (the “Policy”). The said Policy was introduced as an incentive to attract investors for transferring and/or establishing their businesses in the Republic of Cyprus and, to this end, it afforded -those eligible to take advantage of its provisions- with a series of benefits, including the employment of a relatively large number of high-skilled third-country nationals in particular professions and/or businesses through an expedited admission procedure, which may not require the receipt of any consent(s) and/or approval(s) of any other services and/or authorities.

In view of the demanding framework with regards to investment programs of any kind and in the course of applying stricter criteria for the admission of third country nationals in the Republic of Cyprus on that basis, the Policy has been amended on October 7, 2020 following a proposal to this end submitted to and approved by the Council of Ministers (the “Revised Policy”). Retrieving from the Revised Policy, a Third Country National may apply for a Temporary Residence and Employment Permit in the event that he will be employed by an International Business Company / Company of Foreign Interests having physical presence and operating in the Republic of Cyprus provided that the employer meets certain qualification criteria:-

1. The majority (51%)* of the employer – company’s shareholders are foreign shareholders. The following cases are excluded:

–          Public companies registered in any recognized stock exchange

–          Former offshore companies that were operating in Cyprus by approval of the Cyprus Central Bank, before the change of their offshore status.

–          Cypriot shipping companies.

–          Cypriot companies of high technology / innovation, that will be certified by the Deputy Ministry of Research, Innovation and Digital Policy based on the applicable framework.

–          Cypriot pharmaceutical companies or companies operating in the fields of biogenetics and biotechnology.

–          Persons who have acquired Cypriot citizenship by naturalization based on economic criteria, given that they will prove that the conditions under which they were naturalized are still met.

2. The percentage of foreign shareholding stake in the employer – company must represent an amount equal to or greater than the amount of the required direct foreign capital investment.

3. The direct foreign capital investment must amount to at least €200.000,00 (for the prescribed purposes) and must be legally brought in Cyprus form abroad (through the prescribed means).
4. The employer – company should operate from its self-contained offices in Cyprus; to be more precise, the employer – company must have physical presence in Cyprus.

Nonetheless, an approved International Business Company (of foreign interests) has the right to employ a certain number of foreign nationals in official or key positions, such as directors, managers, middle management executives and other key personnel; such employees may be employed in any of the following key-positions:

(a)   Directors (Directors or Partners registered in the Registrar of Companies and Official Receiver; General Managers of branches and of mother companies of alien companies; Departmental Managers; Project Managers) with minimum gross monthly salary at €4.000,00 (subject to periodical adjustments depending on fluctuations in the wage index).

(b) Middle management executives and other key personnel (upper / middle management personnel and other administrative, secretarial or technical staff) with minimum gross monthly salary in between €2.000,00 (subject to periodical adjustments depending on fluctuations in the wage index).

(c) Specialists in specific fields (Software and System Engineers, Application and Data Architects, Information and Communication Technology and Enterprise Solution Architects, Technical Assurance Professionals, Telecom and Space Engineers, Data scientists, Machine Learning Engineers, Web Developers and designers, UX User Experience Professionals, Quantitative Analysts, Quality Assurance Analysts, Mobile Application Developers, Augmented Reality/ Virtual Reality Programmers, Digital Marketing Specialists, Video Production Multimedia Specialists for Mobile Apps and Software, Analysts for Mobile Apps and Software, Designers of Prototype for Mobile Devices, DevOps Engineers, Cyber Security Specialists, Artificial Intelligence, Robotics and Big Data Specialists, Pharmaceutical Formulation Technologists, Pharmaceutical Engineer Validation Specialists, Pharmaceutical Patents Specialists, Pharmaceutical Regulatory and Quality Assurance Professionals, Marine Engineers, Naval Architects) with minimum gross monthly salary in between €2.000,00 (subject to periodical adjustments depending on fluctuations in the wage index).

(d)   Support staff; if it is proved that there are no qualified Cypriots or European citizens available, the employer – company may employ, through the standard procedure established for General Employment, third country nationals in posts in this category.

Overall, the Revised Policy introduced some ‘minor’ amendments for enhancing its application by persisting and emphasising on the employers’ business and physical presence. The amendment of the previous Policy was imperative in view of the need to ensure its proper implementation by filling in any gaps that could operate in a way that would facilitate the misuse of the procedure.

The position under Cyprus law with regards to the registration of an encumbrance over shares in a Cyprus company has recently been clarified following an opinion provided by the Attorney-General of the Republic of Cyprus; more explicitly, in accordance with the contents of the announcements dated 08/01/2019 and 15/03/2019, (which are available online under the ‘News’ section on the official webpage of the Department of the Registrar of Companies and Official Receiver of the Republic of Cyprus) it has been clarified that the procedure with regards to the registration of an encumbrance pursuant to s.90 of the Companies law, Cap. 113 (hereinafter “Cap. 113”) does not apply to encumbrances concerning the pledge of share certificates of companies registered in Cyprus, or any other encumbrances emanating therefrom. In other words, any such encumbrance concerning shares of companies registered in Cyprus is not capable of registration in the Register of Encumbrances kept at the Department of the Registrar of Companies and Official Receiver of the Republic of Cyprus. On the contrary, an encumbrance over shares of a foreign company is capable of registration in the said register pursuant to the provisions of s.90 of Cap. 113.

Subject to the abovementioned clarification with regards to an encumbrance over shares in a company registered in Cyprus, pursuant to s.90 of Cap. 113, in order for any encumbrance to be valid as against any liquidator and/or any creditor of the company in question, such encumbrance has to registered following the procedure envisaged pursuant to the provisions of s.90(1A) of Cap. 113, in the relevant Register of Encumbrances kept at the Department of the Registrar of Companies and Official Receiver of the Republic of Cyprus. In the context of a pledge over shares, having regard to the abovementioned clarification, the procedure envisaged under s.90 of Cap. 113 only applies to a pledge over shares of a foreign company.

In such a case, it is worth noting that Cap. 113, and in particular s.91 thereof imposes upon the company a duty to deliver to the Registrar of Companies for the purpose of registration, the details of any encumbrance performed by the company and which requires registration on the basis of the procedure envisaged under s.90 outlined hereinabove. In the event of a pledge on shares of a foreign company, within twenty one days from the date such encumbrance came into existence, the company must provide the Registrar of Companies for the purposes of registration, details of the encumbrance, the duly certified instrument evidencing such encumbrance, the date the encumbrance came into effect, the amount secured by the encumbrance, details of the encumbered property and details of the persons for whose benefit the encumbrance shall be registered. Upon such registration, the Registrar of Companies shall proceed to issue a certificate of registration of encumbrance stating the amount secured by such encumbrance in accordance with s.93(2), and the said certificate shall constitute conclusive proof that the registration of the encumbrance was made in compliance with the provisions of Cap. 113.

A copy of any instrument evidencing the existence of such an encumbrance requiring registration must be kept at the registered office of the Company in accordance with the provisions of s.98 of Cap. 113. In addition the Company must keep at its registered office a register of encumbrances on which all encumbrances specifically affecting the assets of the company and all floating charges on the business or any property of the company shall be recorded providing a brief description of the property that is subject to the encumbrance, the encumbrance amount and the names of the persons for the benefit of whom the encumbrance was registered (s.99(1) of Cap. 113). The register of encumbrances kept by the company should be open for inspection during normal business hours by any creditor or member of the company free of charge, as well as by any person upon payment of a nominal fee determined by the Company pursuant to the stipulations of s.100(1) of Cap. 113.

On the other hand, if the encumbrance in question concerns a pledge over shares in a company registered in Cyprus, recourse must be had to s.138 of the Contracts Law, Cap. 149, pursuant to which any pledge in respect of share certificates as security for the payment of a debt or fulfilment of an obligation is only valid and enforceable provided that the pledge agreement is made in writing and signed by the pledgor in the presence of two witnesses signing the same. Going further, the validity of such a share pledge shall rest on the fulfilment of the following conditions, namely that (a) the pledgee sends to the company a notice for the creation of the pledge along with a certified copy of the pledge agreement, (b) the Company registers such pledge to the Register of Shareholders as against the shares in which such notice relates and (c) the Company delivers to the pledgee a certificate evidencing the registration of the pledge in accordance with the foregoing.

Taking advantage of the flexibility provided by EU Directive 2011/61/EU which provides that Members States may apply a lighter regime for sub-threshold AIFMs, a new legislation titled the “Law which provides for the Incorporation and Operation of Small Alternative Investment Fund Managers” came into force on the 3rd of July 2020 (the “Law”).

According to the Law, small AIFMs, also known as “Mini Managers”, can be set up in the form of a limited liability company pursuant to the provisions of the Law and of the Companies Law Cap. 113. The sole activities of a Mini Manager shall be the management of Alternative Investment Funds (“AIFs”) as defined in article 6(5) of the AIFM Law and its registered office and central management shall be based in the Republic of Cyprus.

The Law applies to:

(A)    Mini Managers of the Republic of Cyprus (also known as “Cypriot Mini Managers”);

(B)    Mini Managers of a Member State;

(C)    Cypriot Investment Services (CIFs) that received CySEC’s permission for managing AIFs.

Cypriot Mini Managers and CIFs can be appointed as external managers for the following AIFs:

(a)    AIFs that are incorporated and operate in the Republic;

(b)    AIFs that are incorporated and operate in a Member State, other than the Republic, or in a third country, provided that this is permitted by the law governing such AIFs;

(c)     AIFs with a Limited Number of Persons (“AIFLNPs”);

(d)    Registered Alternative Investment Fund (“RAIFs”) – as per article 135 of Law which provides for the Alternative Investment Funds and other Related Matters.

As external manager for (a), (c) and (d) above can also be appointed a Mini Manager of other Member State.

The main characteristics of Mini Managers include the following:

(a)    Initial Capital:

Cypriot Mini Managers that apply to CySEC for a license, shall have a minimum initial paid up capital /own funds of EUR50.000 (Fifty Thousand Euros).

Where the value of the portfolios of AIFs managed by the Cypriot Mini Manager exceeds EUR125.000.000 (One Hundred Twenty Five Million Euro), the latter shall provide an additional amount of own funds which shall be equal to 0,02% of the amount by which the value of the portfolios of the Cypriot Mini Manager exceeds EUR125.000.000 (One Hundred Twenty Five Million Euro).

(b)    Board of Directors and Senior Management:

The Board of Directors of a Cypriot Mini Manager consists of at least 4 (four) individuals out of which 2 (two) shall perform executive duties.

(c)     Shareholders:

The shareholders or members of the Mini Manager that have qualifying holdings, are suitable taking into account the need to ensure the sound and prudent management of the Cypriot Mini Manager.

(d)    Offices:

The head office and the registered office of the Mini Manager are located in the Republic of Cyprus.

(e)    Permitted Activities:

        i.           Portfolio management and risk management;

       ii.            Management of the AIF which includes:

• legal and fund management accounting services;
• customer inquiries;
• portfolio valuation and pricing, including tax returns;
• regulatory compliance monitoring;
• maintenance of unit/shareholder register;
• distribution of income;
• unit/shares issues and redemptions;
• contract settlements, including certificate dispatch;
• record keeping;

     iii.            marketing;

     iv.            activities related to the assets of the AIF, namely services necessary to meet the fiduciary duties of the Mini Manager, facilities management, real estate administration activities, advice to undertakings on capital structure, industrial strategy and related matters advice and services relating to mergers and the purchase of undertakings and other services connected to the management of the AIF and the companies and other assets in which it has invested.

(f)     Delegation of functions:

Subject to the following conditions, a Cypriot Mini Manager may delegate to a third person one or more of its managing functions:

         i.            the Cypriot Mini Managers has notified CySEC in writing about the subject delegation, before such delegation comes into force;

       ii.            such delegation does not prevent the effective supervision of the Cypriot Mini Manager and more importantly it does not hinder the operations of the AIF;

     iii.            the Cypriot Mini Manager does not delegate its functions to an extent that would result for it not to be considered as the manager of the AIF.

     iv.            In case where the delegation concerns the management of portfolio or the risk management, such delegation shall be allowed to be made only to entities that received license for asset management pursuant to article 78 of the EU Regulation 231/2013 or to entities received the prior approval of CySEC.

(g)    Licensing:

A Cypriot Mini Manager is allowed to manage AIFs only upon receiving CySEC’s relevant authorisation.

In order to be duly authorised, a Cypriot Mini Manager, shall submit an application for authorisation to CySEC accompanied by the following:

1. Information on the persons effectively conducting the business of the Mini Manager;
2. Information on the identities of the Mini Manager’s shareholders or members;
3. Business Plan and internal regulations setting out the organisational structure of the Mini Manager including information on how the latter intends to comply with its obligations;
4. Information on arrangements made for the delegation of functions to third persons pursuant to the provisions of articles 23 and 25 of the Law;
5. Information about the investment strategies, the risk profiles, the use of leverage and other characteristics of the AIFs it manages or intends to manage, including information about the member states or the third countries in which such AIFs are established or are expected to be established.
6. Information on where the master AIF is established if the AIF is a feeder AIF;
7. Information on the arrangements made for the appointment of the depositary – in case this is required by the applicable law governing the said AIF.

(h)    Transitional provisions:

CIFs that, prior to the entry into force of this Law, received CySEC’s authorisation pursuant to the provisions of the “Law which provides for the Provision of Investment Services, the Exercise of Investment Activities, the Operation of Regulated Markets and Other Related Matters of 2007 to 2016” or “the Law which provides for the Provision of Investment Services, the Exercise of Investment Activities, the Operation of Regulated Markets and Other Related Matters of 2017 to 2020 for the management of AIFs, are considered to be Mini Managers and may continue to provide such activities provided that within 9 months from the entry into force of the Law, they shall take all necessary measures to comply with the provisions of the Law.

For this purpose, prior to the lapse of the 9 months, the mentioned CIFs shall inform CySEC about the compliance measures taken or to be taken by them and submit a written confirmation by their Board members in regard to their compliance with the provisions of the Law.

In case of non-compliance with the above within the set deadline of 9 months, the mentioned CIFs will not be allowed to provide management functions pursuant to the provisions of the Law.

As a general principle, it is not possible for a Cyprus company to buyback and, thus, own or to cancel its shares. Nevertheless, a public company is exceptionally permitted to own its own shares; according to sections 57A – 57D of Cap. 113, the ability of a public company to acquire its own shares is possible although such acquisition is still subject to a series of conditions set forth by the Law. However, this is not the case for a private company that is not allowed to buy and/or otherwise acquire and hold its own shares; this may only be effected, indirectly.

At first instance, a private company may be able to acquire and hold its own shares through the procedure of forfeiture of shares. Subject always to the provisions of the Articles of Association of each particular company, the mechanism of forfeiture may employed in cases the holder of one or more shares in a company fails to comply with a condition or meet an obligation under which the share or shares, as the case may be, in question, was / were issued to that person. That said, it should be stressed that the Companies Law, Cap. 113 makes no reference to the power of the company to forfeit any of its issued shares; instead, it is left open to each company to incorporate (or not) the mechanism of forfeiture as well as its particulars in its Articles of Association. In this regard, the Model Articles of Association included in Part I of Table A of the Companies Law, Cap. 113 provides for a specific mechanism, according to which the company’s Board of Directors may forfeit the share(s) of a member only in the case the said member “fails to pay any call or instalment of a call on the day appointed for payment thereof”. Given that, although, the Model Articles of Association included in Part I of Table A does not necessarily apply in all cases, the forfeiture mechanism can be interpreted in a more broad and liberal, but always reasonable, way and thus, the particulars thereof can be adjusted to the specific needs of each particular company.

In any event, however, following the exercise of forfeiture, the forfeited shares (free of any rights for the benefit of the holder for so long as these are held by the company) may be held by the company for an indefinite period of time while such forfeited shares are considered, in essence, as forming part of the unissued share capital of the company and, thus, may at any time be sold (issued), re-allotted, cancelled or otherwise disposed of at the discretion of the Company. That said, in view of the fact that forfeited shares will be treated as unissued shares, it becomes apparent that the forfeiture of shares could therefore be considered as equivalent to the cancellation of shares out of the company’s issued share capital.

That notwithstanding, depending on the circumstances of each particular case, the forfeiture of shares may not be the proper way to achieve the desired result. To be more precise, despite that the forfeiture of shares may serve the purpose of cancelling issued shares leading in their inflow to the company’s unissued capital (but not the transfer thereof in the ownership of the company), this may also be effected through their direct cancellation by way of reduction of the issued share capital of a company. However, the cancellation of issued shares in that way is a bit complicated in the sense that the legitimizing basis of the cancellation must be well-justified.

More specifically, in so far as the reduction of the share capital of a company is concerned, section 64 of the Companies Law, Cap. 113, provides an indicative list of reasons on which a company could rely for the reduction of its company’s share capital:

(a) Extinguish or reduce the liability on any of its shares in respect of share capital not paid up.

(b) Cancel any paid-up share capital which is lost or unrepresented by available assets;

(c) Pay off any paid-up share capital which is in excess of the wants of the company;

(d) Cancel paid up share capital for the purpose of writing off losses of the company;

(e) Cancel paid up share capital by the creation of a reserve, to be called “the capital reduction reserve fund” which will be subject to the same treatment as the share premium account.

In terms of the reduction of the share capital of a company, the fact that the list provided for in the Law is not exhaustive, is of particular importance, since it enables the company to make various adjustments in its share capital. Besides, both section 64 of the Companies Law, Cap. 113 (“[…] a company […] having a share capital may […] by special resolution reduce its share capital in any way […]”) and the regulation 46 of the Model Articles of Association included in Part I of Table A of the Companies Law, Cap. 113 (“the company may by way of a special resolution reduce its share capital […] in any way […]”) give the company the power to reduce its issued capital in any way. In this respect, it is worth to note that, relying on the relevant legislative provisions, the reduction of the share capital of a company is always subject to the confirmation by the Court. Therefore, in view of the fact that the competence of a Court to approve and confirm the reduction of the share capital of a company arises provided that the general meeting of the interested company has duly passed a special resolution for reducing its share capital, it follows that a company may well pass a special resolution to this end according to which its issued share capital is reduced otherwise than in accordance to the rights of the company’s members, including the ability to reduce its issued share capital by cancelling one or more shares out of its issued share capital, provided this is duly justified.

On the whole, although it seems that the mechanism of forfeiture of shares and that of cancellation of shares by way of reducing the issued share capital of a company may serve the same purposes, it is of utmost importance to underlying the key-elements underlying each of the said mechanisms, as explained above. In any event, however, it is clear that in order for a company to effect either forfeiture or reduction, its Articles of Association must specifically make a reference to the power of the company to effect the respective action. On that basis, the company through its managing body, the Board of Directors, must specifically examine the particulars of each case it appears before the same so as to assess its merits as well as the options available and powers granted pursuant to the respective company’s Articles of Association so as to be in a position to decide of the treatment of each such case.

The ability of a Cyprus company to issue redeemable shares is determined in its Articles of Association that constitutes the instrument that sets out the regulations with regards to the operation of the Company. More specifically, relying on template Articles of Association included in Table A of the First Schedule of the Companies Law (Cap 113), and in particular to regulation 3 thereof, “subject to the provisions of Section 57 of the Law, any preference shares may, with the sanction of an ordinary resolution, be issued on the terms that they are or at the option of the Company are liable, to be redeemed on such the terms, and in such manner [in terms of, among others, time, notice period, price and tranches] as may be determined by special resolution of the Company before the issue of such shares”. According to the said mechanism, a person may temporarily become a shareholder of a Cyprus company while his/her share shall be redeemable either at the option of the same or the company.

Retrieving from the aforesaid regulation included in Table A of the First Schedule of the Companies Law (Cap 113), the issue of redeemable shares is made by ordinary resolution while it is the Company -at a General Meeting- that determines through a special resolution (passed before the issue of such redeemable shares) the manner of redemption. In light of the provisions of the regulation in question, whether the holder of the shares or the Company can proceed with the redemption is determined by an ordinary resolution of the General Meeting while the particular manner of redemption (among others, whether, in the case the shares are redeemable at the option of the Company, the General Meeting or the Board of Directors will have the right to redeem the said shares), is determined by a special resolution of the General Meeting. However, in the event that the Company fails to determine the manner of redemption, the remaining provisions of the Company’s Articles of Association must be taken into consideration so as to find out whether the Board of Directors is authorized to exercise such power; if not, the Board of Directors may -in the circumstances- have to bring the matter to the attention of the General Meeting so as for the latter to resolve, by way of special resolution, the manner of redemption.

Moreover, in so far as the status of redeemable preference shares is concerned, it is worth noting that, as a general principle, preference shares usually carry some preferential rights in relation to other classes of shares, particularly, in relation to ordinary shares. Besides, neither the Law nor the common law attach a rigid, uniformly applicable meaning to ‘ordinary’, ‘preference’ or other description of shares. In other words, while preference shares are usually associated with certain preferential rights, in the absence of specifically determined rights in the terms of issue thereof, it follows that the redeemable preference shares are issued on the same terms as the existing shares. Besides, as noted by the Supreme Court of the Republic of Cyprus in Lavinia Investments Ltd ν. Republic (1998) 3 C.L.R. 827 ‘it is assumed that all shares, unless there is evidence to the contrary, grant the same rights and impose the same responsibilities’; this coincides with the presumption of equality of shares. On that basis, we may assume that in the absence of specifically determined rights in the terms of issue of the redeemable preference shares, these are differentiated on that these are issued on the term that they are subject to redemption. That said, it seems that in all other aspects the redeemable preference shares carry the same rights as the existing (at the time of the issue of the first redeemable shares) shares.

Lastly, as regards the substantial nature of redeemable preference shares in terms of their classification as either equity or liability for accounting purposes pursuant to the IFRS, it is stressed that, in general, preference shares redeemable only at the option of their holder can be categorized as equity while preference shares redeemable at the option of the Company are regarded as liabilities or loans, especially in the case that these seem that are or were used as a means for financing; however, such classification always depends on the particularities of each case which must be examined under the IFRS.

All in all, the specific procedure for the redemption of the respective preference shares to be followed in each particular case is largely determined by the manner of redemption as this is set forth in the relevant instrument passed in accordance to the relevant provisions of the Company’s Articles of Association, while of considerable importance is whether the shares in question are redeemable at the option of their holder and/or the Company. Therefore, it becomes apparent that both at the stage of the issuance of such shares as well as at the stage of the redemption thereof, it is of particular importance to respectfully follow the relevant provisions of the respective company’s Articles of Association, which must be properly interpreted in order for any misconceptions to be avoided.

Not many legal issues in the sphere of Cyprus corporate law has attracted so much debate, uncertainty and varied responses than the issue of whether a shareholder’s contribution to a Cypriot company by way of gift is freely returnable to the same shareholder or to all the shareholders of the company without Court sanction. Apparently, the reason for this uncertainty is the lack of clear guidance in the Law and the fact that the question involves a blend of legal and accounting principles.

The purpose of this article is to provide useful hints and guidance when a legal or accounting professional is agonizing over the treatment of a shareholder’s contribution from either perspective.

Some corporate and accounting practitioners hold the view that this question is a pure legal one. Others they opt to the opposite argument that the matter is purely accounting. As already stressed above, this article supports the view that the issue should be addressed from the standpoint of both areas of practice and to our understanding its resolution is reached by answering the following question:

What is the legal nature of the “shareholder’s contribution” and how should it be accounted for in the company’s accounting records and financial statements having regard to acceptable accounting principles (for instance IFRS)?

Thus, the legal nature of the “contribution” is critical to be firstly examined, both from a legal perspective and from the perspective of the IFRS, namely whether the “shareholder’s contribution” should be considered as share capital, equity, reserves, realized profits or some other element reported in the financial statements of an entity should better characterize it, having regard to the principle that what matters is not the label that one chooses to ascribe on a transaction but rather its purpose and substance.

It is noted that the application of IFRS by Cypriot Companies is obligatory under article 143 of Companies Law, Cap. 113.

Definition of Capital

The terms “capital” and “share capital” are not defined in the Companies Law. The term “capital”, in particular, is so wide, vague and ambiguous that has given rise to numerous and varied interpretations, especially when used in different contexts. The word “capital” sometimes means, or may take the meaning of, “nominal capital”, “issued capital”, “paid-up capital”, “loan capital” etc. Also, there is no definition of the term “capital” in Cap. 113. Indeed, as stated by an honorable judge “it is impossible to say that “capital” has a single technical meaning which prima facie should be attributed to the word in any statutory provision”. It is evident that the meaning of the word “capital” takes a more precise meaning when combined with a descriptive word.

For all practical purposes, though, the “capital” represents the cash injected in a company, in exchange of shares, which is destined to be utilized for the business and investment needs of the company.

In corporate reality and law, the term “capital” or “share capital” takes the following form: (1) Nominal capital; (2) Issued capital; (3) Paid-up capital; (4) Reserve Capital; (5) Quasi-Capital Funds (i.e. share premium and capital redemption reserve fund). In all cases, the capital is associated with the holding of shares in a company and represents the share of a holder to the company’s assets after deducting its liabilities. Apparently, the “shareholder’s contribution” cannot be purely and directly associated with the notion of “capital” having regard to the absence of any allocation of shares in exchange to the contribution made by the shareholder.

Equity and Reserves

Equity is mostly an accounting notion than legal and it encompasses wider spectrum of elements within it. The term “equity share capital” used to be found in article 148 of Cap. 113, however was abolished back in 2003 at the same time when the appication of IFRS became obligatory for Cypriot companies. In IFRS, the term “Equity” is defined as “the residual interest in the assets of the entity after deducting all its liabilities”. In assessing whether an item meets the definition of equity and be included under the Equity section of the balance sheet, attention needs to be given to its underlying substance and economic reality and not merely its legal form (IFRS).

The Equity may be sub-classified into the share capital, retained earnings and reserves. The classifications are relevant to the decision-making needs of the users of the financial statements, including creditors, when they indicate legal or other restrictions on the ability of the entity to distribute or otherwise apply its equity (emphasis added).

In accordance with Cap. 113, in the course of the preparation of the financial statements, the only reserve funds with are recognized is the capital and revenue reserve funds. Any reserve other than capital reserve is taken as “revenue reserve”. The creation of reserves is provided in the articles of a company. Table A of Cap. 113 (article 117) provides that the reserve funds are created out of the realised profits of the company at the discretion of the directors who may decide to withhold any amounts out of the profits for investment purposes, for the needs of the company’s business or for any other purpose at their discretion (provided of course that the purpose falls within the objects of the company taking into consideration its best interests).

It has been seen that many professionals, when asked with the question as to where the “shareholder’s contribution” should be recorded they provide the simple answer: under Equity. But, having regard to the definition of Equity, this is not the end of the story. What is important to be stated and determined, of course, is the specific classification of the “shareholder’s contribution” under Equity. 

Classification of Contribution by way of gift

Having regard to the above definitions and interpretations, the absence of any definite quidance in the Companies Law, the principle of both law and accounting which dictates reliance on the purpose and substance of a transaction and the fact that almost invariably the reason that a shareholder contributes in a company is, obviously, to increase its cash reserves so that the company defrays its existing and future business and investment needs, we confidently express our accord with the treatment and classification adopted by many or probably most of the accounting professionals in Cyprus who account the “shareholder’s contribution” by way of gift as a quasi-capital element under Equity and describe it as shareholder’s contribution or equity contribution or alike.

As stressed, the substance and commercial reality of this item is evident or at least anticipated: the injection of the company with additional capital/funds in order to tone up or boost the activities and business of the Company or to settle existing liabilities. A sound reason for which a shareholder may inject funds in a company by way of contribution without getting shares in exchange (as a gift) is for avoiding dilution of the existing holdings. Sometimes, however, the real reason and ultimate aim for the contribution without taking shares in exchange, is the ability and leeway which this arrangement offers to attain return of capital to the contributing shareholder without the sanction of the Court. Nonetheless, it is very much doubted that such an arrangement may stand at law as a legal and tolerable one when it, admittedly, serves as a mechanism to sidestep the provisions of the Law and clearly falls afoul the doctrine of “capital maintenance” which is recognized both in common law and by IFRS (further details about capital maintenance are outlined further down).

Besides, the argument that the contribution by way of gift should be classified as a quasi-capital item in the financial statements is supported by quite recent English caselaw which, even though it is not common law and has only persuasive power for the Cypriot Courts, having regard to the practice of Cypriot Courts, we tend to believe that it would have been followed had the issue come before them. In particular, the Court in that case ruled that capital contributions are to be treated as if they were part of paid up capital and, as such, they are NOT and should not be considered as realized profits available for distribution to shareholders. Yet, it needs to be stressed that the aforesaid caselaw did not examine the issue in question in conjunction with the IFRS rules and did not consider the question of whether a cash contribution gives rise or may also be treated as “realized profits”. Now, whether, in accordance with the accounting principles as enunciated in the IFRS, the cash contribution can be considered as realized profit and as such included in the distributable reserves, is an issued for IFRS experts to opine upon.

Position in the UK

At this point, it is important to note, at least for the sake of information and thought even though not applicable in Cyprus, that in the UK, the recognition of a cash contribution as realized profit in the books of UK companies has been incorporated into the Companies Law of the UK. In particular, section 830(2) of the Companies Act defines a company’s profits available for distribution as “its accumulated, realized profits…”. Realized profits and realized losses are defined in the Act as “such profits or losses of the company as fall to be treated as realized in accordance with principles generally accepted at the time when the accounts are prepared…”. Section 853(4) of the Companies Act 2006 includes in the definition of “profit” any amounts which are profits as a matter of law or which are treated as profits including gratuitous contributions of assets from owners in their capacity as such.

In addition to the abovementioned, ICAEW technical release (Tech 02/17BL) issued in 2017 representing generally accepted accounting practice as of 31 December 2016, suggests that a profit is realized where it arises from, amongst others, a transaction where the consideration received by the company is “qualifying consideration” which, in turn, comprises, amongst others, a gift such as a capital contribution received in the form of cash or in the form of an asset that is readily convertible to cash or in such other form of qualifying consideration (however, it goes on to clarify that it does not apply when the legal form of the transaction is a loan even though it is accounted for as a capital contribution).

The extent of the application, binding or guiding effect of ICAEW’s Technical Release to the accounting principles applying to Cypriot companies is out of the scope of this Article.

Capital Maintenance Doctrine

In light of the aforesaid and on the premise that the substance and economic reality of the gratuitous contribution paid by the shareholder to the Company is pervaded with capital elements (i.e. not a liability or some other element), it is reiterated that the contribution should be recognized and accounted for under Equity as a quasi-capital fund.

Another question which surfaces in the context of this analysis is “whether a company has the option to distribute, in any manner, to a company’s shareholder(s) a past contribution made by the sole shareholder to the company as a gift”, given that, according to the aforesaid, it will be recorded under the Equity as shareholder’s contribution.

The doctrine of capital maintenance has been adopted for the protection of the companies’ creditors and to counterbalance the limited liability priviledge that the shareholders of a company enjoy. According to caselaw, a creditor relies on the financial statements of a company before he transacts with the company and he also gives credit on the faith of the representation that the capital of the company shall be applied only for the purposes of the business and shall not be retunred back to its shareholders. In a leading common law case and, therefore, binding authority in Cyprus, the following important remarks have been enunciated:

“The capital may, no doubt, be diminished by expenditure upon and reasonably incidental to all the objects specified. A part of it may be lost in carrying on the business operations authorized. Of this, all persons trusting the company are aware, and take the risk. But I think they have a right to rely, and were intended by the Legislature to have a right to rely, on the capital remaining undiminished by any expenditure outside these limits, or by the return of any part of it to the shareholders … Whatever has been paid by a member cannot be returned to him. It also follows that what is described in the memorandum as the capital cannot be diverted from the objects of the company. It is, of course, liable to spent or lost in carrying on the business of the company, but no part of it can be returned to a member so as to take away from the fund to which the creditors have a right to look as that out of which they are to be paid”.

Further, in more recent English caselaw, the Court said or accepted the following upon citing earlier common law judgments which deal with the principle of capital maintenance and with the power of a company to make payments to shareholders from sources other than the distributable profits of the company:

“Whether or not the transaction is a distribution to shareholders does not depend exclusively on what the parties choose to call it. The court looks at the substance rather than the outward appearance … A company can only lawfully deal with its assets in furtherance of its objects. The corporators may take assets out of the company by way of dividend, or, with the leave of the court – by way of reduction of capital – or in a winding-up. They may of course acquire them for full consideration. They cannot take assets out of the company by way of voluntary distribution, however described, and if they attempt to do so, the disgtribution is ultra vires the company”.

It is a well-known principle of law that a company cannot lawfully make a distrubution of its capital. On the question whether a payment to a shareholder should be considered a “distribution” and whether has been a return of capital, it is clearly NOT a matter what label is put on a transaction but what matters is its purpose and substance. In that regard, it is very interesting to mention that in a UK case, unjustified payment of remuneration to a director who was also shareholder in the company was deemed to be an indirect return of capital and therefore the Court found the shareholder liable to return the received amounts back to the company.

The concept of capital and capital maintenance is also found in IFRS. The financial concept of capital, which is adopted by most entities in preparing their financial statements, is described in IFRS as the money or purchasing power invested in a company. As such, capital is regarded to be synonymous with the net assets or equity of the entity. This is what a creditor looks at when examining the company’s financial situation and viability to form a decision as to whether to transact with the company or not, i.e. the company’s Equity. The concept of capital maintenance, as stressed in IFRS, is concerned with how an entity defines the capital that it seeks to maintain. It provides the linkage between the concepts of capital and the concepts of profit in the sense that it sets the point of reference by or after which the profit is measured; only inflows of assets in excess of amounts needed to maintain capital may be regarded as profit and therefore as a return on capital. Capital maintenance is a prerequisite for distinguishing between an entity’s return on capital and its return of capital (which is prohibited). Hence, profit is the residual amount that remains after expenses – including capital maintenance adjustments where appropriate – have been deducted from income.

Conclusion

In the absence of definite guidance, rules or principle of law in Cyprus on the issue under examination and having regard to the above-mentioned principles and definitions cited in UK legislation, caselaw and guidance (some of which are binding, other have persuasive power and other offer useful guidance) but also the practice and views of most of the accounting practitioners, we tend to the conclusion that the cash contribution by way of gift should, in most of the cases, be safely recognized and accounted for under the Equity element of the financial statements and classified as shareholders’ or equity contribution.

However, it is suggested that the cash contribution might, if the occassions permit, be recognised as “realised profit” in the form of a gain falling to the benefit of the company (not revenue) which even though has not arisen in the course of the ordinary activities of the company’s business, it still increases its economic benefits (see IFRS). Obviously, in order to ascertain whether the item in question should be accounted for under the element of Equity or Income, its nature and function in the business of the company as well as its substance and economic reality should first be examined. Needless to say that this exercise and assessment must be addressed to the people practicing IFRS or even experts of IFRS to carry out, provided they have before them all the relevant and requisite background information of the company under examination.

As one would expect, if the cash contribution is accounted for directly under Equity and take the form of a quasi-capital fund, will be clothed with the qualities, characteristics and restrictions of capital. In the aforesaid case, it should definitely NOT be recorded in the distributable reserves fund account of Equity. In such case (i.e. if goes under Equity as shareholders’ contribution), it should be returned to the shareholders (always based on their respective holdings) ONLY on the winding-up of the company or upon the SANCTION OF THE COURT which is the guardian to safeguard the interests of the creditors. In order to equip the Company with the necessary constitutional mechanisms permitting the return of cash contribution back to the shareholder(s), it is recommended that requisite adjustments are being done, or relevant provisions with appropriate wording are included, in the Company’s Articles of Association (“AoA”) and the usual reduction of capital rules and procedure provided in the Law is followed (that is, reduction of capital through Court).

If the cash contribution is deemed by the IFRS practitioner to be closer to a gain/income and thus a “realised profit”, it should be recorded in the reserves and fall under the discretion of the entity’s board of directors to decide whether will be placed in a distributable reserve and thus available for distribution to the shareholders pro rata to their holdings or to any other reserve fund that may be utilized for the purposes of the business. Again, in the aforesaid scenario, it should be recommended that the AoA of the entity in question is adjusted in such fashion as to reflect and sanction the above reporting arrangement.

Finally, it is worth underlying and someone should always have in contemplation the fiduciary position and duties of the directors to act for the best insterests of a company in the exercise of the powers vested on them. The directors have an obligation to safeguard the company’s assets and take reasonable steps to ensure that the company is in a position to settle its debts as they fall due. Directors must, therefore, specifically consider whether the company will still be solvent following a proposed distribution. Thus, directors should consider both the immediate cash flow implications of a distribution and the continuing ability of the company to pay its debts as they fall due.