Out of the shadows: risks of shadow directors for Cyprus companies

“He lurks in the shadows, sheltering behind others who, he claims, are the only directors of the company to the exclusion of himself. He is not held out as a director by the company.”

This was Millet J in Re Hydrodam (Corby) Limited (1994) 2 BCLC 180, delivering the most vivid, yet strikingly accurate, judicial interpretation of a shadow director. This note considers the implications of shadow directorships on Cyprus company structures.

Cyprus, like most common law jurisdictions, recognises the concept of the shadow director. The statutory definition of ‘director’ in Cyprus law includes any person occupying the position of director by whatever name called. The effect of the legislation is that a person on whose directions or instructions the directors of the company are accustomed to act is deemed to be a director of that company.

Under Cyprus law, shadow directors must be named in the register of directors of Cyprus companies and are subject to certain statutory obligations. Non-compliance with obligations relating to shadow directors could give rise to significant liability for those shadow directors, create issues at liquidation and potentially impact the tax position of the company.

Who is deemed to be a shadow director?

Whether or not a person is a shadow director is a question of fact and depends upon all of the relevant circumstances. Shareholders, beneficial owners of Cyprus companies, directors in parent entities of Cyprus companies or, in some cases, directors of companies which act as directors in Cyprus companies, could all be deemed to be shadow directors under certain factual scenarios.

English case law, which is generally consistent with Cyprus law on this issue and is accepted as persuasive authority by the courts of Cyprus, defines shadow directors as those with real influence in the corporate affairs of a company, those ‘pulling the strings’ without formally being appointed to the board.

Influence exerted by a shadow director does not have to cover all or even the majority of the corporate activities of a company. It is sufficient that the majority of the directors, not all of them, act on the directions or instructions of the purported shadow director. Moreover, it is not necessary to demonstrate any degree of compulsion beyond that implicit in the fact that the board are accustomed to act in accordance with directions or instructions of the shadow director.

Although there are many capacities in which a person may be found to be a shadow director, English case law has referenced a number of examples. These include a foreign shareholder giving instructions to a board or a chief executive of a group of companies openly giving directions to the board of a subsidiary on which he does not sit. Others at risk of being classified as shadow directors include private equity fund managers, management consultants or “company doctors”, lenders and creditors of a company.

In determining the involvement of a shadow director, communications regarded as ‘directions or instructions’ will be objectively assessed in the light of all the evidence. It may be sufficient simply to show that some of the directors of a board surrendered their respective discretions in light of the shadow’s ‘directions or instructions’.

Professional advisors

An express exclusion is provided under statute for a person giving advice in a professional capacity, on the basis of which directors act. Whether the advice is provided in a professional capacity will be determined on the relevant facts.

Non-professional advice can fall within the definition of ‘directions or instructions’ as the concepts of ‘direction and instruction’ do not exclude that of ‘advice’ and all three share the common feature of ‘guidance’. Furthermore, although it would certainly suffice to show that the directors surrendered their discretions or cast themselves in a subservient role to the purported shadow, such circumstances do not necessarily need to be evidenced.

Risks to the tax position of the company

Under Cyprus law a company is tax resident in Cyprus if its management and control are exercised in Cyprus. Although ‘management and control’ is not a term defined by statute, the competent authorities generally take into account the composition of the board of directors and where its members are tax resident, the location of board meetings and where major decisions are taken, when determining where management and control of a company is exercised.

Many tax authorities rigorously assess the tax residency of foreign companies. For example, in the case of the UK, HMRC deals with companies established in a number of jurisdictions that hold assets in or through the UK. Although the location of board meetings of a company is generally where ‘central management and control’ is located, this will not always be the case for HMRC, particularly if there are ‘shadow directors’ influencing the board. If HMRC can show, for example, that a Cyprus company’s central management and control are located in the UK, by virtue of the location of individuals it deems to be shadow directors, the company may be deemed to be a UK tax resident, removing any tax benefits deriving from non-UK tax residence.

In Cyprus, where shadow directors not resident in Cyprus have real influence in the corporate affairs of a company, there is a significant risk of that company being classified as tax resident in one or more foreign jurisdictions. Directors serving on boards who are supplied as a service by fiduciary providers, who are accustomed to act on the instructions or directions of third parties such as shareholders, beneficial owners, directors of parent or group companies and the like are at significant risk of being deemed to act on the instructions of a shadow director. As a consequence, the tax residency of the Cyprus company may be compromised.

Key takeaway

Interested parties should consider whether:

  • corporate procedures and documentation (particularly meetings and minutes of board meetings) of their Cyprus companies indicate that a shadow director may be providing instructions and directions to board members
  • communications between directors and the parties they liaise with on the company’s affairs, such as shareholders, beneficial owners, directors in other group companies and service providers, may indicate the existence of a shadow director
  • board meeting papers properly consider and document the commercial rationale for transactions intended to deliver a particular outcome for tax purposes
  • directors provided as an administrative service are genuinely discharging their duties as directors.
error: