On 9 July 2015, the Cypriot House of Representatives enacted certain important tax amendments aiming to further improve the competitiveness of the Cyprus tax system (see post here). One of those amendments was the introduction of the Notional Interest Deduction (NID) on equity under Cyprus laws.
As from 1 January 2015, Cyprus Companies and PEs shall be entitled to the NID deduction based on the amount of “new equity” raised after January 2015 multiplied by a “notional interest rate”. This NID expense will be subject to the restrictions currently applied on interest and in any case it cannot exceed 80% of the taxable profits as calculated before taking into account the NID.
In general Interest is deductible provided the funds have been used to finance business assets and activities which generate taxable income. An exemption to this rule is for interest expense incurred for the acquisition of a 100% subsidiary (directly or indirectly).
New equity refers to share capital and share premium introduced in the company after 1 January 2015 which is fully paid.
Reference interest rate refers to the interest rate yield (as at the end of the prior tax year) of the 10 year government bond of the country where the funds are used plus a 3% premium. However, the reference interest rate cannot be lower than the interest rate yield of the Cypriot 10 year government bond increased by a 3% premium.
In order to address possible abuse of the NID provisions, the law includes a general anti-avoidance rule and a number of specific anti-avoidance provisions aiming to restrict the NID.
The Cyprus tax authorities will issue a circular in order to clarify the application of the NID provisions.
Simplified example on the application of the NID provisions:
- A Cyprus Company raised on 1 January 2015 €10m of new equity. The equity consists a mixture of share capital and share premium which was fully paid up. The existing share capital and share premium before the new equity injection was €1m
- The Cyprus Company gave the €10m (in the form of loan) to a German which carries trading activities.
- As at 31 December 2014, the German 10 year government bond was say 0.6% and the Cypriot 10 year government bond was say 4%.
-New Equity: €10m
-Reference late: 7%, which is the higher of
- German rate: 0.6% + 3% = 3.6%
- Cypriot rate: 4% + 3% = 7%
Calculation of NID: €10m x 7% = €700k
The amount of €700k shall be treated as an interest expense for the Cyprus Company. It will be however subject to the existing limitations which apply on interest expense and to the limitation of 80% mentioned above.
The introduction of this provision aims to serve as an incentive to entrepreneurs to capitalise their companies instead of trying to obtain bank loans in order to achieve interest deductions. This provision already exists in other EU jurisdictions and surely shall further improve the use of Cyprus companies in international tax planning.