There has been a positive development on Cyprus Notional Interest Deduction (NID). The EU Code of Conduct Group (Business Taxation) issued a report on Cyprus Notional Interest Deduction (NID). On 27 November 2020, the Cyprus Notional Interest Deduction (NID) regime was approved by the Economic and Financial Affairs Council configuration (Ecofin) of The European Union as not “harmful”
The Notional Interest Deduction incentive on Cyprus Companies, Cyprus taxation advantages, and illustrative examples
NID – Notional Interest Deduction was introduced in 2015 in Cyprus to provide tax relief to all Cypriot companies and enterprises that use equity and not debt, to finance their investments.
The NID – Notional Interest Deduction is provided to companies resident of Cyprus and to entities that do business in Cyprus.
Notional Interest Deduction – NID is an annual deduction from the taxable profits of a Cypriot company which is calculated based on the interest rate as mentioned above multiplied by new capital that is introduced, owned, and used for the purposes of the Cypriot company. The Notional Interest Deduction – NID is limited to 80% of the taxable income of a Cypriot company. The Notional Interest Deduction – NID allows Cypriot companies to reduce their tax rate in Cyprus from 12.5% to 2.5%, thus gaining a significant tax advantage.
According to Cyprus taxation laws, Cyprus companies that are originally financed by their own funds/equity are given a notional Interest deduction (NID). This means a reduction of the overall effective tax rate of a Cyprus Company depending on the level of Cyprus Company capitalization. The notional Interest deduction (NID) is granted annually for as long as capital is used for business purposes in the Cyprus Company.
The Cyprus taxation law on Cyprus Notional Interest Deduction (NID)
Equity. New equity can be introduced either in the form of cash or in kind. Where new equity will be introduced in the form of assets (in-kind), the sum of these may not exceed the market value. Assets must be fully documented. Notional interest deduction (NID) will be given on new capital (share capital and share premium to the extent that they have been paid) issued from 1st January 2015.
Interest. Notional interest deduction (NID) was initially calculated on the amount of new share capital/share premium the same way as with interest on loans. The rate of notional interest deduction (NID) is defined as the 10-year government bond yield (on December 31 of the year preceding the tax year) of the country in which the new equity is invested, increased by 3% and having as a lower limit the 10 year Cyprus government bond increased by 3%.
From 1 January 2020, the annual interest rate for the purposes of Notional Interest Deduction – NID will be the ten-year government bond of the country in which the funds are invested in the activities of an entity plus 5% instead of 3%
There is no minimum interest rate therefore, in the case of countries that have a lower rate than the Cypriot one then this lower rate should be used. The Cypriot interest rate should be used only in cases where:
- the investment is made in Cyprus and
- the country in which the investment took place has not issued a government bond.
Cyprus Company illustrative example (In this case a Cyprus Company used as a Cyprus financing company)
– New equity is introduced in the Cyprus Company in the form of capital
– The Cyprus equity is used to finance other associated foreign companies i.e. by granting an interest-bearing loan to a foreign Company
– Associated foreign company will use the funds to finance its operations
– Cyprus Company receives income in the form of interest from foreign Company
– Cyprus Company pays dividends to a foreign investor
Illustrative example 1 of a Cyprus Company (Cyprus financing company)
In the year 2020 new equity was introduced in the Cyprus Company in the form of capital €10m. The equity consists of a mixture of share capital and share premium fully paid up
Cyprus Company grants an interest-bearing loan to foreign a Company. The other foreign company jurisdiction’s 10-year government bond is 3.5% and the Cypriot 10-year government bond is for example 2%.
Cyprus Company receives income in the form of interest from foreign Company at the rate of 10%
| CYPRUS COMPANY (FINANCING) |
€ |
|
| STATEMENT OF FINANCIAL POSITION | ||
| Assets | ||
| Loan receivable |
10.000.000 |
|
| Equity | ||
| Share Capital |
10.000.000 |
|
| INCOME STATEMENT | ||
| Interest received (10m x 10%) |
1.000,000 |
|
| Taxable income before NID |
1.000.000 |
|
| Cyprus Notional Interest Deduction is: | ||
| The lower of: | ||
| 8.5% (Foreign gov bond rate 3.5% + 5%) X 10m |
850.000 |
|
| 80% of taxable income i.e. X 1.000.000 |
800.000 |
800.000 |
| Net income after Notional Interest Deduction |
200.000 |
|
| Cyprus tax at 12.5% |
25.000 |
|
| Effective tax on interest received |
2.5% |
Illustrative example 2
In the year 2020 new equity is introduced in the Cyprus Company in a form of capital €10m. The equity consists of a mixture of share capital and shares premium fully paid up.
Cyprus Company grants an interest-bearing loan to foreign a Company. The other foreign company jurisdiction 10-year government bond is 2.5% and the Cypriot 10-year government bond is for example 3.0%.
Cyprus Company receives income in the form of interest from foreign Company at the rate of 10%
| CYPRUS COMPANY (FINANCING) |
€ |
|
| STATEMENT OF FINANCIAL POSITION | ||
| Assets | ||
| Loan receivable |
10.000.000 |
|
| Equity | ||
| Share Capital |
10.000.000 |
|
| INCOME STATEMENT | ||
| Interest received (10m x 10%) |
1.000,000 |
|
| Taxable income before NID |
1.000.000 |
|
| Cyprus Notional Interest Deduction is: | ||
| The lower of: | ||
| 7.5% (Foreign gov bond rate 2.5% + 5%) X 10m |
750.000 |
|
| 80% of taxable income i.e. X 1.000.000 |
800.000 |
750.000 |
| Net income after Notional Interest Deduction |
250.000 |
|
| Cyprus tax at 12.5% |
31.250 |
|
| Effective tax on interest received |
3.13% |
Cyprus Taxation Consequences
– Low or no withholding tax on interest payments due to the “favorable” Cyprus double tax treaty network or EU directives
– Deductibility of interest expenses in the borrowing company subject to borrowing company jurisdiction conditions
– Provided that one of the major business activities of the Cyprus Company is that of financing activities, the Cyprus Company will be taxed at a Corporation tax rate of 12,5%
– Cyprus Notional Interest Deduction (NID) is deducted from interest income and therefore Interest income is taxable in Cyprus at an effective tax rate of 2.5% i.e. (20% X 12.5% – 80% is given as a notional interest deduction)
– No withholding tax on dividend payments from Cyprus at all times
Conclusion and our views
– The law aimed to harmonize the tax treatment of equity finance with the tax treatment of finance by borrowing (equal treatment). It aimed also to further strengthen Cyprus companies’ competitiveness. Investors are financing their companies through equity instead of through borrowings without entering in the process of creating complex corporate structures ‘back to back’ borrowing etc.
– It is expected that there will be no law contradictions between the EU and Cyprus as Notional Interest Deduction has already been applied with success in the other Member States.
Since the Cyprus companies have the right to use and enjoy the interest received unconstrained, other countries could not argue that the Cyprus Company is not the beneficial owner. Therefore the treaties between Cyprus and foreign countries apply.
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