Cyprus Income Tax law has a new tax deduction applicable as from 1.1.2015 under the description Notional Interest Deduction (the “NID“) on new capital (the “NC“). The NID is calculated on the amount of new capital introduced in the entity on or after 1.1.2015, by using a reference interest rate which may reduce the effective tax rate from 12.5% to as much as 2.5%.
In November 2020, the EU Code of Conduct Group (Business Taxation) and ECOFIN confirmed that the NID regime has been assessed as “not harmful” since its introduction 01.01.2015. We also note that the provisions of the NID are in line with the European Commission’s Debt Equity Bias Reduction Allowance initiative, which aims to set an equal footing between the tax efficiency of debt and equity funding in entities across the EU.
Who is eligible?
Cyprus tax resident companies and permanent establishments of Non-Cyprus tax resident companies that inject new capital for the purpose of producing taxable income.
How is the NID benefit calculated?
The NID is calculated by applying the Reference Interest Rate to the New Capital introduced i.e. using the following formula referred to as the “Basic Calculation“.
Notional Interest Deduction = New Capital x Reference Interest Rate
The application of the Basic Calculation is done in two steps as described below
The regime requires that each asset financed by NC should be identified through a tracing/matching method. The CY NID deduction cannot exceed 80% of the taxable income from each asset as determined before the application of the NID provisions. The 80% cap is calculated based on the taxable income derived from each asset financed by NC separately. This cap is then compared to the NID calculated for each asset under the Basic Calculation above. The deduction for each asset is then determined as the lower of these two amounts.
A second calculation is then made on the total taxable income from all assets financed by NC. If this amount is lower than the total deduction under the first step, this lower amount is used as the deduction.
The lowest effective rate that may be achieved with the maximum deduction is 2.5% (12.5% CIT rate*(100% taxable – 80% taxable income/maximum NID deduction).
An example of the application of the Basic Calculation in the two steps described above are shown in the table below.
|Description||Asset 1||Asset 2||Asset 3||Total|
|Reference Interest Rate||17%||12%||15%|
|NC x RIR||34||36||75|
|80% of taxable income||40||–||64|
|First Step: max deduction ||34||–||64||98|
|Second Step: max deduction ||———-||100 x 80%||———-||80|
What is defined as New Capital?
New capital for the purposes of NID can be any form of paid up share capital or share premium, either in cash or in kind, contributed to the entity from 01 January 2015, for the production of taxable income. In the case that NC is contributed in the form of in kind contributions, the entity must ensure that the NC value does not exceed the market value of the asset.
The following may qualify as NC for the purposes of this regime:
- Loans payable and other debt instruments converted into issued share capital
- Shareholders’ credit balances converted into issued share capital
- Non-refundable capital contribution converted into issued share capital
- Realised reserves created after 1 January 2015 converted into share capital
What is the Reference Interest Rate (RIR)?
Following the June 2020 amendments, the Reference Interest Rate means the interest rate of the 10 year government bond yield of the country in which the NC is invested increased by 5% with no minimum.
The bond yield is the one applicable as of 31 December of the tax year preceding the relevant tax year. A full list of the ten year government bond yield rates is published by the Cyprus Tax Department on its website.
To claim the benefit of the NID the company or the permanent establishment should duly complete the Income Tax Return with respect to the claim of NID and to declare that it has complied with the Circular 2016/10. Furthermore, per the Circular, no NID will be granted in cases where the Tax Department has requested a detailed calculation of the claimed NID, in which the implementation of the Circular is documented, and the taxpayer does not respond within the specified date prescribed in the notice.
Are there any specific anti-abuse provisions?
- In case NC of a Cyprus tax resident company (or Cyprus PE of a non-Cyprus tax resident company) is derived directly or indirectly from NC of another Cyprus tax resident company (or Cyprus PE of a non-Cyprus tax resident company), the NID is available in one of those businesses only, except where the reinvestment of the NC creates new separate taxable income.
- The NID is denied in cases where transactions do not have any substantial economic or trading purposes.
- The NID does not include capital deriving from the revaluation of movable or immovable assets.
- NC does not include Capital deriving from the company’s reserves that existed as at 31 December 2014 (i.e. immediately prior to the introduction of the NID).
Interaction with the IP regime
It is possible to combine the IP regime with the NID regime, however the IP regime and the NID regime are designed in such a way that, in case they interact, they are not both fully claimable on the same income. In case of such interaction, the lowest possible effective tax rate that may be achieved with both the IP regime and NID applied to the same income is 2,1%.
How we can help you?
Our dedicated team here at Sagehill Partners can assist you in the application of the NID in your specific circumstances. Please contact us for further information.