When Slobodan Milosevic died in his jail cell in March, he left behind an $800 million mystery. Between 1992 and 2000 the Serbian strongman spirited at least that amount, much of it in cash, out of the former Yugoslavia, according to papers filed at the war crimes tribunal in The Hague, Netherlands.

The money was loaded onto an airplane and flown 1,000 miles to a small airport in Larnaca, Cyprus. Why there? Because, says an alleged co-conspirator and courier, the tiny Mediterranean island was "a passage to the world."

Where did the money go from there? Court papers say Milosevic and co-conspirators set up eight Cypriot front companies, including one registered by the law firm of Tassos Papadopoulos, the nation's current president. (Pambos Ioannides, head of Tassos Papadopoulos & Co., admits the firm opened a holding company called Southmed but strenuously denies it was set up on behalf of Milosevic or his regime.)

These outfits allegedly set up some 250 bank accounts in Cyprus and Greece and funneled money to more than 50 countries, including Liechtenstein, Luxembourg and Switzerland.

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Much of it was used for purchases from military supply businesses in the U.S., Russia and Israel; at least $3.5 million went to a company called Aviatrend, run by reputed Russian arms dealer Valeri Tchernyi. What happened to the rest is anyone's guess.

Once part of the Byzantine Empire, Cyprus is a great place to make things disappear. This nation, population 740,000, has long been a way station for rogues and scoundrels, where officials have traditionally been willing to look the other way.

Just 150 miles from Beirut, closer to the Middle East than to Europe, Cyprus has been a mecca for cigarette smuggling, money laundering, arms trading--even terror financing, according to a post-Sept. 11 U.S. congressional hearing. The site of secret meetings between Israelis and Palestinians, it has also been a refuge for Russians transporting wealth of immense size and dubious provenance.

So it may come as a shock that Cyprus is now selling itself as the next tax haven for corporate America. Here, as in Luxembourg or the Cayman Islands, businesses can cut their tax bills by setting up a holding company without any physical assets.

By the Numbers

Open for Business: Cyprus wants to become the new Caymans of the Mediterranean. Good luck.

38: The number of domestic and international banks in government-controlled Cyprus.

$16.3 billion: The total assets held by international banks in government-controlled Cyprus.

476%: The total increase in the number of suspicious activity reports filed by banks since 2000.

Source: U.S. Bureau for International Narcotics & Law Enforcement Affairs.

Officials deny that Cyprus has had any problems with cigarette smuggling, terror finance or the arms trade. To prepare for its entry into the European Union in May 2004, lawmakers enacted legislation to strengthen anti-money-laundering rules, require greater transparency in business dealings and discourage tax evaders.

Cyprus has come a long way in cleaning up its act. Over the past decade it has put in laws that comply with international standards, requiring, for example, people entering or leaving the country to declare currency or gold bullion worth $15,500 or more.

Banks must report large cash deposits and suspicious transactions, and bank officials may be held personally liable if their institutions scrub clean dirty money. U.S. Treasury officials do concede that Cyprus is likely to have money-laundering problems for some time. "The question is, what are the Cypriots going to do about it?" says one.

For American companies, though, there are still obvious attractions. Cyprus offers the lowest corporate tax rate in the EU, 10%, as well as a bevy of tax breaks and 33 international treaties to prevent double-taxation.

To spread the word, delegations of Cypriot tax professionals and chamber-of-commerce types have traveled in the last year to such places as Shanghai, Beijing, Bangalore, New Delhi and Vienna.

Timothy Osburne, an American partner with PricewaterhouseCoopers, flies from his home base in the capital, Nicosia, to San Francisco and other U.S. cities to persuade investors that Cyprus offers some of the best tax breaks around. As a result, the number of new holding and trading companies registered in Cyprus last year was 14,500, up 70% from the 2002 volume. That's just a start.

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"No serious international investor will do his planning without having Cyprus as one of the top options," says Phidias Pilides, head of PWC's Nicosia office.

To the casual observer, this remote island appears to be a quiet vacation spot, with English speakers, safe streets, pleasant beaches and decent restaurants. Banks and government offices shut down by the early afternoon in the summer. Shops are closed Wednesday afternoons and most of the weekend.

In the mountains that rise to the northeast of Kyrenia, with its glittering horseshoe-shaped harbor, sits the village of Bellapais, where there is a peaceful abbey and an old mulberry called the Tree of Idleness. Legend has it anyone who sits under the tree is struck by a sudden and intense languor.

The mythic birthplace of Aphrodite, Cyprus has long been a center of intrigue. Many times conquered by stronger powers, it landed in British hands in 1878. Sunlight and low crime brought tourists from the U.K.; low taxes kept them there.

The Cypriots won their independence in 1960, but it was a fleeting moment in a 10,000-year history. Amid a coup attempt in 1974, Turkey invaded, seized the northern third of the island, expelled Greek-Cypriots from their homes and named the new entity the Turkish Republic of Northern Cyprus--not recognized by any nation other than Turkey. The Turkish exclave remains.

Tension festered and occasionally flared, but compared with its neighbors, Cyprus was an island of stability. Years of British rule meant British law and plenty of well-schooled accountants and lawyers. Multinationals set up outposts to do business in the Middle East and North Africa.

In the mid-1970s Michael Zampelas, then head of PWC's Cyprus office (and now mayor of Nicosia) heard from Dutch clients that they wanted to set up investment vehicles in Cyprus, but the taxes were too high. He and others did some lobbying. The government repaired its oversight by offering a 4.25% tax rate for offshore companies and drew as many as 50,000 of them in the years to come.

These new businesses created jobs and $600 million in annual tax revenue. But Cyprus also became something of an entrep�t for dirty dealings in the Middle East. Cigarette smuggling was one perennial problem. And in the 1990s Cyprus was among 14 countries with businesses that illegally provided Saddam Hussein with conventional weapons, according to a comprehensive report to the CIA on Iraq's weapons of mass destruction.

Cyprus-registered companies also contracted to buy oil and chemical materials from Iraq in violation of the UN embargo. One company in the southern city of Limassol, Pediment Holdings Ltd., wrote a letter to an Iraqi official, according to the report to the CIA, saying it was prepared to buy petroleum products at the Iraq-Iran border, transport them by truck and send a $10 million payment to an Amman, Jordan bank account.

One result of these dirty dealings with Saddam was the UN-backed oil-for-food program, which itself proved easy to manipulate. Once again Cyprus was in the center of a storm. Both U.S. and UN investigations show evidence that the administrator of the program, Cypriot diplomat Benon Sevan, reaped at least $150,000 through the illicit sale of Iraqi crude. (He denies it.)

A far bigger alleged participant was a privately held Swiss company called Glencore, formerly known as Marc Rich & Co. AG (Marc Rich divested his interest in 1994). According to the exhaustive inquiry into the program conducted by Paul Volcker, Glencore bought at least 122 million barrels of oil from Iraq through other trading companies and often paid surcharges to agents such as Murtaza Lakhani, Glencore's "man in Baghdad."

At least some of the surcharge money was allegedly routed through Lakhani's Cyprus bank account. In a letter included in the Volcker report, Glencore denies wrongdoing.

U.S. companies ensnarled in the scandal also went through Cyprus. One leading financier of Iraqi crude, a Houston company called Bayoil, allegedly paid for 28 liftings of oil for extremist Russian politician Vladimir Zhirinovsky, sending $1.7 million to the account of a Liberian outfit called Plasco Shipping Co. Ltd., allegedly linked with a Bayoil employee.

Bank records show Plasco transferred a similar sum to a Cyprus account with the reference "in favor of Igor Lebedev"--Zhirinovsky's son. (Zhirinovsky has denied any wrongdoing.) Bayoil's owner, David Chalmers Jr., has been indicted by a federal grand jury in New York for alleged manipulation of the program. He has pleaded not guilty.

So has Oscar Wyatt Jr., to charges of conspiracy to commit wire fraud and engage in prohibited financial transactions with Iraq. The iconoclastic Texas oil tycoon allegedly acted as an oil consultant or trader on behalf of two Cyprus companies, Mednafta Trading Co. and Nafta Petroleum.

Wyatt had a long history with Saddam. The first to bring Iraqi oil to the U.S. back in 1972, Wyatt met with the dictator in December 1990 and helped with the release of 21 U.S. hostages there. But according to the indictment and the Volcker report, Nafta and Mednafta companies paid surcharges for Iraqi oil and arranged for cargo ships to pick up the oil from Iraq and ship it to larger companies with their own refineries.

As late as January 2003 Wyatt allegedly sent a fax to an Iraqi official on Mednafta stationery to request a meeting in Baghdad.

At the same time, Cyprus proved a magnet for Russian kleptocrats who were drawn by the low tax rate, visa-free travel and a shared religious heritage. Russian businessmen bought villas in the hills surrounding Limassol. By 1995 Cyprus was home to some 2,000 Russian companies, and $1 billion a month was flowing out of Russia into Cypriot banks.

Much of it unclean. The Russian mafia controlled as much as 70% to 80% of all business in the motherland during the mid-1990s, according to a report by Izvestiia. Sending money to havens like Cyprus kept it safe from tax collectors, on-the- take bureaucrats, creditors, other gangsters and shaky Russian banks.

The now imprisoned Mikhail Khodorkovsky owned his shares in Yukos through a complex structure of offshore companies in Cyprus and elsewhere.

Sometimes violence followed the money. In one case two years ago three Russians were bludgeoned to death in a villa in the resort town of Paphos, in western Cyprus. Today Russian crime has a different face in Cyprus, where a thriving sex trade draws women from former Soviet states. In 2001 Cyprus' immigration chief was reportedly jailed for 20 months after being found guilty of accepting bribes to issue work permits for foreign women to work in so-called cabarets with names like White Girls Nightclub and Frolix.

By 2003 some 2,000 women per year arrived in Cyprus to work in these clubs, often under duress, helping to generate $70 million per year in prostitution revenue--plus fees for pimps who work in the women's home countries and broker the traffic.

While the government has made headway in cracking down on the problem, a recent U.S. State Department report says trafficking is still a problem and tells a fairly typical story of an 18-year-old Ukrainian woman who spoke no English but responded last year to an Internet ad for a waitress job in Cyprus.

Instead she landed at a cabaret in a rural area, where the owner withheld her travel documents and forced her to have sex with customers. One purchased her for the night, took her to his farm, had sex with her and then forced her to clean his barn. In a case cited by sex-traffic researchers at Johns Hopkins University, a young Russian cabaret worker was held captive in a Nicosia apartment and tried to escape by tying bed sheets together and climbing down the balcony. The sheets slipped apart and she fell to her death.

Cyprus has also gained notoriety, thanks in part to geography, as a hub for the trade in small arms and ammunition. Year after year, reports the annual Small Arms Survey, produced by the Graduate Institute of International Studies in Geneva, Cyprus imports these goods in quantities that vastly exceed the amount its citizens or military could reasonably use.

In 2003 the nation imported an estimated $185 million worth of revolvers, military rifles and machine guns, putting it second after the U.S. Incomplete data from 2004 put Cyprus up there with Germany, France and the U.K.

The single biggest supplier of arms: Russia. Yet the bulk of goods come from unspecified nations, and it is unclear if the guns ever make it ashore--or are simply invoiced through Cypriot front companies. No one seems to know where the guns go.

Cypriot officials assert that the nation complies with all international arms-trade regulations and protocols. While the survey information comes directly from Cyprus customs records, researchers are befuddled by the lack of transparency.

"This stuff kind of appears from nowhere and then disappears to nowhere," says Nicholas Marsh, a researcher at the International Peace Research Institute, in Oslo, which compiled the data.

If you want dirty business, look at the Turk-occupied north, say Cypriot authorities. A potentially charming tourist destination, this slice of the island has been racked by embargoes and years of ethnic anger, making it all but impossible for sizable investment to take root.

A visitor notices the abundance of half-finished construction projects--launched when the island's divisions seemed at an end--and a dearth of upscale hotels, Western banks and amenities. The void is filled by casinos, some two dozen of them, owned by Turkish mainlanders and essentially unregulated.

Some 500 "finance institutions" that give loans are also unregulated, and a 2004 U.S. State Department report says northern Cyprus has become a conduit for narcotics trade between Turkey and Britain, as well as a destination for money launderers.

One finance institution, First Merchant Bank OSH, was a conduit for funds transferred between organized crime rings and corrupt politicians, according to the U.S. Treasury Department. The department also reports allegations that one of the bank's original shareholders, Vladimir Kobarel, was a former KGB employee who used First Merchant to transfer "underground" money to Russian banks.

Another partner, Tarik Umit, served in Turkish intelligence and is believed to have been killed in connection with a Turkish investigation into links among intelligence, right-wing politicians and the mafia. A third founder, Hakki Yaman Namli, was convicted along with the bank for laundering $450 million.

The conviction was overturned, but at the trial he insisted First Merchant was owned by one Charles Ewert, a onetime executive at Austrian gun manufacturer Glock who was later sentenced to 20 years in a Luxembourg prison for attempting to murder the company founder. Namli is now running from another U.S. federal court indictment alleging wire fraud.

Stories like this make the occupied area an easy target for Cypriot officials. "There are some very, very serious problems regarding illegal action in the occupied areas of Cyprus," says Doros Theodorou, minister of justice, as one cigarette after another burns slowly in the ashtray in front of him. "And I'm not speaking only about money laundering. I'm speaking about every illegal action."

But such politicians are part of the problem because they refuse to deal with leaders of the occupied areas. Rather than cracking down on criminals wherever they live on the island, the government's political energy is channeled almost exclusively into etching deeper divisions--three decades after the invasion.

In January the Cypriot president refused to meet with Jack Straw after the British foreign minister had the gall to seek a solution to the division by meeting with the leader of the northern entity in his presidential palace. The Turkish side behaves no better.

For all that, the campaign to lure outside corporations seems to be working. Big multinationals like Oracle and Microsoft already have representatives on the island or regional offices for sales into the rest of the Mediterranean and Middle East. Chinese companies have recently expressed interest in sending thousands of workers over to set up clothing and soft-toy factories there for easier access to these markets.

But Antis Nathanael, director of trade at the Cyprus Chamber of Commerce & Industry, says Cyprus is too small to accommodate this kind of large-scale industry. "We're only 700,000 people," he says. "Where are we going to house 50,000 Chinese?"

A bigger benefit would come from creating more holding companies, boosting a financial services industry that, along with tourism, already accounts for three-quarters of the country's $17 billion economy. Marketing materials play up the fact that Cyprus follows the same regulations as other nations in the EU--but has lower taxes.

"Taxwise, Cyprus is probably in the best position in the European Union," says Charilaos G. Stavrakis, deputy chief executive at the Bank of Cyprus Group.

Setting up a holding company involves paying $4,000 or so to a lawyer or an accounting firm like PWC, which will help select an approvable company name, write up articles of association and appoint shareholders and directors. The process takes a few weeks, and most larger firms will require various forms of identification, as well as reference letters from a prior bank.

A small Nicosia outfit called Vishnu Enterprises advertises it can set up a ready-made company in a mere 24 hours. There is no need for the investor to visit Cyprus, and Vishnu says it can appoint a director, secretary and shareholder, which "makes it impossible for a third party to identify the real owner." Emil Deecken, Vishnu's managing director, says he knows of plenty of lawyers who ask no questions at all before setting up a new company. Says he: "It's like buying a piece of bread, it's so easy."

So far there has been some interest in Cyprus from U.S. construction and airline businesses, says Kyriacos Kokkinos, president of the American-Cyprus chamber and head of IBM Cyprus. But the Cypriots still have to compete with Switzerland, which recently attracted multinationals like Procter & Gamble and Colgate by offering even lower tax rates.

For investment in India, American investors are more comfortable with tried-and-true Mauritius. Even Russian investors are starting to look elsewhere, paying a bit more in taxes in a place like Luxembourg to avoid the stigma of Cyprus.

"U.S. investors are not worried about reputation," says London tax lawyer Joel McDonald. "It's just a tax-planning tool. But if you're a Russian, it's another black mark. People say, 'Oh, Cyprus, of course.'"

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