Cyprus tax resident companies and Cyprus permanent establishments (PEs) of non-Cyprus tax resident companies, are entitled to a Notional Interest Deduction (NID), on the injection of new equity used to generate taxable income.

Cyprus Tax amendments in 2020 further enhanced the tax benefits for Cyprus companies financing their operations through new equity, and to align these provisions with the recommendation of the European Commission.

• Objective of the NID: to reduce corporate debt by increasing the attractiveness of equity from a corporate income tax perspective. Furthermore, the introduction of the NID overall enhances the international attractiveness of the Cyprus tax system as the effective tax rate can now be minimized from 12.5% to as low as 2.5%, the lowest possible in Europe.

• Who it applies to: Cyprus tax resident entities and the Cypriot permanent establishments of non-resident entities.

• NID in brief: it is an annual tax allowable expense, calculated as a percentage of new equity (share capital and share premium) introduced within a company from 1 January 2015 onwards. A company can claim this annual tax expense indefinitely until there is a share capital/premium reduction or redemption of preference shares.

• What is “new equity”: new equity is defined as new capital injections into a company, either in the form of paid-up share capital or share premium.

New equity does not need to be paid-up in cash, but can also be paid-up via a contribution in kind (CIK). If a CIK applies, its value cannot exceed the fair market value of the asset being contributed, and such market value must be substantiated via a professional and independent valuation report.

IMPORTANT NOTE: The NID cannot be applied to reserves existing at 31 December 2014 which were converted into new equity, unless the new equity created from pre-existing reserves is invested in business assets earning taxable income which did not exist on 31 December 2014.

From 1 January 2021, the NID can no longer be claimed on equity arising from capitalisation of pre-existing reserves at 31 December 2014.

• How is the NID rate determined: the rate of the NID is the higher of:

• The yield of the 10-year Cyprus government bond at the end of the previous tax year (i.e., for 2015, as at 31 December 2014) plus a margin of 3%; or

• The yield of the 10-year government bond in the country where the funds are employed within the business of the company, at the end of the previous tax year, plus a margin of 3%.

From 1 January 2020 the reference rate is the yield of the 10-year government bond (as at 31 December of the year preceding the tax year the NID is claimed) of the country where the new equity is employed/invested plus 5%, and there is no minimum reference rate.

Where the country in which the new equity is employed/invested does not have an issued 10-year government bond as at 31 December of the relevant year, the reference rate is the Cyprus 10-year government bond yield plus 5%.

The following are some examples of the yields offered on some 10-year government bonds at 31 December 2015 to 2019 (applicable for the tax years 2016 to 2020, respectively):

• Applicability of the NID: The NID is permitted in a similar manner when considering whether interest expense from a loan is tax deductible. Therefore, the NID can be applied when proceeds were used to finance business assets and/or to finance the acquisition of 100% subsidiaries.

• Cap on NID: The NID cannot exceed 80% of taxable profit of a given tax year, as calculated before the inclusion of the NID in the tax computation. Any amount restricted cannot be carried forward. Furthermore, the taxpayer has the right not to claim the entire amount of the NID (e.g. when there are unused tax losses brought forward which expire, or tax losses available from other group companies). Similar to the NID cap, any unutilised amounts cannot be carried forward.

The amending law of 2020 clarifies that for the purposes of calculating the NID cap, the relevant taxable profits are those arising from the employment of the new equity, so that the NID can only be claimed against such profits. It also clarifies that the cap applies separately to the taxable profits derived from each business asset that is financed by the new equity. These amendments will apply retroactively as of 1 January 2015, as the changes effectively adopt the “matching concept” which has been applied in practice since the introduction of NID.

• Anti-avoidance measures: Several anti-avoidance and anti-abuse measures have been introduced in order to restrict the “non-commercial” use of the NID.

1. In case of double tiered structures (Shareholder -> CypCoA -> CypCoB) the NID is available to only one company (either CypcoA or CypCoB);

2. If an entity within the group has claimed in Cyprus an interest expense deduction on funds used to finance new equity, then the NID is reduced by that interest expense. For example, CypCoA borrows at 5% and uses the proceeds to inject new equity in CypCoB- CypCoB can only claim NID of 3.02% for the year 2015;

3. Company reorganisations are ignored for the purposes of the NID;

4. The Commissioner of Taxation may decide not to grant the NID, if:

1. He considers that actions or transactions have taken place without substantial economic or commercial purpose, which aim at granting the NID; or

1. The new equity, for which a claim for NID is made, was derived from capital that existed prior to 1st January 2015 and which is presented as new capital through actions or transactions with related parties, with the main purpose of granting the NID.

• Tax Circular: The tax authorities have issued a Technical Circular (2016/10) detailing the practical application of the NID.

• Tax planning opportunities: There are significant tax planning opportunities arising from the introduction of the NID. Please feel free to contact one of our tax professionals at info@savvacyprus.com or c.savva@savvacyprus.com for further details and advice on how the NID can be used in your specific case.